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Table of Contents

 

 

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

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 0-29092

 

 

PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   54-1708481

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

7901 Jones Branch Drive, Suite 900, McLean, VA   22102
(Address of principal executive offices)   (Zip Code)

(703) 902-2800

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

None   N/A

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.001 per share

Contingent Value Rights

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    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  ¨    No  x

Indicate by 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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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  ¨    No  ¨

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 registrants’ 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. (Check one):

 

Large accelerated filer  ¨    Accelerated filer  ¨
Non-accelerated filer  ¨ (Do not check if a smaller reporting company)    Smaller reporting company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

Non-affiliates of Primus Telecommunications Group, Incorporated held 119,500,670 shares of Common Stock as of June 30, 2009. The fair market value of the stock held by non-affiliates is $1,792,510 based on the sale price of the shares on June 30, 2009.

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  x    No  ¨

As of March 31, 2010, 9,743,157 shares of Common Stock, par value $.001, were outstanding.

Documents Incorporated by Reference:

Portions of the definitive Proxy Statement to be delivered to Stockholders in connection with the Annual Meeting of Stockholders are incorporated by reference into Part III.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

Item

  

Description

   Page
Part I

1.

  

Business

   3

1A.

  

Risk Factors

   26

1B.

  

Unresolved Staff Comments

   40

2.

  

Properties

   40

3.

  

Legal Proceedings

   41

4.

  

(Removed and Reserved)

   41
Part II

5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    42

6.

  

Selected Financial Data

   44

7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   47

7A.

  

Quantitative and Qualitative Disclosures about Market Risk

   74

8.

  

Financial Statements and Supplementary Data

   75

9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   76

9A.

  

Controls and Procedures

   76

9B.

  

Other Information

   77
Part III

10.

  

Directors, Executive Officers and Corporate Governance

   78

11.

  

Executive Compensation

   78

12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    78

13.

  

Certain Relationships and Related Transactions, and Director Independence

   78

14.

  

Principal Accountant Fees and Services

   79
Part IV

15.

  

Exhibits and Financial Statement Schedule

   80

 

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PART I

 

ITEM 1. BUSINESS

General

We are an integrated facilities-based communications services provider offering a portfolio of international and domestic voice, wireless, Internet, VoIP, data and data center services to customers located primarily in the United States Australia, Canada, Brazil, the United Kingdom and western Europe. Our primary markets are Australia and Canada where we have deployed significant network infrastructure. We classify our services into three categories: Growth Services, Traditional Services and Wholesale Services. Our focus is on expanding our Growth Services, which includes our broadband, IP-based voice, local, wireless, data and data center services, to fulfill the demand for high quality, competitively priced communications services. This demand is being driven, in part, by the globalization of the world’s economies, the global trend toward telecommunications deregulation and the migration of communication traffic to the Internet. We manage our Traditional Services, which includes our domestic and international long-distance voice, prepaid cards, dial-up Internet services and Australian off-network local services for cash flow generation that we reinvest to develop and market our Growth Services, particularly in our primary markets of Australia and Canada. We provide our wholesale voice termination services to other telecommunications carriers and resellers requiring IP or time-division multiplexing access.

Through our increased investments in sales and marketing spending focused on our Growth Services we believe that over time our growth in revenue from Growth Services will exceed the decline in our revenue from Traditional Services and Growth Services will increase as a percentage of our total retail revenue.

We target customers with significant telecommunications needs, including SMEs, multinational corporations, residential customers, and other telecommunication carriers and resellers. We provide services over our global, facilities-based network, which consists of:

 

   

10 data centers in 8 cities in Canada, Australia, and Brazil

 

   

18 carrier-grade international gateway and domestic switching systems (the hardware/software devices that direct voice traffic across the network), Internet routers and media gateways in the U.S., Canada, western Europe and the Asia-Pacific region;

 

   

approximately 500 interconnection points to our network, or POPs, which includes DSLAMs, which is equipment that allows digital traffic to flow over copper wiring, within our service regions and other markets;

 

   

undersea and land-based fiber optic transmission line systems that we own or lease and that carry voice and data traffic across the network;

 

   

a global network that uses a high-bandwidth network standard ATM+IP; and

 

   

a global VoIP network based on routers and gateways with an open network architecture which connects our partners in over 150 countries.

Our Services

Within our three main service categories, Growth Services, Traditional Services and Wholesale Services, we offer our customers a wide range of products, including:

Growth Services:

   

data center services (colocation and managed services).

 

   

Internet, including business and residential broadband services;

 

   

residential and business VoIP services through SIP and hosted IP-PBX;

 

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local services;

 

   

wireless Mobile Virtual Network Operator (MVNO) services; and

 

   

data, including frame relay.

Traditional Services:

 

   

domestic and international long-distance voice services;

 

   

prepaid phone card services;

 

   

local landline services in Australia that do not utilize our owned network (or “off-net” or “off-network” services); and

 

   

dial-up Internet services.

Wholesale Services:

 

   

Internet-based protocol and time-division multiplexing wholesale access and transport.

We continue to selectively target growth opportunities in areas of growing demand for telecommunications, including broadband, VoIP, local, wireless, data and data hosting center services. In order to accomplish this objective, we have sought, and continue to seek to:

 

   

manage our Traditional Services business for cash flow generation and prudently reinvest that cash flow in additional sales and marketing spending to gain market share, develop innovative and differentiated services, expand coverage and capacity of our existing network infrastructure to service new customers and to migrate existing customers onto our network and meeting our debt service obligations;

 

   

prudently expand Growth Services through our enhanced sales and marketing programs in order to steadily improve net revenue and contribution from these Growth Services; and

 

   

make targeted and prudent investments in support systems intended to reduce customer churn and customer service costs.

Strategy

We have refocused our strategy and efforts to enhance the revenue growth from our Growth Services while managing the decline in revenue from our Traditional Services. Key elements of our strategy to achieve these objectives are the following:

 

   

Capitalize on our competitive position in our primary markets to expand Growth Services revenue. We have refocused efforts to transition away from our traditional businesses of domestic and international long-distance voice, prepaid cards and dial-up Internet services to an integrated provider of broadband, VoIP, local, wireless, data and data center services. We believe there is strong demand for high quality, competitively priced communications services that is being driven by the globalization of the world’s economies, the global trend toward telecommunications deregulation and the migration of communication traffic to the Internet. We believe that we can capitalize on this demand given our competitive position by offering bundled communications services at attractive prices, particularly where we have a competitive cost structure as a result of our facilities-based network. We are leveraging our brand recognition, network infrastructure and existing customer base in Australia and Canada where we have competitive operations by virtue of our scale to bundle Growth Services and capture new customers.

 

   

Focus on our primary markets of Australia and Canada where we have established brand-recognition. We are focused on our primary markets of Australia and Canada where we believe we have the

 

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scalability and service offerings to effectively compete. For the year ended December 31, 2009, net revenues from our Australia and Canada operations, collectively, generated approximately 57% of our total net revenues and 78% of our total retail net revenue. We are focused on making prudent and effective investments in Australia and Canada where we believe that these markets present us with the highest potential for future growth. Supporting our strategy, during the year ended December 31, 2009 we spent in excess of 90% of our total capital expenditures in our primary markets of Australia and Canada. Our target customer base consists of SMEs, multinational corporations and residential customers.

 

   

Bundle traditional voice services with growth products to increase margins and create customer loyalty. By bundling our traditional long-distance voice services with one or more of our local, broadband, wireless, data and data center services, combined with a prudent increase in sales and marketing investment, we seek to increase net revenue per customer and improve our competitive ability to attract and retain additional new business and residential customers.

 

   

Leverage our global facilities-based network infrastructure. We have a significant amount of capital already invested in our global, voice and data network and our product capabilities and we are making additional investments in support of our Growth Services. By increasing the volume of voice and data traffic that we carry over our network, we are able to reduce transmission costs and other operating costs as a percentage of net revenue and enhance our ability to introduce new products and services with more efficient capital expenditures through utilization of available network capacity. In addition, by leveraging multiple customer segments in different geographical regions, including retail and carrier customers, we achieve greater utilization of our network assets, because our network experiences multiple periods of peak usage throughout each day. We are committed to migrating existing customers to our owned facilities (or “on-net”) that in most instances generate significantly higher margins than off-network customers.

 

   

Retail portfolio optimization. Given our retail focus in our primary markets of Australia and Canada where we have extensive operations, we believe there should be opportunities to optimize our remaining retail portfolio to accomplish our strategic objective of positioning us in Growth Services. We will opportunistically assess our alternatives to optimize the economic return from such on-going portfolio restructuring efforts.

 

   

Manage Traditional Services for cash flow which we will reinvest into our Growth Services and use to reduce our debt. The overall market for domestic and international long-distance voice, prepaid cards and dial-up Internet services continues to decline in favor of Internet-based, wireless and broadband communications. To mitigate this revenue decline and preserve cash flow, we focus on customer retention by bundling services, enhancing the customer service experience, and by prudently investing in effective marketing campaigns. For the year ended December 31, 2009, Traditional Services comprised 43% of total net revenue. To further manage cash flow from Traditional Services, we will continue to explore and implement outsourcing or off-shoring options for our non-sales and marketing operations in order to lower costs, improve coordination among our business units to deliver synergy savings and run an aggressive cost management program. We seek to redeploy associated savings and resulting available cash flow into sales and marketing activities for our Growth Services.

2009 Voluntary Reorganization under Chapter 11

On March 16, 2009, Primus Telecommunications Group, Incorporated (“Group” or “PTGI”) and three of its non-operating holding company subsidiaries, Primus Telecommunications Holding, Inc. (“Holding” or “PTHI”), Primus Telecommunications International, Inc. (“PTII”) and Primus Telecommunications IHC, Inc., (“IHC” and together with Group, Holding and PTII, collectively, the “Holding Companies”) each filed a voluntary petition in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) for reorganization relief (“Reorganization”) under chapter 11 of title 11 of the United States Code, 11 U.S.C. §§ 101 et seq., as amended (the “Bankruptcy Code”).

 

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None of Group’s operating companies in the United States, Australia, Canada, India, Europe and Brazil were included in the Bankruptcy Court filing. These operating units continued to manage and to operate their businesses normally during the financial reorganization of the Holding Companies.

The consensual plan of reorganization (the “Plan” or “Plan of Reorganization”) was confirmed by the Bankruptcy Court on June 12, 2009 (the “Confirmation Date”). On July 1, 2009 (the “Effective Date”), the Holding Companies consummated their reorganization under the Bankruptcy Code and the Plan became effective. Upon our emergence under the Plan of Reorganization on July 1, the Holding Companies’ principal debt was reduced by $316 million, or over 50%, interest payments were reduced by over 50% and certain debt maturities were extended. For additional detail concerning the effects of the Plan of Reorganization, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Emergence from Voluntary Reorganization under Chapter 11 Proceedings.

Operating Segments

We operate our business segments through a corporate shared services model and through operating segment managers responsible for specific geographic regions in which we operate. We assess performance and allocate resources based on the following operating segments:

Australia. Our Australian operations represented 30% of our net revenue for the year ended December 31, 2009. We believe we are the fourth largest full-service provider in Australia, based upon net revenue. Our Australian operations offers a comprehensive range of international and domestic long-distance voice, broadband and dial-up Internet, wireless, local, VoIP, data and data hosting center products, servicing both residential and business sectors. Our network employs Nortel DMS-100 telephone exchanges in Sydney, Melbourne, Brisbane, Perth and Adelaide operating through 66 POPs to provide national coverage for voice services. We operate a prepaid calling platform as well as a platform for delivery of enhanced toll-free service. The voice network supports direct access integrated services digital network (“ISDN”) and telephone line services across Sydney, Melbourne, Brisbane, Perth and Adelaide and some select regional areas of the country. VoIP services are offered to business and consumer customers using softswitch platforms operating in Sydney and Melbourne. Primus Australia owns a national IP network for delivery of business and consumer Internet service. Dial-up Internet is available nationally under a single access code. DSL service is provided on-net through 252 Primus DSLAMs and via wholesale DSLAM access providing reach to more than 400 exchanges nationally. The DSLAMs are capable of delivering a full suite of telecommunication products including asymmetric and symmetric IP services, telephone line, ISDN, frame relay and ATM. Primus Australia offers ATM, frame relay, IP virtual private networking (“VPN”) with quality of service (“QoS”) and managed routers. Metropolitan fiber networks exist in Sydney, Melbourne, Brisbane, Perth and Adelaide to provide high capacity backhaul for domestic carrier interconnects, DSLAM backhaul and fiber connectivity to select customer premises.

A data center in Melbourne offers managed hosting, colocation, and e-commerce applications. Our data center in Sydney is primarily used for colocation services. The Company plans to add growth capacity to these locations in 2010.

We market our services primarily through a combination of direct sales to independent agents, corporate and SME customers, internet based marketing aimed at residential customers, and telemarketing and media advertising aimed at residential customers.

We operate a call center in Melbourne that services all of Australia. We employ staff in Sydney who run our Australian network management center that operates seven days per week, 24 hours per day, 365 days per year.

Canada. Our Canadian operations represented 27% of net revenue for year ended December 31, 2009. We believe we are the largest alternative consumer service providers in Canada based on net revenue. We provide international and domestic long-distance voice, local, broadband and dial-up Internet, data and data center services, VoIP and wireless services to SMEs, residential customers and government agencies. We have sales and customer service offices in key cities throughout Canada, including Vancouver, Toronto, Ottawa, Calgary

 

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and Edmonton. We operate international gateway switches in Toronto and Vancouver and a nationwide SS7 network with signal transfer points (“STPs”) in Vancouver and Toronto. We maintain POPs in all major cities in Canada, and have use of a nationwide integrated network backbone for our voice, data, Internet and private line services. Each of the 24 nodes on the backbone is equipped with synchronous optical networking (“SONET”) add/drop, ATM, and IP equipment to provide a complete spectrum of voice and data communications products to our customers. In September 2009, we signed a new contract with Rogers Wireless Partnership which will significantly expand our coverage area and provide increased wireless data functionality to customers for future smart phone offerings. Additionally, we operate one Nortel DMS 500 switch in Toronto and next generation IP voice switches in Toronto, Vancouver, Montreal, Ottawa, London and Edmonton which provide on-net equal access coverage to an estimated 90% of the population of Canada. Together with and through a competitive local exchange carrier (“CLEC”) partner, we are co-located at 70 incumbent local exchange carriers (“ILECs”) central offices to provide DSL services, T1 access, network interconnection and local dial-tone. We operate a voice dial access network which consists of 70 POPs across the country.

We also own and operate a total of seven data centers in five major cities in Canada: two data centers in Ottawa (totaling 30,000 square feet), two data centers in Toronto (totaling 16,000 square feet), a 18,000 square foot data center in London, Ontario, a 6,000 square foot data center in Edmonton, Alberta and a 3,000 square foot data center in Vancouver through which we offer colocation, managed hosting, storage and other value added services. We have an extensive Internet network and we believe that we provide dial-up and ISDN Internet coverage to over 700 communities across Canada through a network of 51 POPs.

We market our services primarily through a combination of direct sales to independent agents, corporate and SME customers, internet based marketing aimed at residential customers, and telemarketing and media advertising aimed at residential customers.

Wholesale. Our Wholesale operations represented 26% of our net revenue for the year ended December 31, 2009. Our Wholesale business segment provides domestic and international minute transport and termination services and targets a diverse customer base including Tier 1 international carriers, multi-national carriers, wireless providers, VoIP providers, cable companies and ISPs.

United States. Our U.S. operations represented 8% of our net revenue for the year ended December 31, 2009. In the U.S., we provide international and domestic voice, data, broadband, hosted IP-PBX, SIP trunking and VoIP services to SMEs and residential customers. We operate international gateway telephone switches in the New York City area, Los Angeles, and Miami which are connected with Canada and countries in Europe, Latin America and the Asia-Pacific region through owned and leased international fiber cable systems. We have deployed intelligent softswitch architecture to our gateways in New York, Los Angeles and Miami. We lease and own domestic fiber in the U.S. to interconnect our switches, data centers, and POPs. We use a direct sales organization to sell to business customers. Our direct sales personnel offer business customers voice and hosted IP-PBX services. See “—Sales and Marketing; Direct Sales Force.” To reach residential customers, we advertise in national and regional newspapers, other publications, and television channels whose market targets are expatriates, to offer competitive rates for international and domestic telephone calls, data, Internet and VoIP services. We have telemarketing centers in Florida and Iowa. We also sell retail VoIP services through Web-based on-line interactive marketing. We utilize independent agents to reach and enhance sales to both business and residential customers. We maintain customer service centers in Florida, Virginia and Iowa and also outsource selected customer service functions. We operate a 24-hour global network management control center in India which monitors our global voice, Internet and data traffic. Additionally, we offer local and long-distance voice, and DSL services to SMEs in Puerto Rico.

Europe. We operate as a licensed service provider in the United Kingdom, France, Spain, Italy, Belgium and the Netherlands. The European market represents 7% of our net revenue for the year ended December 31, 2009. Our network consists of voice/data switches in London, Paris, Milan and Madrid and an Internet router in Frankfurt. Our European network interconnects with our global network. We have data centers for hosting and related services in London and Paris.

 

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Our European operations are headquartered in London. We provide voice, data, wireless and hosted PBX services to residential customers, SMEs and callshops. We market our services across Europe using a combination of a direct sales force, independent sales agents and direct media advertising.

Brazil. Our Brazilian operations, headquartered in São Paulo, represented 2% of our net revenue for the year ended December 31, 2009. Our Brazilian business segment primarily consists of data hosting center services and retail and wholesale VoIP services.

Network

General. We operate a global telecommunications network consisting of traditional and next-generation international gateway and domestic switches and related peripheral equipment, carrier-grade routers and switches for Internet and data services, data hosting and co-location centers, and undersea and trans-continental fiber optic cable systems. To ensure high-quality communications services, our network employs digital switching and fiber optic technologies, incorporates the use of SS7/C7 signaling, and is supported by comprehensive network monitoring and technical support services.

Switching Systems. Our network makes use of 18 carrier-grade domestic and international gateway switch systems, Internet routers and media gateways throughout the North America, Europe, and Asia-Pacific regions.

The locations and types of our switching systems are as follows:

 

Location

  

Type of Switch

New York City area (two locations)

   International Gateway

Los Angeles

   International Gateway

Toronto

   International Gateway

Vancouver

   International Gateway

London

   International Gateway

Paris

   International Gateway

Sydney

   International Gateway

Milan

   International Gateway

Madrid

   International Gateway

Hong Kong

   International Gateway

Miami

   Internet Peering POP

Frankfurt

   Internet Peering POP

Makati City

   Internet Peering POP

Adelaide

   Domestic

Brisbane

   Domestic

Melbourne

   Domestic

Perth

   Domestic

We also operate a global VoIP network with an open network architecture which connects with our partners in over 150 countries through the use of open settlement protocol.

Fiber Optic Cable Systems. We have purchased and leased undersea and land-based fiber optic cable transmission capacity to connect our various switching systems. We either lease lines on a term basis for a fixed cost or purchase economic interests in transmission capacity through minimum assignable ownership units or indefeasible rights of use to international traffic destinations.

Throughout the previous years we have purchased or acquired through acquisitions various oceanic fiber capacity and land based capacity. This capacity along with leased fiber capacity allows our switching platforms in our operating units to be connected and pass voice and data traffic.

 

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Foreign Carrier Agreements. In selected countries where competition with the traditional Post Telegraph and Telecommunications companies (“PTTs”) is limited, we have entered into foreign carrier agreements with PTTs or other service providers which permit us to provide traffic into and receive return traffic from these countries.

Network Management and Control. We own and operate network management control centers in Toronto, Canada; London, England; New Delhi, India; and Sydney, Australia, which are used to monitor and control our switching systems, global data network, and other digital transmission equipment used in our network. These network management control centers operate seven days per week, 24 hours per day, 365 days per year.

Network for Data and Internet Services. We have built an Internet backbone network that enables our global network to carry Internet and data traffic for our business, residential, carrier and ISP customers. This network uses packet switched technology, including IP and ATM. This network allows us to offer to customers data and voice communications services, including, dial-up, broadband and dedicated Internet access, hosting, e-commerce, managed VPN services, VoIP, ATM and frame relay data services.

Data Centers. We offer world-class data center facilities with advanced 24 hours per day, 365 days per year customer access, onsite engineering support and help desk services; dedicated HVAC and environmental control systems; multi-stage fire suppression systems; uninterruptible power supply and backup generator; redundant data connections and services; routing and switching; shared and secure rack space; physical access technologies and practices; closed-circuit television and video security systems; and 24 x 7 building system and network monitoring. Our Australian data center facilities in Melbourne and Sydney occupy approximately 15,000 square feet. Canada offers national data center coverage with locations in Toronto, Vancouver, Edmonton, London, and Ottawa, with a total combined square footage of 73,000 square feet. Additionally, we own a data center facility in Brazil.

Customers

Our residential customers are attracted to us because of competitive pricing as compared to traditional carriers and responsive customer service and support. We offer VoIP, broadband and dial-up Internet access, local access and wireless products to our residential customers in select markets. We are expanding our local and broadband offerings to additional markets and bundling them with traditional voice services.

Our business sales and marketing efforts primarily target SMEs with data, voice, internet and managed hosting needs. We also target large multinational businesses.

We compete for the business of other telecommunications carriers and resellers primarily on the basis of price, service quality and presence. Sales to other carriers and resellers help us to negotiate better termination costs for our retail business units and increase the utilization of our network, thereby reducing our fixed costs per minute of use, as well as permitting our network to be interconnected with other major carriers to provide global coverage.

No single customer accounted for greater than 10% of net revenue for the year ended December 31, 2009 or for the year ended December 31, 2008.

Sales and Marketing

We market our services through a variety of sales channels, as summarized below:

 

   

Direct Sales Force. Our direct sales force is focused on business customers, including multinational businesses and international governmental organizations. They are engaged in generating new accounts and in the retention of current customers and cross selling products to current customers. A variety of products are utilized to maximize the customer’s lifecycle, based on the customers current product mix.

 

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Direct sales personnel are generally compensated with a base salary plus commissions. We have sales offices in Edmonton, Calgary, Toronto, Vancouver, Ottawa, London, Glasgow, Paris, Adelaide, Brisbane, Melbourne, Perth, Sydney, Sao Paulo, Chicago and Tampa. In addition, we maintain a direct sales team which exclusively sells services to wholesale customers including other telecommunications carriers and resellers.

 

   

Independent Sales Agents. We also sell our services through independent sales agents and representatives, who typically focus on SMEs and residential consumers. An agent receives commissions based on revenue generated by customers obtained for us by the agent. The agents are nonexclusive to us and we require our agents and representatives to maintain minimum revenues.

 

   

Telemarketing. We employ full-time and part-time inbound and outbound telemarketing sales personnel, and we selectively outsource certain telemarketing functions to supplement sales efforts targeted at residential and small business customers.

 

   

Direct Marketing. We use a variety of print, television and radio advertising to increase name recognition and generate new customers. We reach potential customers by advertising in newspapers and on select radio and television programs.

 

   

Web-based Marketing. We use a variety of web-based tools, including search marketing, banner ads and pop-up windows to target Internet users who prefer to purchase and research their purchase decisions on-line.

 

   

Third Party Distribution Agreements and Affinity Channels. Through use of the Primus brand, we have been able to establish relationships to market our services through external retailers, manufacturers, affinity and preferred partnerships and programs. These relationships allow us to increase awareness of our services among customers and reduce the cost of customer acquisition.

Management Information and Billing Systems

We operate various management information, network and customer billing systems in our different operating subsidiaries to support the functions of network and traffic management, customer service and customer billing. For financial reporting, we consolidate information from each of our markets into a single database. For our billing requirements we use several systems developed in-house as well as a few third party systems.

We believe that our financial reporting and billing systems are generally adequate to meet our business needs. We continually consider and evaluate whether our financial reporting and billing systems are generally adequate to meet our business needs, and in the future, we may determine that we need to invest additional capital to purchase hardware and software, license more specialized software and increase our capacity.

Competition

Voice

The telecommunications industry is highly competitive and significantly affected by regulatory changes, marketing and pricing decisions of the larger industry participants and the introduction of new services made possible by technological advances. We believe that long-distance service providers compete on the basis of price, customer service, product quality and breadth and bundling of services offered. In each country of operation, we have numerous competitors including wireline, wireless, VoIP and cable competitors. We believe that as the international telecommunications markets continue to deregulate, competition in these markets will increase. Prices for long-distance voice calls in the markets in which we compete have declined historically and are likely to continue to decrease. In addition, many of our competitors are significantly larger, have substantially greater financial, technical and marketing resources, larger networks and more products for bundling.

 

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Privatization and deregulation have had, and are expected to continue to have, significant effects on competition in the industry. For example, as a result of legislation enacted in the U.S., regional bell operating companies (“RBOCs”) entered the long-distance market; long-distance carriers have entered the local telephone services market; and cable television companies and utilities are allowed to enter both the local and long-distance telecommunications markets. Consolidation among these large companies is also occurring, which could change the dynamics of pricing and marketing. In addition, competition has begun to increase in the European Union (“EU”) communications markets in connection with the deregulation of the telecommunications industry. In addition, alternatives to wireline services, such as wireless and VoIP services, are significant competitive threats. This increase in competition adversely affects net revenue per minute and usage of traditional wireline services, and these trends are expected to continue.

The following is a brief summary of the competitive environment in our principal service regions:

United States. In the U.S., which is among the most competitive and deregulated long-distance markets in the world, competition is based on pricing, customer service, network quality and the ability to provide value-added services and the bundling of services. AT&T, Inc. and Verizon Communications, Inc. are the largest suppliers of long-distance services. Wireless carriers have gained significant ground particularly in the domestic long-distance markets, and VoIP cable-based service providers present a growing source of competition.

Australia. Australia is one of the most deregulated and competitive communications markets in the Asia-Pacific region. Our principal competitors in Australia are Telstra, the dominant carrier, SingTel Optus Pty Limited, iiNet Limited, SP Telemedia Limited (known as TPG) and AAPT, an affiliate of Telecom New Zealand. Repeated pricing threats and actions by Telstra present serious competitive challenges (see “Regulation—Australia”). In September, 2009, the Australian government has proposed the separation of Telstra’s wholesale and retail arms in order to promote more competition and better prices.

Canada. The Canadian communications market is highly competitive and is dominated by a few established carriers whose marketing and pricing decisions have a significant impact on the other industry participants, including us. In residential markets, we compete with each of the incumbent telecommunication companies (of which the largest are those owned by Bell Canada in eastern Canada, and TELUS and MTS Allstream, Inc. in western Canada) in their respective territories and the large cable companies, including Rogers and Shaw Communications Inc., who have launched their telecom service portfolio. We also compete against smaller resellers. In the highly competitive business market, we compete with Bell Canada and TELUS, who are both expanding beyond their traditional territories and competing with each other across the country, and with the national division of MTS Allstream, Inc., Rogers, Shaw Communications, Inc. and other smaller carriers, including Bragg Communications Inc., COGECO Inc. and Quebecor Inc. Major wireless carriers are also a significant source of competition. In 2008 the CRTC conducted a review of the regulatory framework for wholesale services and the definition of essential services. See “Regulation—Canada.”

United Kingdom. Our principal competitors in the United Kingdom are BT Group plc, the dominant provider of telecommunications services in the United Kingdom, ntl:Telewest Business, Carphone Warehouse Group plc, Cable & Wireless plc, Colt Telecom Group S.A. and MCI/Verizon Communications Inc. Major wireless carriers are also a significant source of competition.

Internet and Data

The market for Internet services and data services is extremely competitive. We anticipate that competition will continue to intensify. Our current and prospective competitors offering these services include national, international, regional and local ISPs, web hosting companies, other long-distance and international long-distance telecommunications companies, local exchange carriers (“LECs”), cable television, direct broadcast satellite, wireless communications providers and on-line service providers. Many of these competitors have significantly greater resources, product portfolios, market presence and brand recognition than we do.

 

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Government Regulation

We are subject to varying degrees of regulation in each of the jurisdictions in which we operate. Local laws and regulations, and the interpretation of such laws and regulations, differ among those jurisdictions. There can be no assurance that (1) future regulatory, judicial and legislative changes will not have a material adverse effect on us; (2) domestic or international regulators or third parties will not raise material issues with regard to our compliance or noncompliance with applicable regulations; or (3) regulatory activities will not have a material adverse effect on us.

Regulation of the telecommunications industry continues to change rapidly both domestically and globally. Privatization, deregulation, changes in regulation, consolidation, and technological change have had, and will continue to have, significant effects on competition in the industry. Over time we have become subject to increasing competition in all of the markets in which we operate, and we expect such increases in competitive pressure to continue. Although we believe that continuing deregulation with respect to portions of the telecommunications industry will create opportunities for firms such as us, there can be no assurance that deregulation and changes in regulation will be implemented in a manner that would benefit us.

The regulatory frameworks in certain jurisdictions in which we provide services are described below:

United States

In the U.S., our services are subject to the provisions of the Communications Act, the FCC’s regulations, and the applicable laws and regulations of the various states.

Certain of our services (our “telecommunications services”) constitute common carrier offerings subject to Title II of the Communications Act and associated FCC regulations and similar state laws. Among other things, these requirements impose an obligation to offer service on a nondiscriminatory basis at just and reasonable rates, and to obtain regulatory approval prior to withdrawing from the provision of regulated services, to any assignment of authorizations, or to any transfer of legal or actual control of the company.

Our interstate telecommunications services are subject to various specific common carrier telecommunications requirements set forth in the Communications Act and the FCC’s rules, including operating, reporting and fee requirements. Both federal and state regulatory agencies have broad authority to impose monetary and other penalties on us for violations of regulatory requirements.

International Service Regulation. The FCC has jurisdiction over common carrier services linking points in the U.S. to points in other countries. We provide such services. Providers of such international common carrier services must obtain authority from the FCC under Section 214 of the Communications Act. We have obtained the authorizations required to use, on a facilities and resale basis, various transmission media for the provision of international switched services and international private line services on a non-dominant carrier basis. The FCC is considering a number of possible changes to its rules governing international common carriers. We cannot predict how the FCC will resolve those issues or how its decisions will affect our international business. FCC rules permit non-dominant carriers such as us to offer some services on a detariffed basis, where competition can provide consumers with lower rates and choices among carriers and services. With some exceptions, current FCC rules require facilities-based U.S. carriers, like us, with operating agreements with dominant foreign carriers, to abide by the FCC’s International Settlements Policy by following uniform accounting rates, an even split in settlement rates, and proportionate return of traffic, for agreements with carriers on certain routes. U.S. carrier arrangements with non-dominant foreign carriers or on a substantial number of international routes where competition exists are not subject to these requirements. We may take advantage of these more flexible arrangements with non-dominant foreign carriers, and the greater pricing flexibility that may result, but we may also face greater price competition from other international service carriers.

 

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Domestic Service Regulation. With respect to our domestic U.S. telecommunications services, we are considered a non-dominant interstate carrier subject to regulation by the FCC. We are not required to obtain FCC authority to initiate or expand our domestic interstate operations, but we may be required to obtain FCC approval to assume control of another telecommunications carrier or its assets, to transfer control of our operations to another entity, or to discontinue service. We are also required to file various reports and pay various fees and assessments to the FCC and various state commissions. Among other things, interstate common carriers must offer service on a nondiscriminatory basis at just and reasonable rates. The FCC has jurisdiction to hear complaints regarding our compliance or non-compliance with these and other requirements of the Communications Act and the FCC’s rules, including, for example, alleged unauthorized changes in a customer’s preferred carrier. We are also subject to CALEA and associated FCC regulations which require telecommunications carriers and VoIP providers to configure their networks to facilitate law enforcement authorities to perform electronic surveillance; to the Do-Not-Call Registry and related restrictions set out the specific parameters for telemarketing solicitation and prohibit outbound telemarketing in some circumstances; and to the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003, which places certain restrictions on commercial electronic mail messages.

Normally our long-distance customers, and the recipients of calls from our customers, do not connect directly to our network but, instead, are connected to our network by means of the local facilities of LECs, which impose regulated charges on us, called switched access charges, to originate and terminate calls over their local facilities. FCC rules cap these charges, and, in the case of incumbent LECs, impose additional restrictions on their ability to change their charges. The FCC may modify its rules regarding LEC access charges, including both the caps and the restrictions on incumbent LECs, which could result in an increase in our termination and origination costs over time.

Interstate telecommunications carriers and VoIP providers are required to contribute to the federal USF. The FCC is considering revising its USF mechanisms and the services considered when calculating the USF contribution. We cannot predict the outcome of these proceedings or their potential effect on our USF contributions. Some changes to the USF under consideration by the FCC may affect different entities more than others, and we may be disadvantaged as compared to our competitors as a result of FCC decisions regarding USF. In addition, the FCC may extend the obligation to contribute to the USF to certain services that we offer but that are not currently assessed USF contributions.

Voice-over-Internet Protocol (VoIP). VoIP services that permit subscribers to send calls to and receive calls from the traditional telephone network, known as interconnected VoIP services, are generally subject to the regulatory authority of the FCC. We offer such services. For many years the FCC has been considering whether to classify such services as “telecommunications” services or “information” services under the Communications Act. Information services are generally subject to less regulation than telecommunications services. However, the FCC has extended a number of regulatory obligations normally applicable to telecommunications services to VoIP services, irrespective of the lack of clarity regarding the classification of such services. These include (1) the obligation to contribute to the USF; (2) the obligation to comply with CALEA; (3) the obligation to comply with the FCC’s rules regarding protecting CPNI; (4) the obligation to provide E911 services, and to disclose limitations on such services to end users; (5) the obligation to permit customers to keep their telephone number when changing from one carrier to another; (6) the obligation to deploy equipment and provide services that make reasonable accommodations for the needs of disabled persons; and (7) the obligation to pay a variety of regulatory fees. We cannot predict what other regulatory obligations, if any, will be imposed on our VoIP operations, nor can we predict whether the FCC will eventually classify VoIP as a telecommunications service and, if it does, what additional regulatory obligations, if any, the FCC would choose to impose on such services. The uncertainty regarding the regulatory obligations applicable to interconnected VoIP services presents a number of situations which could have a material negative impact on our operating costs and profitability. These potential regulatory developments include:

 

   

The FCC has ruled that a certain type of interconnected VoIP service is interstate in nature, and not subject to most state-level public utility regulations. We believe that our own VoIP service is subject to

 

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this ruling, but individual states may nonetheless attempt to regulate that service. We cannot predict whether any individual states would make such an effort, nor can we predict the outcome of any such effort.

 

   

While we believe that our VoIP network is in compliance with the requirements of CALEA, we cannot predict whether law enforcement or the FCC will agree, nor can we predict whether we may be subject to fines or penalties if we are found to be not in compliance with CALEA.

 

   

With respect to our VoIP-related 911 obligations, we have contracted with a third-party provider that is a market leader in emergency 911 service solutions to provide these services. Our ability to expand our VoIP services in the future may depend on the ability of that provider to provide E911 access or on any additional 911-related obligations the FCC may impose. At present, and similar to many other VoIP providers, for some of our customers we cannot offer VoIP E911 services that route emergency calls in a manner fully consistent with the FCC rules. We are addressing this issue with our VoIP E911 solutions provider. The FCC may determine that our VoIP E911 solution for some of our customers does not satisfy the FCC’s requirements, in which case the FCC could require us to disconnect a significant number of our VoIP subscribers, which could have a material adverse effect on the Company’s financial position, results of operations and cash flows. In addition, the FCC is considering whether it should impose additional VoIP E911 obligations on interconnected VoIP providers including consideration of a requirement that interconnected VoIP providers automatically determine the physical location of their customer rather than allowing customers to manually register their location. We cannot predict the outcome of this proceeding, nor its impact on us, at this time.

 

   

The FCC’s CPNI rules, to which our VoIP operations are subject, are intended to protect customer information from unauthorized use or disclosure. Those rules currently require us to use enhanced passwords for customer on-line and call-in access to CPNI and account information, as well as customer notification of account or password changes. Complying with these rules may impose additional costs on us and reduce our profitability or cause us to increase the retail price for our services. We may be subject to enforcement actions including, but not limited to, fines, cease and desist orders, or other penalties if we are not able to comply with these new CPNI obligations.

 

   

Section 255 of the Communications Act and associated FCC rulings require traditional phone providers and manufacturers of associated equipment to ensure that their equipment and services meet certain obligations regarding access by persons with disabilities. The FCC has extended those requirement to providers of interconnected VoIP services and to manufacturers of specially designed equipment used to provide those services. While we believe that we are in compliance with these requirements, we can have no assurance that the FCC might not find us not to be in compliance, which could subject us to sanctions including fines.

 

   

The FCC has also extended to VoIP providers the obligations of Section 225 of the Communications Act, which (among other things) requires contributing to the Telecommunications Relay Services fund, and the offering of 711 abbreviated dialing for access to relay services. At this time, we cannot predict the impact of these rules on our business or our ability to comply with these obligations, and we may be subject to enforcement actions including, but not limited to, fines, cease and desist orders, or other penalties if we are not able to comply with them. For example, the FCC mandates that interconnected VoIP providers like us must transmit 711 calls to a relay center that facilitates the ability of speech- and hearing-impaired individuals to communicate. The FCC issued a temporary waiver of that requirement insofar as it requires such providers to transmit the 711 call to an “appropriate relay center,” meaning the relay center(s) serving the state in which the caller is geographically located or the relay center(s) corresponding to the caller’s last registered address. We are currently not able to route such calls in this manner, but we are working on implementing a call routing solution which will route 711 calls to the appropriate relay center as defined in the FCC’s order. We may be subject to enforcement actions including, but not limited to, fines, cease and desist orders, or other penalties if we are not able to comply with these new disability provisions.

 

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The FCC now requires interconnected VoIP service providers like us to pay regulatory fees to the FCC. The assessment of these fees has increased our costs and reduced our profitability and caused us to increase the price of our retail service offerings.

State Regulation. Traditional long-distance calls for which the caller and recipient are both located in the same state are subject to regulation by that state. Our intrastate long-distance operations are therefore subject to various state laws and regulations, including, in most jurisdictions, certification and tariff filing requirements. Primus Telecommunications, Inc. (“PTI”), our principal operating subsidiary in the U.S., maintains the necessary certificate and tariff approvals, to provide intrastate long-distance service in 49 states and Puerto Rico. PTI also maintains the necessary certificate to provide local services in Puerto Rico. Certain of our other subsidiaries also maintain certificates and tariffs in some states. Some states also require the filing of periodic reports, the payment of various fees and surcharges and compliance with service standards and consumer protection rules. States often require prior approval or notification for certain stock or asset transfers or, in several states, for the issuance of securities, debt or for name changes. As a certificated carrier, consumers may file complaints against us at the public service commissions. Certificates of authority can generally be conditioned, modified, cancelled, terminated, or revoked by state regulatory authorities for failure to comply with state law and/or rules, regulations and policies of the state regulatory authorities. Fines and other penalties also may be imposed for such violations. Public service commissions also regulate access charges and other pricing for telecommunications services within each state. The RBOCs and other LECs have been seeking reduction of state regulatory requirements, including greater pricing flexibility which, if granted, could subject us to increased price competition. We may also be required to contribute to universal service funds in some states.

State Taxes and Fees Applicable to VoIP Services. In general, we do not collect or remit state or municipal taxes (such as sales and use, excise, utility user, and ad valorem taxes), fees or surcharges on the charges to our customers for our VoIP services. With limited exceptions, we do not believe that we have sufficient nexus in most states/local jurisdictions to be subject to state or municipal taxes, surcharges or other fees. Should this change or found to be otherwise, we may be subject to retroactive liability for VoIP-specific taxes, fees and surcharges in a number of states and potentially, penalties and interest. Retroactive liability for such taxes, fees or surcharges, as well as penalties and interest, may adversely impact our financial position and we would not be able to recoup any of these liabilities from our customers. If we must collect such state taxes, fees and surcharges on a going-forward basis, we will likely pass such charges through to our customers. The impact of this price increase on our customers or our inability to recoup our costs or liabilities could have a material adverse effect on the financial position, results of operations and cash flows of our VoIP business.

Several states have attempted to impose state-level USF charges on a portion of the revenues from interconnected VoIP service. Thus far, such efforts have been unsuccessful. For example, the U.S. Circuit Court of Appeals for the Eighth Circuit recently affirmed a lower court ruling enjoining the state of Nebraska from attempting to collect such fees. On the basis of this litigation, we do not believe that existing law allows states to subject us to state universal service fund contribution obligations with respect to our VoIP services. However, we cannot predict the final outcome of this litigation, nor any similar litigation that other states might initiate, nor its impact on us.

On July 16, 2009, Kansas and Nebraska filed a petition with the FCC requesting a declaratory ruling that states are not preempted from requiring nomadic interconnected VoIP providers, such as us, to contribute to state universal service funds. The petition also seeks a retroactive ruling finding that states have been able to collect such contributions for a time period that is not clearly defined in the petition. At this time, we cannot predict the outcome of this proceeding nor its impact on our business. If we were required to retroactively pay into state-level universal service funds, that could have a material negative impact on our earnings. However, if the FCC were to adopt retroactivity but limit it to Kansas and Nebraska, we do not believe our potential liability would be material.

If we become subject to state USF fees in additional states or other telecommunications-related surcharges, we will likely pass such charges through to our customers. The impact of this price increase on our customers or

 

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our inability to recoup its costs or liabilities in remitting USF contributions or other factors could have a material adverse effect on our financial position, results of operations and cash flows.

Australia

The provision of our telecommunications services is subject to federal regulation in Australia. The two primary instruments of regulation are the Telecommunications Act 1997 (the “Telecommunications Act 1997”) and federal regulation of network access pricing and anti-competitive practices pursuant to the Trade Practices Act 1974 (the “Trade Practices Act”). The current regulatory framework came into effect in July 1997.

We are licensed as a carrier under the Telecommunications Act 1997, which permits us to own or operate transmission infrastructure that is used to supply carriage services to the public. With respect to providing carriage services to the public, we must comply with legislated “service provider” rules contained in the Telecommunications Act 1997 covering matters such as operator services, regulation of land access, directory assistance, provision of information to allow maintenance of an integrated public number database and itemized billing.

Two federal regulatory authorities principally exercise control over the broad range of issues affecting the operation of the Australian telecommunications industry. The Australian Communications & Media Authority (the “ACMA”) is the authority regulating matters including the licensing of carriers and technical matters, and the ACCC has the role of promotion of competition and consumer protection and in particular dealing with carrier to carrier interconnection and network access. Telstra, the dominant carrier and former Government owned monopoly, has typically challenged many of the key principles applied by the ACCC to access pricing and endeavors to have some key decisions removed from the charter of the ACCC. For example, Telstra has previously applied to the High Court of Australia to overturn its obligation to provide access to unbundled local loop lines (and also access to those lines pursuant to spectrum sharing). While that petition to the highest court in Australia was unsuccessful, Telstra continues to lodge challenges against regulatory decisions, with recent unsuccessful Federal Court challenges relating to the unconditional local loop service (“ULLS”) and leased line sharing (“LLS”) pricing. Telstra has also lodged a number of exemption applications with the ACCC submitting that it should be exempted from an obligation to provide wholesale telecommunications services on various routes and locations in Australia. Some of these applications have been successful, particularly in respect to wholesale line rental, the local carriage service and public switched telephone network originating access services supplied from certain CBD and metro exchanges, and also some transmission services where the ACCC considered sufficient alternative supply was available. There is a risk that Telstra will significantly increase its prices in respect of these exempt services and/or deny us access to essential services we need to compete. Separately, Telstra has also petitioned the ACCC for the right to impose significantly higher unconditional local loop (“ULL”) pricing. The ACCC has made a decision to reject this, however Telstra has challenged this decision in the Federal Court. Telstra and the ACCC are also presently contesting the appropriate pricing for all the fixed line regulated services supplied by Telstra. There is currently a significant divergence of view on some of this pricing and in August 2009 the ACCC published its draft pricing proposing increased ULL pricing. The ACCC subsequently indicated it would withdraw from that proposed pricing, and is expected to publish its final indicative pricing decision in the second quarter of 2010. The ACCC will also be establishing SSS and ULL pricing in the context of access disputes during the second quarter of 2010.

In September 2009 the Australian Government announced a regulatory reform package that if enacted, we expect will significantly reform the industry for the better. The key reforms are rules designed to separate Telstra’s retail arm from its wholesale business (proposing scope for either functional or structural separation), and the reform of the access pricing regime to enable the ACCC to conduct more efficient and forward looking pricing inquiries, give the ACCC greater price setting powers and provide greater certainty by removing merits review of ACCC decisions. These reforms generally represent improvement in the conditions and prospects for competitors such as us. However, the removal of merits review does expose us to some risk, as negative outcomes will not be open to challenge. The reforms were subject to debate and consideration by the Federal

 

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Senate during November 2009, and again debated in March 2010, however at this time its not clear whether the Government will obtain the necessary support to pass the legislation. Combined with other measures (including amendment of undertakings and exemption processes), the legislative reforms if and when enacted should ultimately lead to better price certainty and less regulatory risk. Given the reluctance of Telstra to take the lead in constructing a high speed broadband network in Australia, and the failure of a competitive tender to construct such a network (given global conditions at the time), the Government has moved to establish a Government owned company (NBN Co) to construct and operate a National Broadband Network. It is expected that draft legislation will be introduced within the next 6 months setting out the governance and regulatory framework for NBN Co. At this time NBN Co is in discussion with industry in connection with its construction plans. This development represents the prospect of long-term improvement in the conditions for industry competitors such as Primus Telecom, given the Government’s intention that NBN Co operate as a stand alone wholesale company, therefore removing some of the friction that currently exists between competitors and the monopoly wholesale service provider, Telstra, which because if its vertically integrated nature has incentives to favour its own retail operations over the interests of its wholesale customers.

The Government has recently announced a policy to require internet service providers to impose mandatory filtering of certain objectionable and illegal material through blocking access to specified URLs. At this stage it’s not clear what cost and operational implications this policy will have on Primus. More detail on these implications should emerge over coming months.

In addition to the Trade Practices Act and the Telecommunications Act 1997, the industry is also subject to other federal legislation, state legislation, various regulations pursuant to delegated authority and legislation, ministerial declarations, codes, directions, licenses, and statements of Australian government policy.

Licensed carriers are subject to charges that are intended to cover the costs of regulating the telecommunications industry and are obliged to comply with license conditions (including obligations to comply with the Telecommunications Act 1997 and with the telecommunications access regime and related facilities access obligations). Carriers also must meet the cost of the Universal Service Obligations (“USO”), which assists in providing all Australians, particularly in remote areas, with reasonable access to standard telephone services. Telstra is currently the sole universal service provider. Since 2000, the responsible Minister of the Australian government may make a determination of the amount of USO subsidies, with advice from the ACMA. No methodology is provided in legislation and the Minister could make a determination of a Universal Service Levy (“USL”) that would be material to us. However, the USL has been set previously at levels that we do not consider to have a material impact. The ACMA is presently proposing a determination for 2010 that is consistent with earlier determinations.

Fair Trading Practices. The ACCC enforces legislation (the Trade Practices Act) for the promotion of competition and consumer protection, and is responsible for regulating rights of access to services (including pricing for access) and interconnection. The ACCC can issue a competition notice to a carrier which has engaged in anti-competitive conduct. Where a competition notice has been issued, the ACCC can seek pecuniary penalties, and other carriers can seek damages. Under the Trade Practices Act other carriers can also initiate their own proceedings in the event of violation of competition laws.

As indicated, the Trade Practices Act provides for a telecommunications access regime that sets out a framework for regulating access rights to specific carriage services and related services through the declaration of access services by the ACCC. The regime establishes mechanisms by which the terms and conditions of access to a declared service can be determined by the ACCC in an access arbitration. The telecommunications specific provisions in the Trade Practices Act are intended to ensure fair and competitive access to essential facilities and monopoly services, and address anti-competitive conduct of carriers, particularly those with substantial market power such as Telstra. The right of access provisions also apply to any carrier that owns or controls essential infrastructure or services that have been declared by the ACCC on grounds that access should be provided for the purposes of competition.

 

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Consumer Protection. The ACCC’s consumer protection role as set out in the Trade Practices Act is also shared with other state based regulators. Each state has its own Fair Trading Act administered by consumer affairs authorities and ACMA undertakes some activities in consumer protection predominantly in connection with industry codes of conduct. As a service provider we must also be a member of the Telecommunications Industry Ombudsman (“TIO”) Scheme. The TIO is responsible for handling complaints from consumers about carriers and Internet service providers. The TIO may impose financial penalties upon carriers that do not satisfactorily deal with consumer complaints.

Canada

We are a reseller of telecommunications services in Canada. Because we do not own or operate transmission facilities in Canada, we are not subject to direct regulation by the CRTC pursuant to the Telecommunications Act (as amended, the “Canadian Telecommunications Act”). We may resell long-distance service, local telephone service, wireless service and Internet access without the regulation of our rates, prices or the requirement to file tariffs. In addition, as described below, as a reseller we are not subject to restrictions on foreign ownership or control.

Regulation. The CRTC has issued various decisions and constructed certain frameworks that directly affect our obligations and operations as a reseller.

In 2000, the CRTC implemented a revenue-based contribution regime to replace the per minute contribution charge formerly in place to support universal access. The revenue-based contribution mechanism collects from a wider base of telecommunications service providers, including resellers, and has lowered our contribution expenses since 2001.

We are required to hold a license to provide Basic International Telecommunications Services (a “BITS” license) pursuant to which we are subject to the requirements not to engage in anti-competitive conduct in relation to the provision of international telecommunications services and the requirement to observe the contribution regime described immediately above.

We operate as a local services reseller, both in reselling CLEC local services and in the provision of local VoIP services interconnected with the public switched telephone network. As such, we are subject to a number of obligations that are passed on through our contractual arrangements with LECs from which we purchase services. These include:

 

   

Registration. We are required to be registered with the CRTC to provide these services.

 

   

The provision of 911 services. For fixed services such as our circuit-switched local services, we are required to provide the same standard of 911 service as the underlying LEC. For our VoIP services, however, which are considered to be “nomadic” by the CRTC, we are required to implement an interim solution under which the CRTC requires us to employ the zero-dialed emergency routing services provided by the ILEC in its serving territory in order to route 911 calls to an operator, who determines the caller’s location in the first instance. A CRTC Interconnection Steering Committee submitted a report to the CRTC in 2007 establishing some of the parameters for a permanent solution for the provision of emergency services by nomadic VoIP providers. A CRTC proceeding is currently underway to identify remaining parameters for such a solution.

 

   

Customer notifications. Local VoIP providers are subject to stringent and detailed customer notification requirements regarding the limitations associated with their 911 services. These include warnings to be included in all of the providers’ print, online and broadcasting marketing materials.

 

   

Number portability. Although local voice resellers and VoIP providers must obtain their numbers from a LEC, they are subject to the requirement to permit porting out of local numbers.

 

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Privacy safeguards. Local resellers are required to provide certain privacy safeguards, including the provision of the privacy indicator, automated universal per-call blocking of calling line identification and others. To the extent that VoIP providers are unable to provide these privacy safeguards, they are required to inform their customers of this fact.

 

   

Message Relay Service. All local resellers, including VoIP providers, are required to provide access to message relay service (“MRS”). This is to include both Teletypewriter Relay Service (“TTY Relay”) and, as of July 21, 2010, Internet Protocol Relay Service (“IP Relay”).

In a Price Cap decision issued in May 2002, the CRTC lowered the prices incumbent providers can charge competitors for a range of competitor services, i.e. certain facilities and services required by competitors to provide telecommunications services to their end-customers and mandated by the CRTC (see discussion of the new framework for wholesale services, below). The Price Cap formula set out in this decision required the ILECs to revise the rates of selected services (primarily local telecommunications services) yearly by the rate of inflation minus a productivity offset of 3.5%. The rates of other service groupings were “capped” and others were “uncapped” with upward pricing constraints. The CRTC typically relied on a four-year Price Cap period, but in 2005 it decided to extend the period by one year in order to complete a public proceeding to establish the parameters of the next Price Cap period. In a decision dated April 2007, the CRTC issued the parameters of the new Price Cap framework. The new Price Cap framework is similar to the previous framework in that rates for service groupings are “capped,” “uncapped” and subject to upward or downward pricing constraints. The productivity offset still applies to selected services. CRTC decided not to impose an expiry date for the current Price Cap framework. Accordingly, the current Price Cap framework continues to allow for certain savings on competitor services for resellers.

In 2005 the federal government appointed a Telecom Policy Review Panel to review Canada’s telecommunications policy framework. The Panel’s report was released in March of 2006. Following the release of the report, the federal government issued a Policy Direction to the CRTC on December 18, 2006 that required, among other things, that in exercising its powers and duties, it rely on market forces to the maximum extent feasible. The Policy Direction has had an impact on the CRTC’s recent decision involving essential facilities and wholesale services, described immediately below. The policy directs the CRTC to take into account the principles of technological and competitive neutrality, the potential for incumbents to exercise market power in the wholesale and retail markets for the service in the absence of mandated access to wholesale services, and the impediments faced by new and existing carriers seeking to develop competing network facilities.

On March 3, 2008, the CRTC issued a decision revising the definition of an essential service and the classifications and pricing principles under which facilities-based carriers are to offer wholesale services to competitors at regulated rates. Under this revised regulatory framework for wholesale services, the CRTC has classified existing wholesale services into six categories: essential, conditional essential, conditional mandated non-essential, public good, interconnection, and non- essential subject to phase-out. More than a third of wholesale services will be deregulated by 2012, including intra-exchange transport services which we use to interconnect our sites where we have located DSLAM equipment. The area likely to have the next-largest impact involves high-speed access to business services, which is to be deregulated in 2013.

In a regulatory policy update related to the new wholesale framework, dated January 2009, the CRTC determined that it would be appropriate to allow for negotiated agreements for certain services that were mandated pursuant to the wholesale framework (i.e., those services classified as “conditional essential” and “conditional mandated non-essential”). Accordingly, we now have the ability to purchase these services on a tariff basis or through a negotiated agreement. As we utilize a significant amount of these services, it is expected that the ILECs will attempt to convince us to enter into negotiated agreements for these services going forward. However, it is not yet certain whether such agreements will offer or result in preferable terms for us.

In addition to the above, our competitors have filed applications to review or appeal other aspects of the CRTC’s new wholesale framework, as well as other wholesale data and Internet service obligations. In a decision

 

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dated January 2009, the CRTC withdrew a directive contained in the wholesale framework decision that would have required the ILECs to provide unbundled access to the facilities used to provide Internet service to all end-users that they are able to serve. In parallel, the CRTC initiated a proceeding to consider the appropriateness of mandating certain ILEC and cable company wholesale high-speed access services, including unbundled access to next-generation facilities. In March 2009, several of our competitors applied to the Governor in Council for the variance or rescission of CRTC decisions related to wholesale data or Internet services, in which the CRTC directed the ILECs to provide wholesale ADSL services at speeds equivalent to their retail offerings. In an Order in Council dated December 2009, the Governor in Council referred these decisions back to the CRTC for reconsideration. The proceeding in which the CRTC is considering the appropriateness of mandating certain ILEC and cable company wholesale high-speed access services has been expanded to include this reconsideration.

In a decision dated August 2009, the CRTC granted interim approval to an application by an ILEC, Bell Canada, to implement usage-based billing on its wholesale Internet access service. If this application is granted final approval, it will require us to pass down the cost of usage-based billing incurred by us through the Internet usage of our end-users that are served via Bell Canada’s wholesale Internet access service to those customers. It is possible that other ILECs will also implement usage-based billing on their wholesale Internet services. This would also permit us to implement usage-based billing on our retail Internet service that is provided via ILEC unbundled facilities obtained through CLEC arrangements.

In a decision dated October 2009, the CRTC set out a framework which will guide the implementation of Internet traffic management practices by ISPs and facilitate reviews of such practices against that framework. This framework is focused on four rules: Internet traffic management practices must be designed to address the stated need and achieve the stated purpose and effect, and nothing else; they must result in as little discrimination or preference as reasonably possible; they must result in as little harm to end-users and others as reasonably possible; and economic approaches, such as network investment, would not have reasonably addressed the need or effectively achieved the same purpose. As a result of this decision, we may continue to utilize the traffic management practices that we have implemented on our retail Internet service that is provided via ILEC unbundled facilities obtained through arrangements with CLECs. However, we may be obliged to notify our customers of such practices, with a 30-day wait period after notification before we can implement them. In addition, our arrangements with ILECs or with CLECs may require that the practices we implement respect the above-mentioned framework. Finally, the CRTC also determined that it would not require prior approval of the continued application of traffic management practices by the providers of wholesale Internet access services, provided that these are not more restrictive than those imposed on its retail customers and do not affect its wholesale customers disproportionately. As a result, our customers that are served via wholesale Internet services are, or may be, subject to the traffic management practices of the wholesale provider.

In an application dated June 2009, an ILEC, Bell Canada, requested approval to increase the tariffed rates for its unbundled local loops. This application has the potential to increase the cost of the unbundled facilities that we obtain through CLEC arrangements and use to provide retail telephone and Internet services. A review of Bell Canada’s application is ongoing.

Competition. Long-distance competition has been in place in Canada since 1990 for long-distance resellers and since 1992 for facilities-based carriers. In June 1992, the CRTC issued Telecom Decision CRTC 92-12 requiring the ILECs to interconnect their networks with their facilities-based, as well as reseller, competitors. Since 1994, the ILECs have been required to provide “equal access,” which eliminated the need for customers of competitive long-distance providers to dial additional digits when placing long-distance calls. The ILECs disbanded the Stentor alliance in 1999, and former Stentor companies, Bell Canada and TELUS Corporation, the two largest ILECs in Canada, compete against each other. MTS Allstream, Inc., the ILEC serving the Canadian province of Manitoba, has acquired Allstream, Inc. (formerly AT&T Canada Corp.) in 2004 and is now competing nationally as well. The other nationwide competitor, Call-Net Enterprises Inc., which operated as Sprint Canada, was acquired by Rogers in 2005. Cable TV companies, such as Rogers, Shaw Communications

 

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Inc. and Vidéotron Limited, launched their local telephone services in July 2005 and have had a great deal of success thus far. Their local service is provided either via their cable network or acquired CLEC (i.e., Call-Net) or on a resold basis from an underlying LEC.

As markets become competitive, the Canadian Telecommunications Act permits the CRTC to forbear from regulating the rates and terms of service of Canadian carriers. The long-distance rates of Canadian ILECs have largely been forborne from regulation since 1997. The ILECs’ rates for retail Internet services were forborne from regulation in 1999. On April 6, 2006, the CRTC established a framework for forbearance in respect of local services by defining the geographic markets in which the CRTC will forbear from regulating as the criteria for deregulation are met, and by establishing these criteria. On April 4, 2007 the Governor-in-Council varied this framework by reducing to the size of the geographic market in which the criteria are to be met and by relaxing the criteria to be met. As of June 2009 approximately 77% of all residential local lines and 68% of commercial local lines in Canada have been deregulated.

The Competition Bureau issued an Information Bulletin on the Abuse of Dominance Provisions as applied to the Telecommunications Industry on June 6, 2008, in which the Bureau describes its approach in reviewing abuse of dominance complaints in telecommunications markets where the CRTC has forborne from regulating conduct.

On March 12, 2009, the Competition Act was amended to provide the Competition Tribunal with the power to order the payment of an administrative monetary penalty of up to 15 million CAD in cases of abuse of dominant position. Subject to any relevant defenses, these amendments apply to telecommunications service providers.

Foreign Ownership Restrictions. Under the Canadian Telecommunications Act and the Radiocommunication Act, and certain regulations promulgated thereunder (i.e. the Radiocommunication Regulations and the Canadian Telecommunications Common Carrier Ownership and Control Regulations), foreign ownership restrictions apply to telecommunications common carriers and radiocommunication carriers (“Canadian carriers”), a concept which includes, for example, CLECs and microwave license holders, but not to companies, such as resellers, that do not own or operate transmission facilities. Accordingly, resellers may be wholly foreign-owned and controlled.

The restrictions applicable to Canadian carriers limit the amount of foreign investment in Canadian carriers to no more than 20% of the voting equity of a Canadian carrier operating company and no more than 33 1/3% of the voting equity of a Canadian carrier holding company. The restrictions also limit the number of seats which may be occupied by non-Canadians on the board of directors of a Canadian carrier operating company to 20%. In addition, under Canadian law, a majority of Canadians must occupy the seats on the board of directors of a Canadian carrier holding company. Although there is no restriction on foreign investors holding non-voting equity in a Canadian carrier, the law requires that the Canadian carrier not be “controlled in fact” by non-Canadians. The concept of “control in fact” is very broad, and takes into account all commercial arrangements between the Canadian carrier and third parties.

The Canadian issuer, along with several other telecommunications service providers, has sought to have the Canadian government review foreign ownership restrictions with a view to lowering these restrictions or eliminating them. In April 2003, the Industry Committee of the House of Commons recommended removing these restrictions in their entirety, for both telecommunications common carriers and for broadcasting distribution undertakings (“BDUs”) such as cable companies. In June 2003, however, another committee of the House of Commons (the Heritage Committee) expressed concerns that changes in ownership restrictions for either telecommunications common carriers or BDUs could have an adverse impact on the broadcasting system. In its September 2003 response to the Industry Committee’s recommendation, the government acknowledged the appropriateness of the committee’s conclusion that removing foreign investment restrictions would benefit the telecommunications industry. However, the government also noted the concerns expressed by the Heritage

 

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Committee. The government recognized that it has a responsibility to determine how best to reconcile the conflicting recommendations of the two committees and undertook to analyze this question and be in a position to examine possible solutions by the spring of 2004. However, no solutions were brought forward in 2005 although the issue was raised once again by the Telecom Policy Review Panel (“TPRP”), who recommended in its Final Report that the foreign ownership restrictions be relaxed. In July 2007, Industry Canada announced the creation of the Competition Policy Review Panel (the “Panel”), which was asked to provide recommendations to the government on how to enhance Canadian competitiveness. The Panel’s duties included a sector specific review of the current telecommunications foreign ownership restrictions. We filed a submission in favor of eliminating the restrictions and also presented options to accommodate concerns such as national security. In its report dated June 2008, the Panel supported the TPRP’s recommendations regarding the easing of foreign ownership restrictions. Specifically, the Panel recommended a two phase approach to liberalize the Canadian foreign ownership restrictions. The initial phase would permit foreign companies to establish new telecommunication companies or acquire existing telecommunication companies with less than a 10% share of the Canadian telecommunication market. The second phase would consist of further liberalization upon a review of existing cultural policies and an assessment of the impact of the foreign investment resulting from the initial phase. However, despite the support of both the TPRP and the Panel it is premature to predict whether any recommendation to remove the restrictions for telecommunications common carriers will be implemented. In July 2009, the CRTC issued a new Canadian ownership and control review policy which subjects foreign investment arrangements in Canadian carriers to more formal procedures. These new procedures include greater public scrutiny of the investment arrangements, in some cases extending to detailed disclosure requirements, and may involve significant delays and limit investors’ opportunity to consult informally with the regulator.

European Union

In Europe, the regulation of telecommunications is governed at a supranational level by the European Parliament, the Council of the European Union (the “Council”) and the European Commission (the “EU Commission”), each consisting of members including the following countries: Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the United Kingdom. These institutions are responsible for creating European Union-wide policies and, through legislation, have progressively developed a regulatory framework aimed at ensuring an open, competitive telecommunications market.

In February 2002, the Council agreed to a new European regulatory framework for the communications sector, which was adopted formally on March 7, 2002. The new regime comprises the following legislative texts:

 

   

Directive 2002/21 on a common regulatory framework for electronic communications networks and services (“Framework Directive”);

 

   

Directive 2002/20 on the authorization of electronic communications networks and services (“Authorization Directive”);

 

   

Directive 2002/19 on access to, and interconnection of, electronic communications networks and associated facilities (“Access Directive”); and

 

   

Directive 2002/22 on universal service and users rights relating to electronic communications networks and services (“Universal Service Directive”).

EU member states were obligated to implement these directives by July 25, 2003. As of December 31, 2008, these directives have not materially affected our business operations in Europe.

One of the requirements of the Authorization Directive is that no company seeking to provide electronic communications networks or services is required to obtain prior authorization, although such a company could be required to notify relevant regulatory authorities in the member states where it intends to operate.

 

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This regulatory framework is currently under review by the EU Commission. A number of proposed changes have been adopted, including the desire to create a European level telecom market body to complement national regulator, and assist in opening up markets with low levels of competition. The proposed changes have been adopted by the European Parliament and are awaiting consideration by the Council. Once adopted at the European level, the revised rules have to be incorporated into national law before taking effect. The EU Commission is hopeful that the new framework could be in place from 2010 onwards.

The Regulation of the European Parliament and of the Council of June 27, 2007 on roaming on public mobile telephone networks within the community and amending Directive 2002/21/EC is a regulation by the EU Commission, primarily backed by the EU Commissioner for Information Society and Media, which regulates the charges of mobile phone use when abroad in the EU. The regulation caps the rates operators can charge each other while roaming in the EU and also limits the tariffs an operator can charge from customers. The proposal for a regulation to lower international roaming charges within the EU was published by the EU Commission in July 2006. The regulation entered into force on June 30, 2007. From this date on, mobile phone operators within the EU had one month to inform customers about the new tariffs called “Eurotariff” and provided an offer for switching to the new tariff and the new tariff automatically applied on September 30, 2007, except special roaming package. The Eurotariffs is proposed to gradually decrease over the next three years.

A Eurotariff is available in all 27 member states of the EU. It applies only to voice calls within the EU irrespective of a pre-paid or post-paid status. It does not apply to other mobile phone services, such as short message service (“SMS”), multimedia messaging service (“MMS”) or data transfer.

The regulation caps roaming prices for voice services only but it also requires national regulators to monitor developments in the prices of roamed voice, SMS and data services closely. The EU Commission called on mobile operators to demonstrate their willingness to voluntarily reduce the very high roaming charges for SMS and data roaming. Under new rules as of July 1st, 2009, consumers will also benefit from per-second billing after 30 seconds for calls made and per-second billing throughout for calls received to ensure that consumers do not face any hidden costs when they are roaming. This is expected to increase consumer’s savings by over 20%.

The regulation is meant to expire in three years from 2007 (in Summer 2010). The EU Commission, together with the National Regulatory Authorities will monitor the development of the prices over the next 18 months. If normal market conditions are established in the market for roaming calls, the regulation will expire after three years. However, the Commission can also propose to continue to regulate the roaming market, if normal market conditions are not working yet. Under the latest EU proposal on September 23, 2008, this regulation would be extended to June 30, 2012.

A regulation on SMS and Data is currently being studied by the EU Commission. The operators were given until July 1, 2008 to lower SMS and data roaming charges. The EU Commission then sent letters to the CEOs of all European mobile operators inquiring about their SMS and data prices. The assessment showed that prices are still too high. The EU Commission then decided to introduce maximum price limits for sending SMS messages while roaming. The European Regulators Group has suggested a level between 11 and 15 eurocents. As of May 2009 a maximum price of SMS send within EU borders on the level of 11 eurocents from July 1, 2009 is almost certain. This would also include a wholesale maximum rate of €0.04.

The price cap for the rates the host operator charges a roaming customer’s home operator, calculated on a kilobyte basis is:

 

   

from July 1, 2009: a maximum of €1.00 per megabyte (excluding VAT);

 

   

from July 1, 2010: a maximum of €0.80 per megabyte (excluding VAT); and

 

   

from July 1, 2011: a maximum of €0.50 per megabyte (excluding VAT).

 

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Data and Internet services are not regulated for the moment by the EU at the retail level. A wholesale price cap will be applicable as of July 1, 2009 for 1 EUR/MB. Customers traveling to another member state would also receive an automated message of the charges that apply for data roaming services. On July 1, 2010, operators must provide customers with the opportunity to determine in advance how much they want to spend before the service is cut-off.

A further directive relating to privacy and electronic communications (“Directive 2002/58”) was added to the new regime. This directive aims to harmonize national laws regarding personal data protection in the electronic communications age and deals with matters including the confidentiality of billing information, the use of caller identification devices, the use of subscriber directories and unsolicited communications. The directive was supposed to be implemented by EU member states and incorporated into the regulatory regime of each member state by October 31, 2003, but as was also the case with the earlier directives referred to above, a number of member states missed this deadline. Each EU member state in which we currently conduct or plan to conduct our business has historically had a different regulatory regime, and we expect that, even with the adoption of the new EU regulatory regime, differences will continue for the foreseeable future. There may well be differences in the manner in which the new EU regulatory regime is implemented from one member state to another. The requirements for us to obtain necessary approvals have varied considerably from one country to another. We have obtained and will continue to seek to obtain interconnection agreements with other carriers within the EU. While previous EU directives have required that carriers with significant market power offer cost-based and non-discriminatory interconnection to competitors, individual EU member states have implemented this requirement differently and may continue to do so under the new EU regulatory regime. As a result, we may be delayed in obtaining or may not be able to obtain interconnection in certain countries that would allow us to compete effectively.

Further, member states must now introduce domestic legislation to implement the EC Directive on Waste Electrical and Electronic Equipment (“WEEE”) and the EC Directive on the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”). The WEEE seeks to implement legislation on electrical and electronic equipment in relation to its composition and levels to which it should be recycled, while making producers responsible for financing most of these activities. Information technology and telecommunications equipment is WEEE, and subject to the WEEE Directive. RoHS seeks to restrict hazardous substances in WEEE.

The Commission also is concerned with services, such as VoIP, and published a working paper applicable to VoIP based services—Commission Staff Working Document of June 14, 2004 on the Treatment of VoIP under the EU Regulatory Framework- an Information and Consultation Document, which identifies various issues that can arise in relation to VoIP. The introduction of 3G mobile broadband services raised new regulatory issues and the Commission published a Communication on Mobile Broadband Services (June 30, 2004-COM (2004) 447), which covers issues, such as spectrum trading.

 

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Employees

The following table summarizes the number of our employees as of December 31, 2009 by region:

 

     Total

Canada

   704

Australia

   582

United States

   158

India

   108

Europe

   102

Brazil

   47
    

Total

   1,701
    

We have never experienced a work stoppage. Only some of our employees in Australia are represented by a labor union and covered by a collective bargaining agreement. We believe that our employee relations are positive.

Other Information

Our Internet address is www.primustel.com. We make available free of charge through our Internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to the Securities Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the United States Securities and Exchange Commission (SEC).

 

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ITEM 1A. RISK FACTORS

A wide range of factors could materially affect our performance. In addition to factors affecting specific business operations and the financial results of those operations identified elsewhere in this report, the following factors, among others could adversely affect our operations:

The following is not intended as, and should not be construed as, an exhaustive list of relevant risk factors. There may be other risks that are relevant to its own particular circumstances or generally.

RISKS RELATED TO OUR BUSINESS AND INDUSTRY

Continuing global economic conditions could adversely affect our business.

The global economy and capital and credit markets have been experiencing exceptional turmoil and upheaval. Many major economies worldwide entered significant economic recessions in 2007 and continue to experience economic weakness even though economies have begun to show signs of recovery. Ongoing concerns about the systemic impact of potential long-term and widespread recession and potentially prolonged economic recovery, volatile energy costs, geopolitical issues, the availability, cost and terms of credit, consumer and business confidence, substantially increased and increasing unemployment rates and the crisis in the global housing and mortgage markets have all contributed to increased market volatility and diminished expectations for both established and emerging economies, including those in which we operate. In the second half of 2008, added concerns fueled by government interventions in financial systems led to increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions have contributed to economic uncertainty of unprecedented levels. The availability, cost and terms of credit also have been and may continue to be adversely affected by illiquid markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in many cases cease to provide, credit to businesses and consumers. These factors have led to a substantial and continuing decrease in spending by businesses and consumers over the past two years, and a corresponding decrease in global infrastructure spending. Continued turbulence in the U.S. and international markets and economies and prolonged declines in business and consumer spending may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers, including our ability to refinance maturing debt instruments and to access the capital markets and obtain capital lease financing to meet liquidity needs. This financial crisis may have an impact on our business and financial condition in the following ways as well as in other ways that we currently cannot predict.

 

   

Potential risk in refinancing outstanding debts: Although none of our major debt instruments are scheduled to mature before 2013, at the earliest, if the volatility in the global capital markets were to continue, our ability to refinance our existing indebtedness when due could be severely constrained. See “—Risks Associated with Our Liquidity Needs and Debt Securities.” Any such refinancing could require significantly more expensive interest rates and covenants that restrict our operations to a significantly greater extent.

 

   

Negative impacts from increased financial pressures on customers: Uncertainty about current and future global economic conditions and credit markets may cause consumers, business and governments to defer purchases in response to tighter credit, decreased availability of cash and credit, and declining business and consumer confidence, any of which may affect the usage of our services by the customers and the ability of those customers to pay for our services. Accordingly, future demand for our products and services could differ from our current expectations. Similarly, our customers may experience liquidity issues of their own that adversely affect our ability to collect amounts due from them in a timely fashion or at all. In addition, if the global economy and credit markets continue to deteriorate or cease to recover and our future sales decline, our financial condition and results of operations would be adversely impacted.

 

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Strengthening of the United States Dollar (“USD”) against certain foreign currencies reduces the amount of USDs generated from foreign currency payments from our foreign operating subsidiaries and may adversely affect our results of operations and our ability to service our debt.

A significant portion of our net revenue (about 82% for the year ended December 31, 2009) is derived from sales and operations outside the U.S. The reporting currency for our consolidated financial statements is the USD. Our foreign operating subsidiaries, including our largest operating subsidiaries in Canada and Australia, generates cash in their respective local currencies and fluctuations in exchange rates can have a material adverse impact on amounts of USDs transferred to U.S. parent entities. In the future, we expect to continue to derive a significant portion of our net revenue (which is a substantial source for servicing our significant debt obligations at the parent entity level, as well as a source for making principal payments) and incur a significant portion of our operating costs outside the U.S., and changes in exchange rates have had and may have a significant, and potentially adverse, effect on our results of operations.

From June 30, 2008 through December 31, 2008, the Canadian and Australian dollars (“CAD” and “AUD,” respectively) declined by 17% and 28%, respectively, relative to the USD, and this has had a material adverse impact on amounts of USDs transferred to U.S. parent entities. Conversely, from December 31, 2008 to December 31, 2009, the CAD and AUD increased by 11% and 35%, respectively. Due to the large percentage of our operations conducted outside of the U.S., and the cash transfers from these foreign operating subsidiaries to the U.S. parent, a strengthening of the USD relative to one or more of the foregoing foreign currencies could have an adverse impact on future results of operations and could adversely affect our ability to service or repay our consolidated indebtedness and obligations.

We historically have not engaged in hedging transactions. The exposure of our income from operations to fluctuations in foreign currency exchange rates is reduced in part because a majority of the costs that we incur in connection with our foreign operations are also denominated in local currencies. In addition, the operations of affiliates and subsidiaries in foreign countries have been funded with investments and other advances denominated in foreign currencies. Historically, such investments and advances have been long-term in nature, and we accounted for any adjustments resulting from currency translation as a charge or credit to accumulate other comprehensive loss within the stockholders’ deficit section of our consolidated balance sheets. In 2002, agreements with certain subsidiaries were put in place for repayment of a portion of the investments and advances made to those subsidiaries. As we anticipate repayment in the foreseeable future of these amounts, we recognize the unrealized gains and losses in foreign currency transaction gain (loss) on the consolidated statements of operations, and depending upon changes in future currency rates, such gains or losses could have a significant, and potentially adverse, effect on our results of operations.

We are substantially smaller than our major competitors, whose marketing and pricing decisions, and relative size advantage could adversely affect our ability to attract and to retain customers and are likely to continue to cause significant pricing pressures that could adversely affect our net revenues, results of operations and financial condition.

The local, long-distance, Internet, broadband, digital subscriber lines (“DSL”), data and hosting and wireless telecommunications industry is significantly influenced by the marketing and pricing decisions of the larger business participants. Prices in the long-distance industry have continued to decline in recent years and, as competition continues to increase within each of our service segments and each of our product lines, we believe that prices are likely to continue to decrease. The most significant competitors in our primary markets include:

 

   

United States: AT&T Inc., Verizon Communications Inc., Qwest Communications International Inc. and other incumbent carriers, cable companies, including Comcast Corporation, Time Warner Cable Inc., Cablevision Systems Corporation and Charter Communications, Inc., other competitive local exchange carriers, including PaeTec Communications, Inc., Time Warner Telecom Inc., XO Communications Services, Inc. and Frontier Communications Corp., independent VoIP providers, including Vonage Holdings Corp and Cbeyond, Inc., wireless carriers in the U.S., including Verizon

 

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Communications Inc., AT&T Inc., Sprint Corp., T-Mobile USA Inc., MetroPCS Communications, Inc. and Leap Wireless International, Inc., and web based companies, including Skype Technologies S.A. and Google Inc.;

 

   

Australia: Telstra Corporation Limited (“Telstra”), SingTel Optus Pty Limited, Telecom New Zealand Limited, iiNet Limited, SP Telemedia Limited (known as TPG), Macquarie Telecom Group Ltd. and other smaller national and regional service providers and resellers.; and

 

   

Canada: TELUS Corporation (“TELUS”), BCE Inc. (“Bell Canada”), MTS Allstream, Inc., Saskatchewan Telecommunications, wireless providers, including Rogers Communications Inc. (“Rogers”), TELUS, Bell Canada, Bragg Communications Inc., COGECO Inc., Quebecor Inc. and Shaw Communications, Inc., cable companies, and other service providers and resellers including Globalive Communications Corp. in Canada.

Customers frequently change local, long-distance, wireless, broadband providers, and ISPs in response to the offering of lower rates or promotional incentives, increasingly as a result of bundling of various services by competitors. Moreover, competitors’ VoIP and broadband product rollouts have added further customer choice and pricing pressure. As a result, customers generally can switch carriers and service offerings at their discretion with little notice to us. Competition in all of our markets is likely to remain intense, or increase in intensity and, as deregulatory influences affect markets outside the U.S., competition in non-U.S. markets is increasing to a level similar to the intense competition in the U.S.

Many of our competitors are significantly larger than us and have substantially greater financial, technical and marketing resources, larger networks, a broader portfolio of service offerings, greater control over network and transmission lines, stronger name recognition and customer loyalty, long-standing relationships with our target customers and lower debt-leverage ratios. As a result, our ability to attract and retain customers may be adversely affected. Many of our competitors enjoy economies of scale that result in low cost structures for transmission and related costs that could cause significant pricing pressures within the industry.

Several long-distance carriers in the U.S., Canada and Australia and the major wireless carriers and cable companies have introduced pricing and product bundling strategies that provide for fixed, low rates or unlimited plans for domestic and international calls. This strategy could have a material adverse effect on our net revenue per minute, results of operations and financial condition if our pricing, which we set to remain competitive, is not offset by similar declines in our costs. We compete on the basis of price, particularly with respect to our sales to other carriers, and also on the basis of customer service and our ability to provide a variety of telecommunications products and services. If such price pressures and bundling strategies intensify, we may not be able to compete successfully in the future, may face quarterly revenue and operating results variability, and may have heightened difficulty in estimating future revenues or results.

Given strong competition in delivering individual and bundled local, wireless, broadband, DSL, VoIP services, we may not be able to operate successfully or expand these parts of our business.

We have accelerated initiatives to become an integrated wireline, wireless and broadband service provider in order to counter competitive pricing pressures initiated by large incumbent providers in certain of the principal markets where we operate and to stem the loss of certain of our wireline voice and dial-up ISP customers to our competitors’ bundled wireline, wireless and broadband service offerings. Our primary competitors include incumbent telecommunications providers, cable companies and other ISPs that have a significant national or international presence. Many of these operators have substantially greater resources, capital and operational experience than we do. We are experiencing increased competition from traditional telecommunications carriers, cable companies and other new entrants that have expanded into the market for broadband, VoIP, Internet services, data and hosting and traditional voice services. In addition, regulatory developments may impair our ability to compete. Therefore, future operations involving these individual or bundled services may not succeed in the competitive environment, and we (1) may not be able to expand successfully; (2) may experience margin pressure; (3) may face quarterly revenue and operating results variability; (4) may have limited resources to

 

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develop and to market the new services; and (5) have heightened difficulty in establishing future revenues or results. As a result, there can be no assurance that we will reverse revenue declines in our traditional long-distance voice and dial-up ISP services or maintain or increase revenues or be able to generate sufficient income from operations or net income in the future or on any predictable or timely basis.

Our repositioning in the marketplace and intense domestic and international competition in these services places a significant strain on our resources, and if not managed effectively, could result in operational inefficiencies and other difficulties.

Our repositioning in the marketplace to focus on Growth Services segments of the telecom market, including broadband, IP-based voice, local, wireless, data and data center solutions may place a significant strain on our management, operational and financial resources and increase demand on our systems and controls. However, the local and long-distance telecommunications, data, broadband, Internet, VoIP, data and hosting and wireless industries are intensely competitive, present relatively limited barriers to entry in the more deregulated countries in which we operate and involve numerous entities competing for the same customers. Recent and pending deregulation in various countries may encourage new entrants to compete, including ISPs, wireless companies, and cable television companies, who could offer voice, broadband, Internet access and television services, and electric power utilities, who could offer voice and broadband Internet access. For example, the U.S. and many other countries have committed to open their telecommunications markets to competition pursuant to an agreement under the World Trade Organization which began on January 1, 1998. Further, in the U.S., the major landline incumbent carriers (including AT&T Inc. and Verizon Communications Inc.) have for many years also provided long-distance services, and previously independent long-distance providers (including AT&T Inc. and MCI Inc.) have been acquired by the landline incumbents. In addition, many entities, including large cable television companies (including Comcast Corporation, Time Warner Cable Inc., Cablevision Systems Corporation and Charter Communications, Inc.) and utilities have been allowed to enter both the local service and long-distance telecommunications markets.

To manage our repositioning effectively, we must continue to implement and improve our operational and financial systems and controls, invest in critical network infrastructure to expand its coverage and capacity including the data centers expansion, maintain or improve our service quality levels, purchase and utilize other transmission facilities, evolve our support and billing systems and train and manage our employee base. If we inaccurately forecast the movement of traffic onto our network, we could have insufficient or excessive transmission facilities and disproportionate fixed expenses. As we proceed with our development, operational difficulties could arise from additional demand placed on customer provisioning and support, billing and management information systems, product delivery and fulfillment, support, sales and marketing, administrative resources, network infrastructure, maintenance and upgrading. For instance, we may encounter delays or cost-overruns or suffer other adverse consequences in implementing new systems when required, such as our need to off-shore certain functions. In addition, our operating and financial control systems and infrastructure could be inadequate to ensure timely and accurate financial reporting, which could impact debt covenant compliance.

We have experienced significant historical, and may experience significant future, operating losses and net losses which may hinder our ability to meet our debt service or working capital requirements.

As of June 30, 2009, Predecessor had an accumulated deficit of $1.06 billion. Predecessor incurred net losses of $10.6 million in 2004, $149.2 million in 2005, $238.0 million in 2006 and $25.0 million in 2008. During the year ended December 31, 2007, Predecessor recognized net income of $15.7 million, of which $32.7 million of revenue was related to the positive impact of foreign currency transaction gains. Even with the elimination of our significant accumulated deficit and the reduction in indebtedness through our recent reorganization under Chapter 11, future losses may continue. We cannot assure you that we will recognize net income in future periods. If we cannot generate net income or sufficient operating profitability, we may not be able to meet our debt service or working capital requirements.

 

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A deterioration in our relationships with facilities-based carriers could have a material adverse effect upon our business.

We primarily connect our customers’ telephone calls and data/Internet needs through transmission lines that we lease under a variety of arrangements with other facilities-based local, wireless, broadband, data and long-distance carriers. Many of these carriers are, or may become, our competitors. Our ability to maintain and expand our business depends on our ability to maintain favorable relationships with the facilities-based carriers from which we lease transmission lines. If our relationship with one or more of these carriers were to deteriorate or terminate, for any reason, it could have a material adverse effect upon our cost structure, service quality, network diversity, results of operations, financial condition and cash flows.

Uncertainties and risks associated with international markets and regulatory requirements could adversely impact our international operations.

We have significant international operations and, for the year ended December 31, 2009, derived about 82% of our net revenues by providing services outside of the U.S. In international markets, we are smaller than the principal or incumbent telecommunications carrier that operates in each of the foreign jurisdictions where we operate. In these markets, incumbent carriers: (1) are likely to modify and/or control access to, and pricing of, the local networks; (2) enjoy better brand recognition and brand and customer loyalty; (3) generally offer a wider range of product and services; and (4) have significant operational economies of scale, including a larger backbone network and longer term customer and supplier agreements on preferred and better terms. Moreover, the incumbent carrier may take many months to allow competitors, including us, to interconnect to their switches within our territory, and we are dependent upon their cooperation in migrating customers onto our network. There can be no assurance that we will be able to: (1) obtain the permits and operating licenses required for us to operate in the new service areas; (2) obtain access to local transmission facilities on economically acceptable terms; or (3) market services in international markets.

In addition, operating in international markets generally involves additional risks, including unexpected changes or uncertainties in regulatory requirements, taxes, tariffs, customs and duties. Given the nature of our operations and uncertainties in, or the absence of definitive regulations or interpretations concerning, the taxation of (including value added tax of) certain aspects of our business in certain international jurisdictions in which we conduct (or may be construed by such authorities as conducting or deriving taxable) operations or revenue, we may become subject to assessments for taxes (which may include penalties and interest) which are either unexpected, or have not been accrued for in our historical results of operations or both. This circumstance occurred during March 2008, when we concluded it was probable that assessments would be forthcoming concerning past European prepaid calling services operations, and it is possible that tax uncertainties concerning our international operations could arise in the future. Such developments, in addition to the other uncertainties and risks described above, could have adverse consequences that might result in restatement of prior period results of operations and unanticipated liquidity demands. Additional operating risks and uncertainties in operating in international markets include trade barriers, difficulties in staffing and managing foreign operations, problems in collecting accounts receivable, political risks, fluctuations in currency exchange rates, restrictions associated with the repatriation of funds, technology export and import restrictions, and seasonal reductions in business activity. Our ability to operate and grow our international operations successfully could be adversely impacted by these risks and uncertainties particularly in light of the fact that we derive such a large percentage of our revenues from outside of the U.S.

The telecommunications industry is rapidly changing, and if we are not able to adjust our strategy and resources effectively in the future to meet changing market conditions, we may not be able to compete effectively.

The telecommunications industry is changing rapidly due to deregulation, privatization, consolidation, technological improvements, availability of alternative services such as wireless, broadband, DSL, Internet, VoIP, data and hosting and wireless broadband through use of the fixed wireless spectrum, and the globalization

 

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of the world’s economies. In addition, alternative services to traditional fixed wireline services, such as wireless, broadband, Internet and VoIP services, are a substantial competitive threat. As the overall market for domestic and international long-distance and dial-up Internet services continues to decline in favor of Internet-based, wireless, and broadband communications, revenue contribution from our Traditional Services, which for the year ended December 31, 2009 comprised 43% of total revenue, has been consequently declining. If we do not adjust to meet changing market conditions or do not have adequate resources, we may not be able to compete effectively. The telecommunications industry is marked by the introduction of new product and service offerings and technological improvements. Achieving successful financial results will depend on our ability to anticipate, assess and adapt to rapid technological changes, and offer, on a timely and cost-effective basis, services, including the bundling of multiple services that meet evolving industry standards. If we do not anticipate, assess or adapt to such technological changes at a competitive price, maintain competitive services or obtain new technologies on a timely basis or on satisfactory terms, our financial results may be materially and adversely affected.

The rapid enhancement of VoIP and Internet technology may result in increasing levels of traditional domestic and international voice long-distance traffic being transmitted over the Internet, as opposed to traditional telecommunication networks. Currently, there are significant capital investment savings and cost savings associated with carrying voice traffic employing VoIP technology, as compared to carrying calls over traditional networks. Thus, there exists the possibility that the price of traditional long-distance voice services will decrease in order to be competitive with VoIP. Additionally, competition is expected to be intense to switch customers to VoIP product offerings, as is evidenced by numerous recent market announcements in the U.S. and internationally from industry leaders and competitive carriers concerning significant VoIP initiatives. Our ability effectively to retain our existing customer base and generate new customers, either through our traditional network or our own VoIP offerings, may be adversely affected by accelerated competition arising as a result of VoIP initiatives, as well as regulatory developments that may impede our ability to compete, such as restrictions on access to broadband networks owned and operated by others and the requirements to provide enhanced 911 emergency services (“E911”). As competition intensifies as a result of deregulatory, market or technological developments, our results of operations and financial condition could be adversely affected.

If we are not able to operate a cost-effective network, we may not be able to grow our business successfully.

Our long-term success depends on our ability to design, implement, operate, manage, maintain and upgrade a reliable and cost-effective network infrastructure, including data hosting centers. In addition, we rely on third party equipment and service vendors to enable us to expand and manage our global network and to provide local, broadband Internet, data and hosting and wireless services. If we fail to generate additional traffic on our network, if we experience technical or logistical impediments to our ability to develop necessary aspects of our network or to migrate traffic and customers onto our network, or if experience difficulties with our third-party providers, we may not achieve desired economies of scale or otherwise be successful in growing our business.

If we are not able to use and protect intellectual property domestically and internationally, it could have a material adverse effect on our business.

Our ability to compete depends, in part, on our ability to use intellectual property in the U.S. and internationally. We rely on a combination of trade secrets, trademarks and licenses to protect our intellectual property. We are also subject to the risks of claims and litigation alleging infringement of the intellectual property rights of others. The telecommunications industry is subject to frequent litigation regarding patent and other intellectual property rights. We rely upon certain technology, including hardware and software, licensed from third parties. There can be no assurance that the technology licensed by us will continue to provide competitive features and functionality or that licenses for technology currently used by us or other technology that we may seek to license in the future will be available to us on commercially reasonable terms or at all. Although our existing intellectual property licenses are on standard commercial terms made generally available

 

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by the companies providing the licenses and, individually, their costs and terms are not material to our business, the loss of, or our inability to maintain existing licenses, could result in shipment delays or reductions until equivalent technology or suitable alternative products could be developed, identified, licensed and integrated and could cause service disruption to our customers. Such delays or reductions in the aggregate could harm our business. We also generally rely on indemnification provisions in licensing contracts to protect against claims of infringement regarding the licensed technology, which indemnification could be affected by, among other things, the financial strength of the licensor.

The loss of key personnel could have a material adverse effect on our business.

The loss of the services of K. Paul Singh, our Chairman and Chief Executive Officer, or the services of our other key personnel, or our inability to attract and retain additional key management, technical and sales personnel, could have a material adverse effect upon our financial condition and results of operations.

RISKS ASSOCIATED WITH OUR FINANCIAL STATEMENTS

Our disclosure controls and procedures and internal control over financial reporting were determined not to be effective as of December 31, 2006, 2007 and 2008 due to a material weakness that existed in our internal control over accounting for income taxes and as of December 31, 2009 due to a material weakness that existed in our internal control over accounting for foreign currency transaction gain (loss). If we fail to maintain effective internal control over financial reporting at a reasonable assurance level, we may not be able to accurately report our financial results, which could have a material adverse effect on our operations, investor confidence in our business and the trading prices of our securities.

Effective internal controls are necessary for us to provide reliable financial reports. In evaluating the effectiveness of our internal control over financial reporting, our management identified as of December 31, 2006, 2007 and 2008 a control deficiency in our controls and procedures over accounting for income taxes and as of December 31, 2009 a control deficiency over accounting for foreign currency transaction gain (loss) and management concluded in each case that the control deficiency in our internal controls over financial reporting constituted a material weakness. These deficiencies represented a material weakness in internal control over financial reporting on the basis that there is more than a remote likelihood that a material misstatement in our interim or annual financial statements could occur and would not be prevented or detected by our internal control over financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of annual or interim financial statements will not be prevented or detected on a timely basis.

Specifically, management’s assessment of our internal control over financial reporting as of December 31, 2006, 2007 and 2008 identified a material weakness in internal control related to a lack of documentation, insufficient historical analysis and ineffective reconciliation procedures, primarily caused by lack of personnel with adequate expertise in income tax accounting matters. Since identifying the material weakness concerning accounting for income taxes, we have undertaken the following initiatives to remediate the material weakness – hired a new Corporate Tax Director and a Manager of Taxation in our Canadian operating unit; established functioning procedures for foreign finance personnel to communicate regularly any tax concerns with the Corporate Tax Director; purchased and implemented tax provision preparation software; and developed quarterly tax documentation formats. Accordingly, as of December 31, 2009 our management concluded the controls surrounding accounting for income taxes are effective.

In March 2010, the Company determined that an error existed related to accounting for foreign currency transaction gain (loss) on certain inter-company balances. Specifically, this error related to activity in the third quarter 2009 resulting in the Company amending its Form 10-Q for the quarter ended September 30, 2009. This amendment restated our financial statements in order to correct a non-cash error relating to accounting for unrealized foreign currency transaction losses associated with certain inter-company balances that were

 

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permanent in nature and, therefore, should have been recorded as currency translation adjustment to accumulated other comprehensive income (loss) in the equity section of the balance sheet. Since identifying this, we have undertaken initiatives to remediate this material weakness by (a) performing additional recalculations and analysis of the foreign currency transaction gain (loss) recorded on these intercompany balances; (b) implementing an improved process for assessing the reasonableness of foreign currency transaction gain (loss) recorded on these intercompany balances; and (c) confirming intercompany settlements related to these balances at a transactional level. Notwithstanding such efforts, the material weakness concerning currency transaction will not be remediated until the new controls operate for a sufficient period of time and are tested to enable management to conclude that the controls are effective. As a result, as of December 31, 2009 management concluded that the control deficiency concerning foreign currency transactions represented a material weakness. See “Item 9A. Controls and Procedures” herein.

Our management will consider the design and operating effectiveness of our controls and necessary changes to such controls. However, we can not assure you that additional material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in additional material weaknesses, and cause us to fail to timely meet our periodic reporting obligations or result in material misstatements in our financial statements. The existence of a material weakness could result in future errors in our financial statements that could result in a restatement of financial statements, cause us to fail to meet our reporting obligations and cause investors to lose confidence in our reported financial information.

Financial information in our future financial statements will not be comparable to our financial information from periods before July 1, 2009 due to our Reorganization and the application of fresh-start accounting to our financial statements.

Upon our Holding Companies’ emergence from Chapter 11 on July 1, 2009, we adopted fresh-start accounting in accordance with Accounting Standards Codification (“ASC”) 852, Reorganizations, pursuant to which our reorganization value, which represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the Reorganization, has been allocated to the fair value of assets in conformity with ASC 805, Business Combinations, using the purchase method of accounting for business combinations. We stated liabilities, other than deferred taxes, at a present value of amounts expected to be paid. The amount remaining after allocation of the reorganization value to the fair value of identified tangible and intangible assets is reflected as goodwill, which is subject to periodic evaluation for impairment. In addition, under fresh-start accounting, our accumulated deficit ($1.06 billion at June 30, 2009) has been eliminated. In addition to fresh-start accounting, our consolidated financial statements reflect all effects of the transactions contemplated by the Plan of Reorganization. Thus, our future consolidated balance sheets and consolidated condensed statements of operations data will not be comparable in many respects to our consolidated balance sheets and consolidated condensed statements of operations data for periods prior to our adoption of fresh-start accounting and prior to accounting for the effects of the Reorganization.

RISKS ASSOCIATED WITH OUR LIQUIDITY NEEDS AND DEBT SECURITIES

We may not be able to generate sufficient cash to service all of our indebtedness, and may be forced to take other actions to satisfy our obligations under our indebtedness that may not be successful.

Our ability to satisfy our debt obligations will depend upon, among other things, our future financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, many of which are beyond our control. We cannot assure you that our business will generate cash flow from operations in an amount sufficient to fund our liquidity needs. If our cash flows and capital resources are insufficient to service our indebtedness, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. Our

 

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ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. In addition, the terms of existing or future debt agreements may restrict us from adopting some of these alternatives. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. We may not be able to consummate those dispositions for fair market value or at all. Furthermore, any proceeds that we could realize from any such disposition may not be adequate to meet our debt service obligations then due.

A significant portion of our future cash flow may need to be committed to repurchasing or redeeming certain outstanding debt prior to its stated maturity, rather than for use in our business operations.

If Group and its “restricted subsidiaries” have Excess Cash Flow (as defined below) for any fiscal year commencing with the fiscal year ending December 31, 2010, then the issuers of the 13% Senior Secured Notes due 2016 (the “13% Notes”) are obligated to jointly apply an amount equal to 50% of such Excess Cash Flow for such period (the “Excess Cash Flow Offer Amount”) and to make a joint offer to the holders of the 13% Notes to repurchase all or a portion of such notes as Units with an aggregate repurchase price in cash equal to the Excess Cash Flow Offer Amount (an “Excess Cash Flow Offer”). Excess Cash Flow means for any such fiscal year (a) the excess of (1) consolidated EBITDA over (2) the sum, subject to certain exceptions, represented by: (i) capital expenditures; (ii) consolidated interest expense paid in cash; (iii) income and franchise taxes paid in cash; and (iv) reductions in certain indebtedness minus (b) the absolute value of negative Excess Cash Flow, if any. See Note 7 to our Consolidated Financial Statements.

Within 110 days after the end of any fiscal year with respect to which an Excess Cash Flow Offer is required, an offer must be sent to each holder of 13% Notes stating the repurchase date, which must be no earlier than 30 days nor later than 60 days from the date such notice is mailed. With respect to each Excess Cash Flow Offer, the Issuers are entitled to reduce the applicable Excess Cash Flow Offer Amount by an amount equal to the sum of (x) the aggregate repurchase price paid for any 13% Notes repurchased by the Issuers in the open market or privately negotiated transaction (and, in each case, cancelled by the Issuers) and (y) the aggregate redemption price paid for any 13% Notes redeemed pursuant to one or more optional redemptions, subject to certain limitations.

If our outstanding 14 ¼% Senior Subordinated Secured Notes due May 2013 (the “14 ¼% Notes”) have not been refinanced in accordance with the terms of its indenture on or prior to January 21, 2013, then the Issuers will be required to redeem the 13% Notes in advance of the 14 ¼% Notes scheduled maturity at a price equal to the then applicable optional redemption price.

If such early redemption of the 13% Notes are required or an Excess Cash Flow Offer is made, there can be no assurance that the Issuers will have available funds sufficient to pay for such redemption or for the Excess Cash Flow purchase price for all the 13% Notes that might be delivered by holders seeking to accept the Excess Cash Flow Offer. Any such failure could have a material adverse effect on us.

We must repay or refinance the 14 ¼% Notes prior to the maturity of the 13% Notes. Failure to do so could have a material adverse effect upon us.

The maturity of the 14 ¼% Notes is earlier than the maturity of the 13% Notes. While we expect to refinance the 14 ¼% Notes, we may not be able to do so or refinancing may not be available on commercially reasonable terms. Our ability to complete a refinancing of the 14 ¼% Notes prior to their maturity is subject to a number of conditions beyond our control. For example, if disruption in the financial markets were to occur at the time that we intended to refinance the 14 ¼% Notes, we might be restricted in our ability to refinance that indebtedness. If we are unable to refinance the 14 ¼% Notes our alternatives would consist of negotiating an extension of such indebtedness with the holders and seeking or raising new capital. If we were unsuccessful, the holders of the 14 ¼% Notes could demand repayment of the indebtedness owed to them on May 20, 2013. As a result, our ability to pay the principal of and interest on such indebtedness would be adversely affected.

 

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We may not be able to repurchase the 14¼% Notes or 13% Notes upon a change of control.

Upon the occurrence of certain specific kinds of change of control events, we (or our subsidiaries) will be required to jointly offer to repurchase all outstanding notes at 101% of the principal amount thereof plus, without duplication, accrued and unpaid interest and additional interest, if any, to the date of repurchase. However, it is possible that they will not have sufficient funds at the time of the change of control to make the required repurchase of all notes delivered by holders seeking to exercise their repurchase rights, particularly as that change of control may trigger a similar repurchase requirement for, or result in an event of a default under a debt indenture and may also constitute a cross-default on other indebtedness existing at that time. In addition, certain important corporate events, such as leveraged recapitalization that would increase the level of our indebtedness, would not constitute a “Change of Control” under the indenture.

Our indentures governing our 14¼% Notes and 13% Notes contain significant operating and financial restrictions which may limit our ability and our restricted subsidiaries’ ability to operate their business.

The indentures governing our 14 ¼% Notes and 13% Notes contain significant operating and financial restrictions on us and our subsidiaries. These restrictions limit the ability of us and our restricted subsidiaries to, among other things:

 

   

incur additional indebtedness or issue certain preferred shares;

 

   

create liens on certain assets to secure debt;

 

   

pay dividends or make other equity distributions;

 

   

purchase or redeem capital stock;

 

   

make certain investments;

 

   

transfer or sell assets;

 

   

agree to restrictions on the ability of restricted subsidiaries to make payments to us or the issuers;

 

   

consolidate, merge, sell or otherwise dispose of all or substantially all of our or an issuer’s assets; and

 

   

engage in transactions with affiliates.

These restrictions could limit the ability of us and our subsidiaries to finance future operations or capital needs, make acquisitions or pursue available business opportunities. We may be required to take action to reduce their debt or act in a manner contrary to our business objectives to satisfy these covenants. Events beyond our control, including changes in economic and business conditions in the markets in which we operate, may affect our ability to do so. We may not be able to satisfy these covenants. A breach of any of the covenants in our debt could result in a default under such debt, which could lead to that debt becoming immediately due and payable and, if such debt is secured, foreclosure on our assets that secure that obligation. A default under a debt instrument could, in turn, result in a default under other obligations and result in other creditors accelerating the payment of other obligations and foreclosing on asset security such debt, if any. Any such defaults could materially impair our financial conditions and liquidity.

Despite current indebtedness levels and restrictive covenants, we and our subsidiaries may still be able to incur substantial additional debt, which could exacerbate the risks described above.

We may be able to incur additional debt in the future, including debt secured by the collateral that secures our 14¼% Notes and 13% Notes, as well as other assets that do not secure such notes. Although the terms of the agreements governing our indebtedness contain restrictions on our ability to incur additional indebtedness, those restrictions are subject to a number of exceptions, and the indebtedness incurred in compliance with those restrictions could be substantial. In addition, if we are able to designate some of the restricted subsidiaries under the indenture governing the notes as unrestricted subsidiaries, those unrestricted subsidiaries would be permitted to borrow beyond the limitations specified in the indenture and engage in other activities in which restricted

 

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subsidiaries may not engage. If we incur any additional secured debt that ranks equally with the 13% Notes, the holders of that debt will be entitled to share ratably with the holders of the 13% Notes in any proceeds distributed in connection with any bankruptcy, liquidation, reorganization or similar proceedings. Adding new debt to current debt levels could intensify the related risks that we now face.

The issuance of the 13% Notes may subject us to additional currency exchange risks.

The 13% Notes were issued and paid for, and the interest to be paid on those notes will be paid, in U.S. dollars. However, the Canadian issuer of such notes receives revenues primarily in Canadian dollars (“CAD”). As a result, the financial condition of the Canadian issuer might be materially adversely affected if the U.S. dollar appreciates against the CAD. From time to time, if we determine it is appropriate and advisable to do so, we may seek to lessen the effect of exchange rate fluctuations through the use of derivative financial instruments. However, we cannot assure you that we will be successful in these efforts.

ADDITIONAL RISKS RELATED TO REGULATION

We are subject to constantly changing regulation, including the imposition of fees and taxes, the potential adverse effects which may have a material adverse impact on our competitive position, growth and financial performance.

Our operations are subject to constantly changing regulation. There can be no assurance that future regulatory changes will not have a material adverse effect on us, or that domestic, foreign or international regulators or third parties will not raise material issues with regard to our compliance or noncompliance with applicable regulations, any of which could have a material adverse effect upon our competitive position, growth and financial performance. As a multinational telecommunications company, we are subject to varying degrees of regulation in each of the jurisdictions in which we provide our services. Local laws and regulations, and the interpretation of such laws and regulations, differ significantly among the jurisdictions in which we operate. Enforcement and interpretations of these laws and regulations can be unpredictable and are often subject to the informal views of government officials. Potential future regulatory, judicial, legislative, and government policy changes in jurisdictions where we operate could have a material adverse effect on us. Many regulatory actions are underway or are being contemplated by governmental agencies.

In the U.S., the Communications Act of 1934, as amended (the “Communications Act”), and associated Federal Communications Commission (“FCC”) regulations, requires that every provider of interstate telecommunications carrier contribute, on an equitable and non-discriminatory basis, to federal universal service mechanisms established by the FCC, which affects our cost of providing services. At present, these contributions are calculated based on contributors’ interstate and international revenue derived from U.S. end users for telecommunications or telecommunications services, as those terms are defined under FCC regulations. AT&T Inc. filed a “Petition for Immediate Commission Action” on July 10, 2009, requesting that the FCC adopt a new mechanism for calculating federal universal service fund contribution that would be applicable to all contributors, including us. The specific proposal, which has been pending at the FCC for some time, is to determine contributions to the Universal Service Fund (“USF”) based on “assessable telephone numbers” rather than interstate and international revenues. We cannot predict whether the FCC will adopt this or some other contribution methodology, nor can we predict the potential impact on our business at this time. But a revised contribution methodology could increase our contribution obligation, including increasing our contribution disproportionately compared to some of our competitors. In such event, we may need to either raise the total amount of our consumer’s bills, potentially making us less competitive with other providers of communications services, or reduce our profit margins.

Increasingly, laws, regulations or rulings that apply to traditional telephone services are being extended to commerce and communications services that utilize Internet Protocol, including VoIP. We are unable to predict the impact, if any, that future legislation, judicial decisions or regulations concerning Internet Protocol products and services may have on our business, financial condition, and results of operations. Regulation may be targeted

 

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towards, among other things, fees, charges, surcharges, and taxation of VoIP services, liability for information retrieved from or transmitted over the Internet, online content regulation, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, filing requirements, consumer protection, public safety issues like E911, the Communications Assistance for Law Enforcement Act (“CALEA”), the provision of online payment services, broadband residential Internet access, and the characteristics and quality of products and services, any of which could restrict our business or increase our cost of doing business. The rules that the FCC has already extended to interconnected VoIP providers include:

 

   

rules with respect to the use of customer proprietary network information (“CPNI”) requiring VoIP providers to adhere to particular customer approval processes when using CPNI outside of pre-defined limits and when using CPNI for marketing purposes, and requiring VoIP providers to take certain steps to verify a customer’s identity before releasing any CPNI over the telephone or the Internet, and to report unauthorized disclosures of CPNI;

 

   

the disability access requirements of Sections 225 and 255 of the Communications Act, which have been interpreted by the FCC to require interconnected VoIP providers to contribute to the telecommunications relay services fund and offer 711 abbreviated dialing access to relay services, and to ensure that VoIP services are accessible to persons with disabilities, if reasonably achievable;

 

   

rules requiring VoIP providers to configure VoIP networks in a manner that facilitates lawful surveillance under CALEA;

 

   

rules requiring VoIP providers to permit customers to retain their assigned telephone numbers when changing carriers including newly established requirements to process customer carrier changes on an expedited basis;

 

   

rules requiring VoIP providers to provide access to E911 emergency services on terms generally similar to those provided by traditional landline carriers; and

 

   

rules requiring VoIP providers to pay regulatory fees based on reported interstate and international revenues.

In Canada the Canadian Radio-television and Telecommunications Commission (“CRTC”) has extended rules to interconnected VoIP providers that are similar to certain of those described above for the U.S., which rules are also subject to change from time to time. In addition, the CRTC is currently conducting public proceedings on whether to recover its operating fees from all telecommunications service providers, including resellers such as us, rather than only from Canadian carriers; and on whether and how to redefine the Basic Service Objectives, for whose subsidization we and other telecom service providers are required to contribute a proportion of our Canadian telecom service revenues.

The increasing growth of the VoIP market and popularity of VoIP products and services heighten the risk that governmental agencies will continue to increase the level of regulation applied to VoIP and the Internet.

Proposed future U.S. federal income tax legislation could impact the Company’s effective tax rate.

In May 2009, President Obama’s administration announced proposed future tax legislation that could substantially modify the rules governing the U.S. taxation of certain non-U.S. subsidiaries. These potential changes include, but are not limited to: (1) limitations on the deferral of U.S. taxation of foreign earnings; (2) limitations on the ability to claim and utilize foreign tax credits; and (3) deferral of various tax deductions until non-U.S. earnings are repatriated to the U.S. Each of these proposals would be effective for taxable years beginning after December 31, 2010. Many details of the proposal remain unknown, although if any of these proposals are enacted into law they could materially impact our effective tax rate.

 

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The applicability of changes in tax policy to our services will increase their cost to consumers thereby decreasing our competitive price advantage over the competing alternatives available to the customer. Further, we may be subject to liabilities for past taxes, surcharges, fees, penalties and interest.

Unlike those of our competitors who offer traditional landline or wireless services, with respect to our VoIP services, we currently do not collect or remit state or municipal taxes, fees or surcharges on the retail charges we collect from our customers, except where we have determined we are required to do so based on tax law. In some jurisdictions we also did not collect and remit 911 surcharges. In some instances, we have received inquiries or demands from state and municipalities for taxes, fees or surcharges, including, in some instances, 911 fees. Depending on the state, statute or municipal code, we have maintained that these taxes, fees, or surcharges, including 911 fees, do not apply to us. However, recent changes in the law, at the federal, state and local level, may change our legal obligations. Accordingly, some taxes, fees or surcharges, including 911 fees, could apply to us retroactively and we could be subject to penalties and interest.

Other international governmental regulation could limit our ability to provide our services, make them more expensive and may have a material adverse impact on our competitive position, growth and financial performance.

Our international operations are also subject to regulatory risks, including the risk that regulations in some jurisdictions will prohibit us from providing our services cost-effectively or at all, which could limit our growth. We cannot assure you that these conditions will not have a material effect on our revenues and growth in the future. International regulatory considerations that affect or limit our business include:

 

   

ongoing regulatory proceedings regarding efforts by Telstra in Australia to increase prices and charges and to deny access to essential facilities and services needed by us to compete;

 

   

the ultimate outcome of the process launched by the Australian government to help fund the construction of a new national broadband network, including whether and the terms upon which (a) we will have access to such network, and (b) the duration for which the copper wire based last mile infrastructure we use to furnish broadband services using our DSLAM network infrastructure will be continued;

 

   

a regulatory reform package recently announced by the Australian government that, if enacted, will (a) separate Telstra’s retail arm from its wholesale business (via either functional or structural separation); and (b) provide the ACCC with greater powers to set access prices;

 

   

general changes in access charges and contribution payments could adversely affect our cost of providing long-distance, wireless, broadband, VoIP, local and other services; and

 

   

regulatory proceedings in Canada determining whether and the extent to which regulation should mandate access to networks and interconnection including intra-exchange transport services which we use to interconnect our DSLAM collocation sites and high speed access to residential and business services.

Any adverse developments implicating the foregoing could materially adversely affect our business, financial condition, result of operations and prospects.

We may be exposed to significant liability resulting from our noncompliance with FCC orders regarding E911 services.

FCC rules require VoIP providers interconnected to the public switched telephone network to provide E911 service in a manner similar to traditional wireline carriers. This requirement took effect as of November 2005. Like many interconnected VoIP providers, Lingo, Inc. (“Lingo”), a subsidiary of ours which sells such services, was able to meet this deadline for some but not all of its customers. We sought a waiver from the FCC asking for additional time to complete deploying our E911 service. The FCC has not yet addressed our waiver petition. As

 

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of December 31, 2009, approximately 99% of our Lingo customers were equipped with E911 service as required by the FCC’s rules. If and to the extent that we are determined to be out of compliance with the FCC order regarding E911 services we may be subject to fines, penalties, cease and desist orders prohibiting Lingo from providing service on the federal and state levels or any combination of the foregoing.

The FCC rules also require interconnected VoIP providers to distribute stickers and labels informing customers of the limitations on their emergency services as compared with traditional landline E911 service, as well as to notify and obtain affirmative acknowledgement from customers that they are aware of those limitations. The FCC’s Enforcement Bureau released an order providing that the Enforcement Bureau will not pursue enforcement against interconnected VoIP providers that have received affirmative acknowledgement from at least 90% of their subscribers. We have received affirmative acknowledgement from substantially all of our customers, and, therefore, believe that we have effectively satisfied this requirement.

Lingo’s current E911 services are more limited than the 911 services offered by traditional wireline telephone companies. These limitations may cause significant delays, or even failures, in callers’ receipt of emergency assistance. Despite the fact that we have notified our customers and received affirmative acknowledgement from substantially all of our customers that they understand the differences between the access Lingo provides to emergency services as compared to those available through traditional wireline telephony providers, affected parties may attempt to hold us responsible for any loss, damage, personal injury or death suffered as a result of certain failures to comply with the FCC mandated E911 service for interconnected VoIP providers. Our resulting liability could be significant.

On June 1, 2007, the FCC released Notice of Proposed Rulemaking considering the imposition of additional E911 obligations on interconnected VoIP providers. Specifically, the FCC is considering requiring interconnected VoIP providers to determine automatically the physical location of their customer rather than allowing customers to manually register their location. Moreover, the notice includes a tentative conclusion that all interconnected VoIP service providers that allow customers to use their service in more than one location (nomadic VoIP service providers such as us) must utilize automatic location technology that meets the same accuracy standards applicable to providers of mobile phone service providers. At this time, we are unable to predict the outcome of this proceeding or its impact on us.

In July 2008, the “New and Emerging Technologies 911 Improvement Act of 2008” was signed into law. Previously, interconnected VoIP providers, like us, did not have the same protection from potential liability as applied wireline or wireless 911 emergency calling services. This law provides public safety entities, interconnected VoIP providers and others involved in handling 911 calls the same liability protections when handling 911 calls from interconnected VoIP users as from mobile or wired telephone service users. In October 2008, the FCC issued regulations implementing the provisions of the new law that require other entities involved in the provision of E911 services to make the technical capabilities used in such services available to VoIP providers, like us, on reasonable terms. The applicability of the liability protection to 911 calling services that do not conform to the FCC’s rules is unclear. Additionally, any liability associated with 911 call placement and handling prior to the enactment of this new law would not be covered. Therefore, while this law provides significant liability protection to interconnected VoIP providers such as us, we may still face significant and material liability with respect to any past, present or future failures of our E911 service to function properly.

We may be similarly exposed to liability in Canada in connection with emergency services associated with our VoIP services. A description of our regulatory obligations associated with our VoIP services in Canada is set forth under “Regulation.”

The rates we pay to interconnected telecommunications carriers in the U.S. may increase, which may reduce our profitability or increase the retail price of our service.

The FCC is considering reform of the methodology that regulated telecommunications carriers use to determine the appropriate payments for the exchange of traffic that is necessary to complete telephone calls to

 

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the traditional telephone network. The result of the FCC’s proceeding may be an increase in the rates we pay to such carriers to send traffic to or receive traffic from the traditional telephone network, which would increase our costs. Such a cost increase may result in us increasing the retail price of our service, which may make us less competitive in the communications marketplace, or may reduce our profitability. We cannot predict the outcome of this proceeding.

We may not be able to comply with recent FCC requirements regarding the transfer of telephone numbers to other providers when customers change providers.

In 2008, the FCC clarified that interconnected VoIP providers, such as us, are subject to its rules regarding transferring the telephone numbers of customers that choose to obtain service from other providers, including both interconnected VoIP providers and traditional carriers. In 2009, the FCC released an order that reduces the amount of time within which voice service providers must transfer a telephone number to a new provider. To comply with these new rules, we will likely have to implement new procedures and may have to increase staffing levels. Should this occur, we may need to increase the price of our retail service offering, which may make us less competitive with other providers of communications services or reduce our profitability. Should we not be able to comply with the order, we may be subject to fines, penalties, or cease and desist orders. At this time, we cannot accurately predict the full impact of this order on our business, as the industry is still developing the technical standards that will govern the new expedited number transfer procedures.

The FCC or federal courts may allow states in the U.S. to subject our service to state universal service fund obligations.

Several states have attempted to require nomadic interconnected VoIP providers to contribute to state universal service funds. One state, Nebraska, engaged in litigation with a provider of interconnected VoIP services similar to ours. The U.S. District Court for Nebraska issued a preliminary injunction on March 3, 2008, finding that the Nebraska Public Service Commission did not have jurisdiction to require universal service fund contributions from nomadic interconnected VoIP providers. A panel of the U.S. Circuit Court of Appeals for the Eighth Circuit affirmed the U.S. District court ruling on May 1, 2009. Subsequently, the Nebraska Public Service Commission requested a rehearing that the Court denied on June 5, 2009. On the basis of this litigation, we do not believe that existing law allows states to subject us to state universal service fund contribution obligations.

On July 16, 2009, Kansas and Nebraska filed a petition with the FCC requesting a declaratory ruling that states are not preempted from requiring nomadic interconnected VoIP providers to contribute to state universal service funds. The petition also seeks a retroactive ruling finding that states have been able to collect such contributions for a time period that is not clearly defined in the petition. At this time, we cannot predict the outcome of this proceeding nor its impact on our business. If we were required to pay retroactively into state-level universal service funds, that could have a material negative impact on our earnings.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

We currently lease our corporate headquarters facility, which is located in McLean, Virginia. Additionally, we lease administrative, technical and sales office space, as well as space for our switches and data centers, in various locations in the countries in which we operate. Total leased space in the United States, Australia, Canada, Brazil and the United Kingdom, as well as other countries in which we operate, approximates 593,000 square feet and the total annual lease costs are approximately $15.0 million. The operating leases expire at various times with the longest commitment expiring in 2019. We believe that our present administrative and sales office

 

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facilities are adequate for our anticipated operations and that similar space can be obtained readily as needed, and we further believe that the current leased facilities are adequate to house existing communications equipment.

Certain communications equipment which includes network switches and transmission lines are leased through operating leases, capital leases and vendor financing agreements.

 

ITEM 3. LEGAL PROCEEDINGS

The Company and its subsidiaries are subject to claims and legal proceedings that arise in the ordinary course of its business. Each of these matters is subject to various uncertainties, and it is possible that some of these matters may be decided unfavorably. The Company believes that any aggregate liability that may result from the resolution of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

ITEM 4. (REMOVED AND RESERVED)

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Common Stock

Primus Telecommunications Group, Incorporated (“we” or “us”) common stock has traded on the OTC Bulletin Board under the ticker symbol “PMUG” since July 1, 2009, (the “New Common Stock”). Shares of our common stock issued and outstanding immediately prior to July 1, 2009 (the “Old Common Stock”) traded on the over-the-counter market, both through listings on the OTC Bulletin Board and in the National Quotation Bureau “Pink Sheets.” The ticker symbol “PRTL” was assigned to our Old Common Stock for over the counter quotations. On June 30, 2009 share of our outstanding Old Common Stock were cancelled pursuant to the terms of our Plan of Reorganization and 9,600,000 share of New Common Stock were issued. We have no continuing obligations with respect to the Old Common Stock.

The following table provides the high and low sale prices for our common stock authorized in connection with our emergence from bankruptcy as reported on the over-the-counter market for the period beginning July 1, 2009 and for our Old Common Stock for the periods through June 30, 2009. These prices do not include retail markups, markdowns or commissions.

 

     Successor          Predecessor
     New Common Stock (1)          Old Common Stock (2)

Period

       High            Low                  High            Low    

2009

                

1st Quarter

              $ 0.09    $ 0.003

2nd Quarter

              $ 0.04    $ 0.01

3rd Quarter

   $ 7.75    $ 3.20           

4th Quarter

   $ 7.25    $ 5.60           
 

2008

                

1st Quarter

              $ 0.46    $ 0.27

2nd Quarter

              $ 0.45    $ 0.24

3rd Quarter

              $ 0.39    $ 0.23

4th Quarter

              $ 0.27    $ 0.05

 

(1) 9,600,000 Shares of New Common Stock were issued pursuant to the terms of our Plan of Reorganization and trading commenced on July 1, 2009 on a “when issued” basis. The New Common Stock was listed on the OTC Bulletin Board and trades under the ticker symbol “PMUG”.
(2) All outstanding shares of the Old Common Stock were cancelled pursuant to the terms of our Plan of Reorganization and no further trading occurred after June 30, 2009.

Dividend Policy

We have not paid any cash dividends on our common stock to date. The payment of dividends, if any, in the future is within the discretion of the Board of Directors and will depend on our earnings, our capital requirements and financial condition. Dividends are currently restricted by the senior secured notes and the senior subordinated secured notes indentures, and may be restricted by other credit arrangements entered into in the future by us. It is the present intention of the Board of Directors to retain all earnings, if any, for use in our business operations, and accordingly, the Board of Directors does not expect to declare or pay any dividends in the foreseeable future.

 

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Contingent Value Rights Distribution Agreement

Pursuant to the terms of the Plan, Group issued to holders of Old Common Stock contingent value rights (“Contingent Value Rights” or “CVRs”) to receive up to an aggregate of 2,665,000 shares (the “CVR Shares”) of New Common Stock. In connection with the issuance of the Contingent Value Rights, Group entered into a Contingent Value Rights Distribution Agreement (the “CVR Agreement”), in favor of holders of CVRs thereunder, dated as of the Effective Date.

The CVRs may not be transferred by the holder thereof except in certain limited circumstances. Subject to the terms of the CVR Agreement, holders of CVRs will receive their pro rata share of up to 2,665,000 CVR Shares. A distribution of CVR Shares is required to be made by Group if, as of any determination date (described below), Group’s equity value (assuming cash exercise in full on such date of in-the-money warrants and options of Group) divided by the sum of the number of shares of New Common Stock then issued and outstanding plus the number of shares of New Common Stock underlying warrants, options and similar securities of Group (other than CVRs) that are then in-the-money exceeds $35.95. The aggregate number of such shares of New Common Stock is referred to as the “Applicable Shares;” the price per share of $35.95, subject to adjustment as described below, is referred to as the “CVR Strike Price;” and the per share amount of any such excess over the CVR Strike Price is referred to as the “Excess Equity Value Per Share.” If such a distribution is required, the number of CVR Shares to be distributed by Group equals the product of Excess Equity Value Per Share multiplied by the number of Applicable Shares divided by the CVR Strike Price. Such product of Excess Equity Value Per Share and the number of Applicable Shares is referred to as the “Excess Equity Value.”

Group will determine if and to the extent a distribution of CVR Shares is required on January 1 and July 1 of each year, commencing on the first such date (but in no event later than July 1, 2013) on which data is available to confirm that Group’s adjusted EBITDA for the immediately preceding four fiscal quarters is equal to at least $100 million, and upon a change of control of Group. Distributions of CVR Shares (if any) will be made within 45 calendar days of a determination by Group that a distribution is required. Notwithstanding the foregoing, no distribution of CVR Shares is required to be made by Group unless Excess Equity Value exceeds $1 million as of any determination date.

The number of CVR Shares and the CVR Strike Price will be adjusted from time to time in connection with any stock dividend or distribution, or subdivision, split, combination, reclassification or recapitalization of the New Common Stock. In addition, if Group distributes to holders of New Common Stock any of its assets (including but not limited to cash), securities or rights to purchase securities of Group (other than any regular cash dividend not to exceed in any fiscal year 45% of the consolidated net income of Group for the immediately preceding fiscal year), then the number of CVR Shares will be increased and the CVR Strike Price will be decreased, in each case pursuant to the terms of the CVR Agreement. Additionally, in case of any reclassification, merger, consolidation, capital reorganization or other change in the capital stock of Group (other than in connection with a change of control) in which all or substantially all of the outstanding shares of New Common Stock are converted into or exchanged for stock, other securities or other property, Group shall make appropriate provision so that the holders of Contingent Value Rights shall thereafter be entitled to receive, at such time such holder would have otherwise been entitled to receive a distribution under the CVR Agreement, the kind and amount of stock and other securities and property having a value substantially equivalent to the value of New Common Stock that the holders of Contingent Value Rights would have been entitled to receive in connection with a distribution of CVR Shares immediately prior to such reclassification, merger, consolidation, reorganization or other change in the capital stock of Group at a CVR Strike Price that, in each case, is reasonably determined by the board of directors of Group after consultation with an independent valuation advisor to preserve, to the extent practicable, the intrinsic value of such CVR immediately prior to such event.

The Contingent Value Rights will expire and the CVR Agreement will terminate upon the earliest to occur of: (1) the date upon which no further CVR Shares are available for distribution, (2) the consummation of a change of control (subject to any potential distribution of CVR Shares as a result thereof), and (3) July 1, 2019.

 

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The foregoing description of the CVR Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of such agreement, a copy of which is attached as an exhibit to Group’s Form 8-A filed with the SEC on July 1, 2009 and such exhibit is incorporated herein by reference.

Holders of Common Stock

As of February 28, 2010, we had one holder of record of our common stock. The Company believes that this represents approximately 700 beneficial owners.

Recent Sales of Unregistered Securities

There are no unregistered sales of securities for 2009, other than the transactions that have been previously reported in our quarterly report on Form 10-Q for the period ended June 30, 2009, which description is incorporated herein by reference.

 

ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data set forth below should be read in conjunction with Item 7 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview” and (ii) our consolidated audited annual financial statements and the notes thereto, each of which are contained in Item 8 entitled “Financial Statements and Supplementary Data.”

As of July 1, 2009, the Company adopted fresh-start accounting in accordance with Accounting Standards Codification (ASC) No. 852. The adoption of fresh-start accounting resulted in the Company becoming a new entity for financial reporting purposes. Accordingly, the financial statements on or prior to July 1, 2009 are not comparable with the financial statements for periods after July 1, 2009. The consolidated condensed statements of operations and any references to “Successor” or “Successor Company” for the six months ended December 31, 2009, show the operations of the reorganized Company from and including July 1, 2009, the Effective Date, through December 31, 2009. References to “Predecessor” or “Predecessor Company” refer to the operations of the Company prior to July 1, 2009, except for Predecessor’s July 1, 2009 statements of operations which reflect only the effect of the plan adjustments and fresh-start accounting as of such date and do not reflect any operating results.

In accordance with ASC No. 805, the preliminary allocation of the reorganization value is subject to additional adjustment until the Company has completed its analysis, but not to exceed one year after emergence from bankruptcy, to provide the Company with the time to complete the valuation of its assets and liabilities. The final determination of the fair value of individual assets and liabilities and the final allocation of the reorganization value may differ from the amounts included in the consolidated financial statements and there can be no assurance that such adjustments will not be material.

 

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PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

    Successor          Predecessor  
    Six Months
Ended
December 31,
2009
         Six Months
Ended
July 1,
2009
    Year
Ended
December 31,
2008
    Year
Ended
December 31,
2007
    Year
Ended
December 31,
2006
    Year
Ended
December 31,
2005
 

NET REVENUE

  $ 424,334          $ 391,216      $ 895,863      $ 896,029      $ 993,034      $ 1,153,253   
 

OPERATING EXPENSES

               

Cost of revenue (exclusive of depreciation included below)

    278,417            255,288        569,865        551,303        653,905        766,963   

Selling, general and administrative

    102,911            95,836        260,430        281,010        278,951        369,666   

Depreciation and amortization

    39,530            12,346        32,791        30,529        47,002        85,952   

(Gain) loss on sale or disposal of assets

    181            (43     (6,028     1,463        14,158        13,364   

Asset impairment write-down

    —              —          —          —          206,139        —     
                                                   

Total operating expenses

    421,039            363,427        857,058        864,305        1,200,155        1,235,945   
                                                   

INCOME FROM OPERATIONS

    3,295            27,789        38,805        31,724        (207,121     (82,692

INTEREST EXPENSE

    (17,323         (14,135     (53,888     (61,347     (54,128     (53,394

ACCRETION ON DEBT PREMIUM, net

    (3         189        583        (449     (1,732     —     

CHANGE IN FAIR VALUE OF DERIVATIVES EMBEDDED WITHIN CONVERTIBLE DEBT

    —              —          —          —          5,373        —     

GAIN (LOSS) ON EARLY EXTINGUISHMENT OR RESTRUCTURING OF DEBT

    (4,146         —          36,872        (7,652     7,409        (1,693

GAIN (LOSS) FROM CONTINGENT VALUE RIGHTS VALUATION

    (2,804         —          —          —          —          —     

INTEREST INCOME AND OTHER INCOME (EXPENSE)

    564            396        3,279        5,665        2,584        2,098   

FOREIGN CURRENCY TRANSACTION GAIN (LOSS)

    18,384            21,121        (47,563     32,699        10,668        (12,285
                                                   

LOSS FROM CONTINUING OPERATIONS BEFORE REORGANIZATION ITEMS AND INCOME TAXES

    (2,033         35,360        (21,912     640        (236,947     (147,966
 

REORGANIZATION ITEMS, net

    (562         440,094        —          —          —          —     
                                                   

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

    (2,595         475,454        (21,912     640        (236,947     (147,966

INCOME TAX BENEFIT (EXPENSE)

    10,041            (3,907     366        9,232        (4,863     (3,809
                                                   

INCOME (LOSS) FROM CONTINUING OPERATIONS

    7,446            471,547        (21,546     9,872        (241,810     (151,775

LOSS FROM DISCONTINUED OPERATIONS, net of tax

    (271         (676     (326     (268     (4,673     2,157   

GAIN (LOSS) FROM SALE OF DISCONTINUED OPERATIONS, net of tax

    (110         251        —          6,132        7,415        —     
                                                   

NET INCOME (LOSS)

    7,065            471,122        (21,872     15,736        (239,068     (149,618

Less: Net loss attributable to the noncontrolling interest

    (333         32        (3,159     —          1,110        381   
                                                   

NET INCOME (LOSS) ATTRIBUTABLE TO PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED

  $ 6,732          $ 471,154      $ (25,031   $ 15,736      $ (237,958   $ (149,237
                                                   

BASIC INCOME (LOSS) PER COMMON SHARE:

               

Income (loss) from continuing operations attributable to Primus Telecommunications Group, Incorporated

  $ 0.74          $ 3.30      $ (0.17   $ 0.07      $ (2.14   $ (1.59

Gain (loss) from discontinued operations

    (0.03         —          (0.01     —          (0.05     0.03   

Gain (loss) from sale of discontinued operations

    (0.01         —          —          0.05        0.07        —     
                                                   

Net income (loss) attributable to Primus Telecommunications Group, Incorporated

  $ 0.70          $ 3.30      $ (0.18   $ 0.12      $ (2.12   $ (1.56
                                                   

DILUTED LOSS PER COMMON SHARE:

               

Income (loss) from continuing operations attributable to Primus Telecommunications Group, Incorporated

  $ 0.73          $ 2.72      $ (0.17   $ 0.06      $ (2.14   $ (1.59

Gain (loss) from discontinued operations

    (0.03         —          (0.01     —          (0.05     0.03   

Gain (loss) from sale of discontinued operations

    (0.01         —          —          0.03        0.07        —     
                                                   

Net income (loss) attributable to Primus Telecommunications Group, Incorporated

  $ 0.69          $ 2.72      $ (0.18   $ 0.09      $ (2.12   $ (1.56
                                                   

 

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    Successor          Predecessor  
    Six Months
Ended
December 31,
2009
         Six Months
Ended
July 1,
2009
    Year
Ended
December 31,
2008
    Year
Ended
December 31,
2007
    Year
Ended
December 31,
2006
    Year
Ended
December 31,
2005
 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

               

Basic

    9,600            142,695        142,643        128,771        112,366        95,384   
                                                   

Diluted

    9,800            173,117        142,643        196,470        112,366        95,384   
                                                   

AMOUNTS ATTRIBUTABLE TO COMMON SHAREHOLDERS OF PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED

               

Income (loss) from continuing operations, net of tax

  $ 7,113          $ 471,579      $ (24,705   $ 9,872      $ (240,700   $ (151,394

Gain (loss) from discontinued operations

    (271         (676     (326     (268     (4,673     2,157   

Gain (loss) from sale of discontinued operations

    (110         251        —          6,132        7,415        —     
                                                   

Net income (loss)

  $ 6,732          $ 471,154      $ (25,031   $ 15,736      $ (237,958   $ (149,237
                                                   

Balance Sheet Data:

 

     Successor          Predecessor  
      As of
December 31,

2009
         As of December 31,  

(in thousands)

            2008     2007     2006     2005  

Total assets

   $ 558,914         $ 330,444      $ 460,403      $ 392,250      $ 641,089   

Total long-term obligations (including current portion)

   $ 257,516         $ 604,837      $ 673,903      $ 644,074      $ 635,212   

Total liabilities

   $ 459,005         $ 789,169      $ 907,943      $ 860,506      $ 877,423   

Total Primus Telecommunications Group, Inc. stockholders’ equity (deficit)

   $ 99,909         $ (461,539   $ (447,540   $ (468,255   $ (236,334

Discontinued Operations Data:

 

     Successor           Predecessor  
     As of
December 31,

2009
          Six Months
Ended
July 1,

2009
    As of December 31,  

(in thousands)

             2008     2007     2006     2005  

Net revenue

   $ —             $ 300      $ 3,851      $ 9,961      $ 24,086      $ 34,143   

Operating expenses

   $ 38           $ 995      $ 4,610      $ 10,233      $ 28,640      $ 31,372   
                                                     

Income (loss) from operations

   $ (38        $ (695   $ (759   $ (272   $ (4,554   $ 2,771   

Interest expense

   $ —             $ —        $ —        $ (26   $ (47   $ (47

Interest income and other income (expense)

   $ (233        $ 19      $ 60      $ 39      $ (2   $ (120

Foreign currency transaction gain (loss)

   $ —             $ —        $ 376      $ (6   $ 10      $ (258
                                                     

Income (loss) before income tax

   $ (271        $ (676   $ (323   $ (265   $ (4,593   $ 2,346   

Income tax expense

   $ —             $ —        $ (3   $ (3   $ (80   $ (189
                                                     

Income (loss) from discontinued operations

   $ (271        $ (676   $ (326   $ (268   $ (4,673   $ 2,157   
                                                     

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated annual audited financial statements and the notes thereto, each of which are contained in Item 8 entitled “Financial Statements and Supplementary Data,” and other financial information incorporated by reference. Some of the information contained in this discussion and analysis includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Introduction and Overview of Operations

We are an integrated facilities-based communications services provider offering a portfolio of international and domestic voice, wireless, Internet, VoIP, data and data center services to customers located primarily in the United States Australia, Canada, Brazil, the United Kingdom and western Europe. Our primary markets are Australia and Canada where we have deployed significant network infrastructure. We classify our services into three categories: Growth Services, Traditional Services and Wholesale Services. Our focus is on expanding our Growth Services, which includes our broadband, IP-based voice, local, wireless, data and data center services, to fulfill the demand for high quality, competitively priced communications services. This demand is being driven, in part, by the globalization of the world’s economies, the global trend toward telecommunications deregulation and the migration of communication traffic to the Internet. We manage our Traditional Services, which includes our domestic and international long-distance voice, prepaid cards, dial-up Internet services and Australian off-network local services for cash flow generation that we reinvest to develop and market our Growth Services, particularly in our primary markets of Australia and Canada. We provide our wholesale voice termination services to other telecommunications carriers and resellers requiring IP or time-division multiplexing access.

Generally, we price our services competitively with the major carriers and service providers operating in our principal service regions. We seek to generate net revenue through sales and marketing efforts focused on customers with significant communications needs, including SMEs, multinational corporations, residential customers, and other telecommunications carriers and resellers.

Industry trends have shown that the overall market for domestic and international long-distance voice, prepaid phone cards and dial-up internet services has declined in favor of Internet-based, wireless and broadband communications. Our challenge concerning net revenue in recent years has been to overcome declines in long-distance voice minutes of use per customer as more customers are using wireless devices and the Internet as alternatives to the use of wireline phones. Also, product substitution (e.g., wireless/Internet for fixed line voice) has resulted in revenue declines in our long-distance voice services. Additionally, we believe that because deregulatory influences have begun to affect telecommunications markets outside the United States, the deregulatory trend is resulting in greater competition from the existing wireline and wireless competitors and from more recent entrants, such as cable companies and VoIP companies, which could continue to affect adversely our net revenue per minute, as well as minutes of use. More recently, adverse global economic conditions have resulted in a contraction of spending by business and residential customers generally which, we believe, has had an adverse affect on our net revenues.

In order to manage our network transmission costs, we pursue a flexible approach with respect to the management of our network capacity. In most instances, we (1) optimize the cost of traffic by using the least expensive cost routing, (2) negotiate lower variable usage based costs with domestic and foreign service providers, (3) negotiate additional and lower cost foreign carrier agreements with the foreign incumbent carriers and others, and (4) continue to expand/reduce the capacity of our network when traffic volumes justify such actions.

Our overall margin may fluctuate based on the relative volumes of international versus domestic long-distance services; carrier services versus business and residential long-distance services; prepaid services versus

 

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traditional post-paid voice services; Internet, VoIP and data services versus fixed line voice services; the amount of services that are resold; and the proportion of traffic carried on our network versus resale of other carriers’ services. Our margin is also affected by customer transfer and migration fees. We generally pay a charge to install and transfer a new customer onto our network and to migrate broadband and local customers. However, installing and migrating customers to our network infrastructure, enables us to increase our margin on such services as compared to resale of services using other carriers’ networks.

Selling, general and administrative expenses are comprised primarily of salaries and benefits, commissions, occupancy costs, sales and marketing expenses, advertising, professional fees, and other administrative costs. All selling, general and administrative expenses are expensed when incurred. Emphasis on cost containment and the shift of expenditures from non-revenue producing expenses to sales and marketing expenses has been heightened since growth in net revenue has been under pressure.

Emergence from Voluntary Reorganization Under Chapter 11 Proceedings

On March 16, 2009, the Holding Companies filed Chapter 11 Cases in the Bankruptcy Court for reorganization relief under Chapter 11 of the Bankruptcy Code. Subsequently, the Holding Companies sought and received an order directing the joint administration of the Chapter 11 Cases under the caption In re: Primus Telecommunications Group, Incorporated, et al., Debtors, Case No. 09-10867. On April 24, 2009, an unsecured creditors’ committee was appointed by the United States Trustee.

On April 27, 2009, the Bankruptcy Court approved the Holding Companies’ use of a disclosure statement dated April 27, 2009 (the “Disclosure Statement”) to solicit votes on the Plan of Reorganization. The Disclosure Statement was distributed to holders of record (as of April 27, 2009) of claims against, and interests in, the Holding Companies who were entitled to vote on the Plan of Reorganization (the “Record Date”).

The Plan was confirmed by the Bankruptcy Court on June 12, 2009 (the “Confirmation Date”). On the Effective Date, the Holding Companies consummated their reorganization under the Bankruptcy Code and the Plan of Reorganization became effective. See “Note 2—Emergence from Voluntary Reorganization under Chapter 11 of the Bankruptcy Code” to our consolidated financial statements for further details.

As of July 1, 2009, we adopted fresh-start accounting in accordance with Financial Accounting Standards Board ASC No. 852, “Reorganizations.” The adoption of fresh-start accounting resulted in the Company becoming a new entity for financial reporting purposes. Accordingly, the financial statements on or prior to July 1, 2009 are not comparable with the financial statements for periods after July 1, 2009. See “Note 4—Fresh-Start Accounting” to our consolidated financial statements for further detail.

Impact of Reorganization on Our Capital Structure, Long-Term Debt and Financial Statements.

Upon our emergence under the Plan of Reorganization on July 1, the Holding Companies’ principal debt was reduced by $316 million, or over 50%, interest payments were reduced by over 50% and certain debt maturities were extended. The significant features of the Plan included the developments summarized below:

 

   

Holding’s $96 million Term Loan facility due February 2011 was reinstated and amended;

 

   

IHC’s $173 million of outstanding 14 1/4% Senior Secured Notes due 2011 were cancelled and the holders thereof received their pro rata portion of $123.5 million of aggregate principal amount of 14 1/4% Senior Subordinated Secured Notes due May 20, 2013 and 4,800,000 shares of the new Common Stock of Group (the “New Common Stock”);

 

   

the $209 million in aggregate outstanding 5% Exchangeable Senior Notes and 8% Senior Notes issued by

 

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Holding (collectively, the “Holding Senior Notes”) were cancelled, and the holders thereof received 4,800,000 shares of the New Common Stock and Class A warrants to purchase up to an aggregate of 3,000,000 shares of New Common Stock;

 

   

the 3 3/4 % Senior Notes due September 2010, 12 3/4% Senior Notes due October 2009 and Step Up Convertible Subordinated Debentures due August 2009 issued by Group (collectively, the “Group Notes”) were cancelled, and the holders thereof received Class B warrants to purchase up to an aggregate of 1,500,000 shares of the New Common Stock;

 

   

all existing shares of common stock outstanding prior to the Effective Date (the “Old Common Stock”) were cancelled on the Effective Date, and holders thereof received their pro rata share of contingent value rights (“Contingent Value Rights” or “CVRs”) to acquire up to 2,665,000 shares of New Common Stock; and

 

   

all outstanding equity incentive grants of Group were cancelled on the Effective Date, and the Primus Telecommunications Group, Incorporated Management Compensation Plan (the “Management Compensation Plan”) became effective. As of the Effective Date, 400,000 restricted stock units, 400,000 service-based stock options and 100,000 performance-based stock options were granted to certain employees and executive officers under the Management Compensation Plan.

In accordance with the Plan, Group’s certificate of incorporation and bylaws were amended and restated in their entirety. Group’s Second Amended and Restated Certificate of Incorporation (the “Amended Certificate Incorporation”) and Amended and Restated By-Laws (the “Amended By-Laws”) both became effective on the Effective Date. The Amended Certificate of Incorporation provides for 80,000,000 shares of authorized New Common Stock and 20,000,000 shares of authorized new preferred stock, of which 9,600,000 shares of New Common Stock were issued on the Effective Date. A further description of the key provisions of the Amended Certificate of Incorporation and the Amended By-Laws is included in Group’s registration statement on Form 8-A under “Description of Capital Stock” filed with the SEC on July 1, 2009, which description is incorporated herein by reference. This description is qualified in its entirety by reference to the full text of these documents, which are attached as exhibits to such Form 8-A and such text is incorporated herein by reference.

Prior to the Effective Date, Group had approximated 142,695,390 shares of Old Common Stock issued and outstanding, and all of these shares were cancelled in connection with the effectiveness of the Plan. On the Effective Date, Group issued 9,600,000 shares of New Common Stock and had an additional 7,165,000 shares of New Common Stock reserved for future issuance in respect of claims and interests filed and allowed under the Plan, consisting of (1) 3,000,000 shares of new common stock reserved for issuance upon exercise of Class A warrants, (2) 1,500,000 shares of new common stock reserved for issuance upon exercise of Class B warrants, and (3) 2,665,000 shares of new common stock reserved for distribution on account of contingent value rights. The total number of shares of New Common Stock issued and reserved for issuance in respect of claims and interests filed and allowed under the Plan was 16,765,000. Including the shares of New Common Stock reserved for issuance under the Management Compensation Plan, the total number of shares of New Common Stock issued and reserved for issuance under the Plan was 17,765,000.

Foreign Currency

Foreign currency can have a major impact on our financial results. During 2009, approximately 82% of our net revenue was derived from sales and operations outside the U.S. The reporting currency for our consolidated financial statements is the United States dollar (“USD”). The local currency of each country is the functional currency for each of our respective entities operating in that country. In the future, we expect to continue to derive the majority of our net revenue and incur a significant portion of our operating costs from outside the U.S., and therefore changes in exchange rates have had and may continue to have a significant, and potentially adverse, effect on our results of operations. Our primary risk of loss regarding foreign currency exchange rate risk is caused primarily by fluctuations in the following exchange rates: USD/Canadian dollar (“CAD”), USD/Australian dollar (“AUD”), USD/British pound (“GBP”), and USD/Euro (“EUR”). Due to the large percentage of

 

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our revenue derived outside of the U.S., changes in the USD relative to one or more of the foregoing currencies could have an adverse impact on our future results of operations. We have agreements with certain subsidiaries for repayment of a portion of the investments and advances made to these subsidiaries. As we anticipate repayment in the foreseeable future, we recognize the unrealized gains and losses in foreign currency transaction gain (loss) on the consolidated statements of operations. The exposure of our income from operations to fluctuations in foreign currency exchange rates is reduced in part because a majority of the costs that we incur in connection with our foreign operations are also denominated in local currencies.

We are exposed to financial statement gains and losses as a result of translating the operating results and financial position of our international subsidiaries. We translate the local currency statements of operations of our foreign subsidiaries into USD using the average exchange rate during the reporting period. Changes in foreign exchange rates affect the reported profits and losses and cash flows and may distort comparisons from year to year. By way of example, when the USD strengthens compared to the EUR, there could be a negative or positive effect on the reported results for Europe, depending upon whether Europe is operating profitably or at a loss. It takes more profits in EUR to generate the same amount of profits in USD and a greater loss in EUR to generate the same amount of loss in USD. The opposite is also true. For instance, when the USD weakens there is a positive effect on reported profits and a negative effect on the reported losses for Europe.

In the year ended December 31, 2009, as compared to the year ended December 31, 2008, the USD was stronger on average as compared to the CAD and AUD; the USD was weaker on average as compared to the GBP and the EUR. The following tables demonstrate the impact of currency fluctuations on our net revenue for the years ended December 31, 2009 and 2008:

Net Revenue by Location—in USD (in thousands)

 

       For the Year Ended December 31,  
       2009
Net Revenue
     2008
Net Revenue
     Variance      Variance %  

Canada

     $ 224,397      $ 260,834      $ (36,437    (14 )% 

Australia

     $ 243,158      $ 276,413      $ (33,254    (12 )% 

United Kingdom

     $ 93,078      $ 87,706      $ 5,372       6

Europe

     $ 89,182      $ 87,623      $ 1,559       2

Net Revenue by Location—in Local Currencies (in thousands)

 

       For the Year Ended December 31,  
       2009
Net Revenue
     2008
Net Revenue
     Variance      Variance %  

Canada (in CAD)

     255,674      276,294      (20,621    (7 )% 

Australia (in AUD)

     308,068      324,724      (16,655    (5 )% 

United Kingdom (in GBP)

     59,919      48,335      11,583       24

Europe* (in EUR)

     63,633      59,640      3,993       7

 

* Europe includes only subsidiaries whose functional currency is the EUR.

In the year ended December 31, 2008, as compared to the year ended December 31, 2007, the USD was weaker on average as compared to the CAD, AUD and EUR, notwithstanding a significant strengthening of the USD relative to such currencies between June 30, 2008 and December 31, 2008, and stronger on average as compared to the GBP. The following tables demonstrate the impact of currency fluctuations on our net revenue for the year ended December 31, 2008 and 2007:

 

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Net Revenue by Location—in USD (in thousands)

 

       For the Year Ended December 31,  
       2008
Net Revenue
     2007
Net Revenue
     Variance      Variance %  

Canada

     $ 260,834      $ 262,412      $ (1,578    (1 )% 

Australia

     $ 276,413      $ 285,963      $ (9,550    (3 )% 

United Kingdom

     $ 87,706      $ 89,363      $ (1,657    (2 )% 

Europe

     $ 87,623      $ 81,891      $ 5,732       7

Net Revenue by Location—in Local Currencies (in thousands)

 

       For the Year Ended December 31,  
       2008
Net Revenue
     2007
Net Revenue
     Variance      Variance %  

Canada (in CAD)

     276,294      281,419      (5,125    (2 )% 

Australia (in AUD)

     324,724      341,361      (16,637    (5 )% 

United Kingdom (in GBP)

     48,335      44,773      3,562       8

Europe* (in EUR)

     59,640      59,771      (131    0

 

* Europe includes only subsidiaries whose functional currency is the EUR.

Critical Accounting Policies

To aid in the understanding of our financial reporting, our most critical accounting policies are described below. These policies have the potential to have a more significant impact on our financial statements, either because of the significance of the financial statement item to which they relate, or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events which are continuous in nature.

Revenue Recognition and Deferred Revenue—Net revenue is derived from carrying a mix of business, residential and carrier long-distance traffic, data and Internet traffic, and also from the provision of local, data center and wireless services. For voice and wholesale VoIP, net revenue is earned based on the number of minutes during a call and is recorded upon completion of a call, adjusted for allowance for doubtful accounts receivable, service credits and service adjustments. Revenue for a period is calculated from information received through our network switches. Customized software has been designed to track the information from the switch and analyze the call detail records against stored detailed information about revenue rates. This software provides us the ability to do a timely and accurate analysis of revenue earned in a period. Separate prepaid services software is used to track additional information related to prepaid service usage such as activation date, monthly usage amounts, fees and charges, and expiration date. Revenue on these prepaid services is recognized as service is provided until expiration, when all unused minutes, which are no longer available to the customers, are recognized as revenue.

Net revenue is also earned on a fixed monthly fee basis for unlimited local and long-distance plans and for the provision of data/Internet (including retail VoIP) and hosting services. Data/Internet and hosting services include monthly fees collected for the provision of dedicated and dial-up access at various speeds and bandwidths and collocation services. These fees are recognized as access and collocation is provided on a monthly basis. Additionally, service activation and installation fees are deferred and amortized over the longer of the average customer life or the contract term. We record payments received in advance for prepaid services and services to be provided under contractual agreements, such as Internet broadband and dial-up access, as deferred revenue until such related services are provided.

 

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A portion of revenue, representing less than 1% of total revenue, is earned from the sale of wireless handsets and VoIP routers. We apply the provisions of ASC No. 605-25, “Revenue Recognition—Multiple Element Arrangements,” which provides guidance on when and how an arrangement involving multiple deliverables should be divided into separate units of accounting. We have concluded that ASC No. 605-25 requires us to account for the sale of wireless handsets and VoIP routers and the related cost of handset and router revenues as a separate unit of accounting when title to the handset or router passes to the customer. Revenue recognized is the portion of the activation fees allocated to the router or handset unit of accounting in the statement of operations when title to the router or handset passes to the customer. We defer the portion of the activation fees allocated to the service unit of accounting and recognize such deferred fees on a straight-line basis over the contract life in the statement of operations.

Net revenue represents gross revenue, net of allowance for doubtful accounts receivable, service credits and service adjustments.

Allowance for doubtful accounts receivable—Determining our allowance for doubtful accounts receivable requires significant estimates. Due to the large number of customers that we serve, it is impractical to review the creditworthiness of each of our customers, although a credit review is performed for larger carrier and retail business customers. We consider a number of factors in determining the proper level of the allowance, including historical collection experience, current economic trends, the aging of the accounts receivable portfolio and changes in the creditworthiness of our customers. Systems to detect fraudulent call activity are in place within our network, but if these systems fail to identify such activity, we may realize a higher degree of uncollectible accounts.

Cost of revenue—Cost of revenue is comprised primarily of costs incurred from other domestic and foreign telecommunications carriers to originate, transport and terminate calls. The majority of our cost of revenue is variable, based upon the number of minutes of use, with transmission and termination costs being the most significant expense. Call activity is tracked and analyzed with customized software that analyzes the traffic flowing through our network switches and calculates the variable cost of revenue with predetermined contractual rates. If the domestic or foreign telecommunications carriers have tracked and invoiced the volume of minutes at levels different than what our activity shows or have invoiced at different rates, we will dispute the charges invoiced. There is no guarantee that we will prevail in such disputes. We use significant estimates to determine the level of success in dispute resolution and consider past historical experience, basis of disputes, financial status, and current relationships with vendors and aging of prior disputes in quantifying our estimates.

Valuation of long-lived assets—We review long-lived assets whenever events or changes indicate that the carrying amount of an asset may not be recoverable. In making such evaluations, we compare the expected undiscounted future cash flows to the carrying amount of the assets. If the total of the expected undiscounted future cash flows is less than the carrying amount of the assets, we are required to make estimates of the fair value of the long-lived assets in order to calculate the impairment loss equal to the difference between the fair value and carrying value of the assets.

We make significant assumptions and estimates in this process regarding matters that are inherently uncertain, such as determining asset groups and estimating future cash flows, remaining useful lives, discount rates and growth rates. The resulting undiscounted cash flows are projected over an extended period of time, which subjects those assumptions and estimates to an even larger degree of uncertainty. While we believe that our estimates are reasonable, different assumptions could materially affect the valuation of the long-lived assets.

We have concluded that we have one asset group: the network. This is due to the nature of our telecommunications network which utilizes all of the POPs, switches, cables and various other components throughout the network to seamlessly form the telecommunications gateway over which our products and services are carried for any given customer’s phone call or data or Internet transmission. Furthermore, outflows to many of the external network providers are not separately assignable to revenue inflows for any phone call or service plan.

 

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We make assumptions about the remaining useful life of our long-lived assets. The assumptions are based on the average life of our historical capital asset additions, our historical asset purchase trend and the fact that our primary assets, our network switches, have an 8-year life. Because of the nature of our industry, we also assume that the technology changes in the industry render all equipment obsolete with no salvage value after their useful lives. In certain circumstances in which the underlying assets could be leased for an additional period of time, we have included such estimated cash flows in our estimate.

The estimate of the appropriate discount rate to be used to apply the present value technique in determining fair value was our weighted average cost of capital, which is based on the effective rate of our long-term debt obligations at the current market values as well as the current volatility and trading value of our common stock.

Valuation of goodwill—Goodwill and other intangible assets—Under ASC No.350 “Intangibles—Goodwill and Other’, goodwill and indefinite lived intangible assets are not amortized but are reviewed annually for impairment, or more frequently, if impairment indicators arise. Intangible assets that have finite lives are amortized over their useful lives and are subject to the impairment provisions of ASC 360, “Property Plant and Equipment.”

Goodwill impairment is tested annually using a two-step process that begins with an estimation of the fair value of each reporting unit as of October 1. The first step is a screen for potential impairment by comparing the fair value of a reporting unit with its carrying amount. The second step measures the amount of impairment loss, if any, by comparing the implied fair value of the reporting unit goodwill with its carrying amount. The implied fair value of goodwill shall be determined in the same manner as the amount of goodwill recognized in a business combination is determined, that is through an allocation of the fair value of a reporting unit to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess.

Our reporting units are the same as our operating segments as each segment’s components have been aggregated and deemed a single reporting unit because they have similar economic characteristics. Each component is similar in that they each provide telecommunications services for which all of the resources and costs are drawn from the same pool, and are evaluated using the same business factors by management.

Intangible assets not subject to amortization consist of trade names. Such indefinite lived intangible assets are tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test shall consist of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of the intangible asset exceeds its fair value, an impairment loss shall be recognized in an amount equal to the excess.

Intangible assets subject to amortization consist of certain trade names and customer relationships. These finite lived intangible assets are amortized based on their useful lives. Such assets are subject to the impairment provisions of ASC 360, wherein impairment is recognized and measured only if there are events and circumstances that indicate that the carrying amount may not be recoverable. The carrying amount is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset group. An impairment loss is recorded if after determining that it is not recoverable, the carrying amount exceeds the fair value of the asset.

As disclosed in Note 4—“Fresh Start Accounting” to the Company’s consolidated financial statements, on July 1, 2009, the Company adopted fresh-start accounting in accordance with ASC No. 852, “Reorganizations.” Fresh-start accounting reflects the value of the Company as determined in the confirmed Plan. Under fresh-start accounting, the Company’s asset and liability values are re-measured and allocated in conformity with ASC No. 805, “Business Combinations.” The excess of reorganization value over the fair value of tangible and identifiable intangible assets is recorded as goodwill in the accompanying consolidated balance sheet. Fresh-start accounting also requires that all liabilities, other than deferred taxes, should be stated at fair value.

 

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The carrying values by reporting unit of the goodwill and other indefinite-lived intangible assets are disclosed in Note 6—“Goodwill and Other Intangible Assets,” to the Company’s Consolidated Financial Statements.

To facilitate the first step of the goodwill impairment analysis the Company first determines the fair value of each reporting unit as of October 1, the goodwill measurement date, and compares those amounts to the carrying value of the respective reporting units as of October 1, 2009. To the extent the fair value of the reporting unit exceeds the book value, no additional analysis is required and no impairment is recognized. To facilitate the Company’s calculation of the fair value of the reporting units, the valuation methods included (i) a discounted cash flow analysis, considering a range of between 12.5% and 17% weighted average costs of capital and market-based multiples of projected earnings of between 2.8 and 5.1 times for its terminal value. A key assumption in the fair value calculations is the Company’s future operating performance and resulting cash flow which is inherently subject to significant uncertainties and contingencies, and are based on management’s best estimates at the date of measurement. Potential events which could have a negative effect on the key assumptions include competitive actions, technological developments, regulatory actions and currency movements. For additional risk factors which could affect the assumptions see “Item 1A—Risk Factors” and “Item 7—Special Note Regarding Forward Looking Statements.” Accordingly, the Company cannot provide assurance that the estimates, assumptions, and values reflected in the valuations will be realized, and actual results could vary materially. The goodwill impairment test date of October 1, 2009, was three months after the initial recording of the fair value of our assets under fresh start accounting. After performing step one of the goodwill impairment test, no impairment was identified, as the fair value was greater than the carrying value of each reporting unit. In the reporting units with significant goodwill balances which are the United States and Canada, the Canada reporting unit is not at risk of failing step one of the test, but the United States reporting unit’s fair value exceeded the carrying value of the United States reporting unit by 15%. The increase in fair value for the Canadian Reporting Unit is due primarily to foreign currency translation as the United States dollar has weakened considerably and cost reduction initiatives were implemented in the second half of the year. Additionally, no impairment was recognized based on the analysis of the fair value of the intangible assets not subject to amortization as compared to their carrying value.

In addition to the forgoing, the Company reviews its goodwill and intangible assets for possible impairment whenever events or circumstances indicate that certain carrying amounts of assets may not be recoverable. The factors that the Company considers important, and which could trigger an impairment review, include, but are not limited to: a significant decline in the market value of our common stock or debt securities for a sustained period; a material adverse change in economic, financial market, industry or sector trends; a material failure to achieve operating results relative to historical levels or projected future levels; and significant changes in operations or business strategy.

Accounting for income taxes—We recognize deferred tax assets and liabilities for the expected future tax consequences of transactions and events. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement bases and the tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. If necessary, deferred tax assets are reduced by a valuation allowance to an amount that is determined to be more likely than not recoverable. We must make significant estimates and assumptions about future taxable income and future tax consequences when determining the amount of the valuation allowance. The additional guidance provided by ASC No. 740 “Income Taxes, clarifies the accounting for uncertainty in income taxes recognized in the financial statements. At January 1, 2007, its implementation resulted in adjustments to increase our total unrecognized tax benefits by $106.4 million. Expected outcomes of current or anticipated tax examinations, refund claims and tax-related litigation and estimates regarding additional tax liability (including interest and penalties thereon) or refunds resulting therefrom will be recorded based on the guidance provided by ASC No. 740 to the extent applicable.

At present, our subsidiaries in the major jurisdictions in which we operate have significant deferred tax assets resulting from tax loss carryforwards. With the exception of our Canadian companies, these deferred tax assets are fully offset with valuation allowances. The appropriateness and amount of these valuation allowances

 

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are based on our assumptions about the future taxable income of each affiliate or available tax planning strategies. Except in the case of our Canadian companies, if our assumptions have significantly underestimated future taxable income with respect to a particular affiliate, all or part of the valuation allowance for the affiliate would be reversed and additional income could result. With the exception of our Canadian affiliates, if our assumptions have significantly overestimated future taxable income with respect to a particular affiliate, there would be no change in the net value of the deferred tax asset and no additional income or tax expense would result. If our assumptions with respect to our Canadian affiliates have significantly overestimated future taxable income, a full or partial valuation allowance would be applied to the corresponding deferred tax assets and additional tax expense would result.

In accordance with ASC No. 852, for periods including and subsequent to the filing of the Chapter 11 petition, prior to the emergence from bankruptcy, all pre-petition liabilities subject to compromise were segregated in the Consolidated Condensed Balance Sheets and classified as liabilities subject to compromise, at management’s estimate of the amount of allowable claims. Liabilities not subject to compromise were separately classified as current and non-current in the Consolidated Condensed Balance Sheet. Revenues, expenses, realized gains and losses, and provisions for losses that result from the reorganization were reported separately as reorganization items, net, in the Consolidated Condensed Statements of Operations. Net cash used for reorganization items was disclosed separately in the Consolidated Condensed Statements of Cash Flows.

After the emergence from bankruptcy on July 1, 2009, the amounts reported on our subsequent financial statements materially changed. We adopted the “fresh start” provisions of ASC No. 852, which requires that all assets and liabilities except deferred taxes be restated to their fair value. Deferred tax balances have been established as a result of the differences in the basis adjustments from fresh-start accounting. Certain of these fair values differ materially from the values recorded on the Predecessor Consolidated Condensed Balance Sheets. Our emergence from reorganization resulted in a new reporting entity that had no retained earnings or accumulated deficit before the Effective Date. Additionally, we must also adopt any changes in GAAP that are otherwise required to be adopted within twelve months of such date. For all of these reasons, our Successor’s financial statements are not comparable to our Predecessor’s. See “Note 8—Income Taxes,” to the Company’s consolidated financial statements for further details.

Discontinued Operations

In the first quarter 2009, the Company sold certain assets of its Japan retail operations. The sale price was $0.4 million (40 million Japanese yen), which included $0.2 million (20 million Japanese yen) in cash and $0.2 million (20 million Japanese yen) receivable. The Company recorded a $0.3 million gain from sale of assets. The Company reported Japan retail operations as a discontinued operation.

In the second quarter 2008, the Company determined it would sell its German retail operations. However, buyers were not found; therefore the Company decided to cease operations of the German retail business during the first quarter of 2009.

In August 2007, the Company sold its 51% interest in its German telephone installation system subsidiaries. The sale price was $0.8 million (0.6 million Euros), which included $0.5 million (0.4 million Euros) in cash and $0.3 million (0.2 million Euros) for payment of outstanding intercompany debt. For the intercompany debt payment, the Company received $0.1 million (0.1 million Euros) in cash at closing. The balance owing is represented by a note receivable and will be paid in fifteen equal monthly installment payments. As a result, the Company recorded a $0.2 million gain from sale of assets. Net assets held for sale were $0.6 million at the closing date.

In February 2007, the Company sold its Australian domain name registry and web hosting subsidiary, Planet Domain. The sale price was $6.5 million ($8.3 million AUD). The Company received $5.5 million in net cash proceeds from the transaction after closing adjustments. As a result, the Company recorded a $6.0 million gain from sale of assets. The net assets of Planet Domain were $0.2 million at the closing date.

 

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As a result of these events, the Company’s consolidated financial statements for all periods presented reflect the Japan retail operations, German retail operations, discontinued German subsidiary and Planet Domain operations as discontinued operations for the six months ended December 31, 2009, six months ended July 1, 2009, years ended December 31, 2008 and 2007. Accordingly, revenue, costs, and expenses of the discontinued operations have been excluded from the respective captions in the consolidated statements of operations. The net operating results of the discontinued operations have been reported, net of applicable income taxes as loss from discontinued operations.

Summarized operating results of the discontinued operations for the year ended December 31, 2009, 2008 and 2007 are as follows:

 

     Successor           Predecessor  
      Six Months
Ended
December 31,

2009
          Six Months
Ended
July 1,

2009
    Year Ended December 31,  

(in thousands)

                 2008             2007      

Net revenue

   $ —             $ 300      $ 3,851      $ 9,961   

Operating expenses

   $ 38           $ 995      $ 4,610      $ 10,233   
                                     

Income (loss) from operations

   $ (38        $ (695   $ (759   $ (272

Interest expense

   $ —             $ —        $ —        $ (26

Interest income and other income (expense)

   $ (233        $ 19      $ 60      $ 39   

Foreign currency transaction gain (loss)

   $ —             $ —        $ 376      $ (6
                                     

Income (loss) before income tax

   $ (271        $ (676   $ (323   $ (265

Income tax expense

   $ —             $ —        $ (3   $ (3
                                     

Income (loss) from discontinued operations

   $ (271        $ (676   $ (326   $ (268
                                     

Explanatory Preliminary Note

In the following presentations and narratives within this Management’s Discussion and Analysis of Financial Condition and Results of Operations, we combine Successor’s results of operations for the period from July 2, 2009 to December 31, 2009 (the “Successor Period”) with Predecessor’s results of operations for the period from January 1, 2009 to July 1, 2009 and we compare these combined results of operations with Predecessor’s results of operations for the year ended December 31, 2008. We also present detailed changes in results, excluding currency impacts, since a large portion of our revenues are derived outside of the U.S., and currency changes can influence or mask underlying changes in foreign operating unit performance. We believe that the comparison of the combined financial results provide management and investors with a meaningful analysis of our performance and trends for comparative purposes. In addition, it should be noted that the application of fresh-start accounting will have a significant non-cash impact on our future results of operations, but will have no impact on the underlying cash flows of the Company.

We have combined the results of operations and the sources and uses of cash for the six months ended June 30, 2009 of the Predecessor and the six months ended December 31, 2009 for the Successor, and compared these combined results with the corresponding periods in 2008 and 2007 to provide a meaningful perspective on our financial and operational performance and trends in order to supplement GAAP data that would not otherwise have been available if we had not combined the results of operations and sources and uses of cash of the Predecessor and the Successor in this manner. The presentation of these combined results for the twelve months ended December 31, 2009 are intended to supplement investors’ understanding of our operating performance and liquidity. However, the combined presentation of the twelve months ended December 31, 2009 are not intended to replace net income (loss), cash flows, financial position or comprehensive income (loss), as determined in accordance with U.S. GAAP for the Predecessor and Successor periods. The Consolidated Financial Statements on or after July 1, 2009 are not comparable to the Consolidated Financial Statements prior to that date. For purposes of calculating constant currency rates between periods in connection with presentations

 

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that describe changes in values “excluding currency effects” herein, we have taken results from foreign operations for a given year (that were computed in accordance with GAAP using local currency) and converted such amounts utilizing the same U.S. dollar to applicable local currency exchange rates that were used for purposes of calculating corresponding preceding year GAAP presentations.

In reviewing the results and narratives below, it is important to note that there were significant effects resulting from the adoption of fresh-start accounting that affected our historical presentations and that will impact future results compared to pre-Reorganization results, including significant changes in:

 

   

debt balances and associated interest expense;

 

   

taxes and the adverse cash flow effects of our obligation to pay additional taxes compared to prior periods, given the termination of significant net operating loss carry-forward credits in connection with the Reorganization; and

 

   

depreciation and amortization, as triggered by our requirement to institute a new capital structure and fully re-measure our tangible and identifiable intangible assets.

Results of Operations

The following information for the years ended December 31, 2009, 2008 and 2007 reflects all the items included in consolidated statements of operations as a percentage of net revenue:

 

     Year Ended December 31,  
         2009             2008             2007      

NET REVENUE

   100.0   100.0   100.0

OPERATING EXPENSES

      

Cost of revenue (exclusive of depreciation included below)

   65.4   63.6   61.5

Selling, general and administrative

   24.4   29.1   31.4

Depreciation and amortization

   6.4   3.7   3.4

(Gain) loss on sale or disposal of assets

   0.0   -0.7   0.2
                  

Total operating expenses

   96.2   95.7   96.5
                  

INCOME FROM OPERATIONS

   3.8   4.3   3.5

INTEREST EXPENSE

   -3.9   -6.0   -6.8

ACCRETION (AMORTIZATION) ON DEBT PREMIUM/DISCOUNT, net

   0.0   0.1   -0.1

GAIN (LOSS) ON EARLY EXTINGUISHMENT OR RESTRUCTURING OF DEBT

   -0.5   4.1   -0.9

GAIN (LOSS) FROM CONTINGENT VALUE RIGHTS VALUATION

   -0.3   0.0   0.0

INTEREST AND OTHER INCOME

   0.1   0.4   0.6

FOREIGN CURRENCY TRANSACTION GAIN (LOSS)

   4.8   -5.3   3.6

LOSS FROM CONTINUING OPERATIONS BEFORE REORGANIZATION ITEMS AND INCOME TAXES

   4.1   -2.4   0.1

REORGANIZATION ITEMS, net

   53.9   0.0   0.0
                  

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

   58.0   -2.4   0.1

INCOME TAX BENEFIT (EXPENSE)

   0.7   0.0   1.0
                  

INCOME (LOSS) FROM CONTINUING OPERATIONS

   58.7   -2.4   1.1

LOSS FROM DISCONTINUED OPERATIONS, net of tax

   -0.1   0.0   0.0

GAIN (LOSS) FROM SALE OF DISCONTINUED OPERATIONS, net of tax

   0.0   0.0   0.7
                  

NET INCOME (LOSS)

   58.6   -2.4   1.8
                  

 

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The following information reflects net revenue by product line for the years ended December 31, 2009, 2008 and 2007 (in thousands, except percentages) and is provided for informational purposes and should be read in conjunction with the Consolidated Financial Statements and Notes.

 

(in thousands)

   2009    %     2008    %     2007    %  

Retail Voice

   $ 393,722    48   $ 461,817    52   $ 481,160    54

Wholesale

     212,961    26     197,278    22     170,450    19

Data/Internet

     160,040    20     182,891    20     196,198    22

Retail VOIP

     48,827    6     53,877    6     48,221    5
                                       

Total

   $ 815,550    100   $ 895,863    100   $ 896,029    100
                                       

Results of operations for the year ended December 31, 2009 as compared to the year ended December 31, 2008

Net revenue: Net revenue, exclusive of the currency effect, decreased $19.3 million, or 2.2%, to $876.5 million for the year ended December 31, 2009 from $895.9 million for the year ended December 31, 2008. Inclusive of the currency effect, which accounted for a decrease of $61.0 million, net revenue decreased $80.3 million to $815.6 million for the year ended December 31, 2009 from $895.9 million for the year ended December 31, 2008.

 

     Exclusive of Currency Effect           Inclusive of
Currency Effect
 
     Year Ended             Year Ended
December 31, 2009
 
     December 31, 2009     December 31, 2008     Year-over-Year          

(in thousands)

   Net
Revenue
   % of
Total
    Net
Revenue
   % of
Total
    Variance     Variance %     Currency
Effect
    Net
Revenue
   % of
Total
 
                     

Canada

     241,603    27.6     260,834    29.1     (19,231   -7.4     (17,206     224,397    27.5

Australia

     262,917    30.0     276,413    30.9     (13,496   -4.9     (19,759     243,158    29.9

Wholesale

     230,285    26.3     197,278    22.0     33,007      16.7     (17,323     212,962    26.1

United States

     66,146    7.5     86,578    9.7     (20,432   -23.6     —          66,146    8.1

Europe

     59,532    6.8     64,629    7.2     (5,097   -7.9     (5,338     54,194    6.6

Brazil

     16,040    1.8     10,131    1.1     5,909      58.3     (1,347     14,693    1.8
                                                             

Total Revenue

   $ 876,523    100.0   $ 895,863    100.0   $ (19,340   -2.2   $ (60,973   $ 815,550    100.0
                                                             

Canada: Canada net revenue, exclusive of the currency effect, decreased $19.2 million, or 7.4%, to $241.6 million for the year ended December 31, 2009 from $260.8 million for the year ended December 31, 2008. The net revenue decrease is primarily attributable to a decrease of $16.3 million in retail voice services, a decrease of $3.8 million in prepaid voice services, a decrease of $1.1 million in wireless services and a decrease of $0.3 million in local services offset, in part, by an increase of $2.3 million in Internet, data and hosting services. Inclusive of the currency effect, which accounted for a $17.2 million decrease, net revenue decreased $36.4 million to $224.4 million for the year ended December 31, 2009 from $260.8 million for the year ended December 31, 2008.

Australia: Australia net revenue, exclusive of the currency effect, decreased $13.5 million, or 4.9%, to $262.9 million for the year ended December 31, 2009 from $276.4 million for the year ended December 31, 2008. The net revenue decrease is primarily attributable to a decrease of $13.5 million in Internet services, a decrease of $3.1 million in residential voice and a decrease of $2.6 million in broadband services offset, in part, by increases of $3.9 million in business voice services and $1.9 million in wireless services. Inclusive of the currency effect, which accounted for a $19.8 million decrease, net revenue decreased $33.2 million to $243.2 million for the year ended December 31, 2009 from $276.4 million for the year ended December 31, 2008.

Wholesale: Wholesale net revenue, exclusive of the currency effect, increased $33.0 million, or 16.7%, to $230.3 million for the year ended December 31, 2009 from $197.3 million for the year ended December 31,

 

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2008. The net revenue increase is primarily a result of expanded routed capabilities and enhanced traffic volumes from existing customers and the obtainment of new customers. Inclusive of the currency effect which accounted for a $17.3 million decrease, net revenue increased $15.7 million to $213.0 million for the year ended December 31, 2009, from $197.3 million for the year ended December 31, 2008.

United States: United States net revenue decreased $20.4 million, or 23.6%, to $66.1 million for the year ended December 31, 2009 from $86.6 million for the year ended December 31, 2008. The decrease is primarily attributable to a decrease of $13.1 million in retail voice services (for residential and small businesses), a decrease of $5.6 million in VoIP services and a decrease of $1.8 million in Internet services.

Europe: Europe net revenue, exclusive of the currency effect, decreased $5.1 million, or 7.9%, to $59.5 million for the year ended December 31, 2009 from $64.6 million for the year ended December 31, 2008. The decrease is primarily attributable to a decline in retail voice services. Inclusive of the currency effect, which accounted for a $5.3 million decrease, net revenue decreased $10.4 million to $54.2 million for the year ended December 31, 2009 from $64.6 million for the year ended December 31, 2008.

Brazil: Brazil net revenue, exclusive of the currency effect, increased $5.9 million, or 58.4%, to $16.0 million for the year ended December 31, 2009 from $10.1 million for the year ended December 31, 2008. The revenue increase is due primarily to an increase in VoIP services. Inclusive of the currency effect, which accounted for a $1.3 million decrease, net revenue increased $4.6 million to $14.7 million for the year ended December 31, 2009 from $10.1 million for the year ended December 31, 2008.

Cost of revenue: Cost of revenue, exclusive of the currency effect, increased $5.3 million to $575.2 million, or 65.6% of net revenue, for the year ended December 31, 2009 from $569.9 million, or 63.6% of net revenue, for the year ended December 31, 2008. Inclusive of the currency effect, which accounted for a $41.5 million decrease, cost of revenue decreased $36.2 million to $533.7 million for the year ended December 31, 2009 from $569.9 million for the year ended December 31, 2008.

Canada: Canada cost of revenue, exclusive of the currency effect, decreased $8.4 million to $106.0 million, or 43.9% of net revenue, for the year ended December 31, 2009 from $114.4 million, or 43.9% of net revenue, for the year ended December 31, 2008. The decrease is primarily attributable to a decrease in net revenue of $19.2 million. Inclusive of the currency effect, which accounted for a $7.5 million decrease, cost of revenue decreased $15.9 million to $98.5 million for the year ended December 31, 2009 from $114.4 million for the year ended December 31, 2008.

Australia: Australia cost of revenue, exclusive of the currency effect, decreased $4.0 million to $165.4 million, or 62.9% of net revenue, for the year ended December 31, 2009 from $169.4 million, or 61.3% of net revenue, for the year ended December 31, 2008. The decrease is primarily attributable to a $13.5 million decrease in net revenue, offset in part by a $5.8 million reduction to cost of revenue in 2008 as the result of rulings by the Australian regulatory authority. Inclusive of the currency effect, which accounted for a $12.4 million decrease, cost of revenue decreased $16.4 million to $153.0 million for the year ended December 31, 2009 from $169.4 million for the year ended December 31, 2008.

Wholesale: Wholesale cost of revenue, exclusive of the currency effect, increased $30.4 million to $220.6 million, or 95.8% of net revenue, for the year ended December 31, 2009 from $190.2 million, or 96.4% of net revenue, for the year ended December 31, 2008. The increase is primarily attributable to an increase in net revenue of $33.0 million offset, in part, by lower costs, as a percentage of net revenues. Inclusive of the currency effect, which accounted for a $16.7 million decrease, cost of revenues decreased $13.7 million to $203.9 million for the year ended December 31, 2009 from $190.2 million for the year ended December 31, 2008.

United States: United States cost of revenue decreased $15.5 million to $29.9 million, or 45.2% of net revenue, for the year ended December 31, 2009 from $45.4 million, or 52.5% of net revenue, for the year ended December 31, 2008. The decrease is attributable to a decrease in net revenue of $20.4 million, a cost recovery of $1.5 million from a dispute settlement and lower costs resulting from our cost control initiatives.

 

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Europe: Europe cost of revenue, exclusive of the currency effect, decreased by $2.6 million to $41.5 million, or 69.7% of net revenue, for the year ended December 31, 2009 from $44.1 million, or 68.3% of net revenue, for the year ended December 31, 2008. The decrease is primarily due to a decrease in net revenue of $5.1 million offset, in part, by slightly higher costs, as a percentage of net revenue. Inclusive of the currency effect, which accounted for a $3.8 million decrease, cost of revenue decreased $6.4 million to $37.7 million for the year ended December 31, 2009 from $44.1 million for the year ended December 31, 2008.

Brazil: Brazil cost of revenue, exclusive of the currency effect, increased $5.3 million to $11.7 million, or 73.1% of net revenue, for the year ended December 31, 2009 from $6.4 million, or 62.8% of net revenue, for the year ended December 31, 2008. The increase is primarily attributable to an increase in net revenue of $5.9 million and a shift in the revenue product mix to lower margin products. Inclusive of the currency effect, which accounted for a $1.0 million decrease, cost of revenue increased $4.4 million to $10.8 million for the year ended December 31, 2009 from $6.4 million for the year ended December 31, 2008.

Selling, general and administrative expenses: Selling, general and administrative expenses, exclusive of the currency effect, decreased $48.8 million to $211.6 million, or 24.1% of net revenue, for the year ended December 31, 2009 from $260.4 million, or 29.1% of net revenue, for the year ended December 31, 2008. Inclusive of the currency effect, which accounted for a $12.9 million decrease, selling, general and administrative expenses decreased $61.7 million to $198.7 million for the year ended December 31, 2009 from $260.4 million for the year ended December 31, 2008.

Canada: Canada selling, general and administrative expense, exclusive of the currency effect, decreased $12.9 million to $85.0 million, or 35.2% of net revenue, for the year ended December 31, 2009 from $97.9 million, or 37.5% of net revenue, for the year ended December 31, 2008. The decrease is attributable to a decrease of $7.0 million in salaries and benefits, a decrease of $7.1 million in sales and marketing expenses and a decrease of $0.7 million in general and administrative expenses offset, in part, by an increase of $0.8 million in advertising expenses and $1.1 million of other expenses. Inclusive of the currency effect, which accounted for a $5.7 million decrease, selling, general and administrative expenses decreased $18.6 million to $79.3 million for the year ended December 31, 2009 from $97.9 million for the year ended December 31, 2008.

Australia: Australia selling, general and administrative expense, exclusive of the currency effect, decreased $18.9 million to $63.3 million, or 24.1% of net revenue, for the year ended December 31, 2009 from $82.2 million, or 29.7% of net revenue, for the year ended December 31, 2008. The decrease is attributable to a decrease of $6.1 million in salaries and benefits, a decrease of $8.4 million in sales and marketing expense, a decrease of $2.0 million in advertising expenses, a decrease of $1.7 million in general and administrative and a decrease of $0.7 million in all other expenses. Inclusive of the currency effect, which accounted for a $4.7 million decrease, selling, general and administrative expense decreased $23.6 million to $58.6 million for the year ended December 31, 2009 from $82.2 million for the year ended December 31, 2008.

Wholesale: Wholesale selling, general and administrative expense, exclusive of the currency effect, decreased $1.2 million to $7.2 million, or 3.1% of net revenue, for the year ended December 31, 2009 from $8.4 million, or 4.3% of net revenue, for the year ended December 31, 2008. Inclusive of the currency effect, which accounted for a $0.5 million decrease, selling, general and administrative expense decreased $1.7 million to $6.7 million for the year ended December 31, 2009 from $8.4 million for the year ended December 31, 2008.

United States: United States selling, general and administrative expense decreased $10.1 million to $25.1 million, or 37.9% of net revenue, for the year ended December 31, 2009 from $35.2 million, or 40.6% of net revenue, for the year ended December 31, 2008. The decrease is attributable to decreases of $4.0 million in salaries and benefits, $2.1 million in general and administrative expenses, $1.6 million in advertising expenses, $1.1 million in sales and marketing expense, $0.7 million in occupancy, and $0.6 million in other expenses.

Europe: Europe selling, general and administrative expense, exclusive of the currency effect, decreased $4.6 million to $17.2 million, or 28.8% of net revenue, for the year ended December 31, 2009 from $21.8 million, or

 

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33.7% of net revenue, for the year ended December 31, 2008. The decrease is attributable to a decrease of $1.8 million in salaries and benefits and $1.1 million of general and administrative and $1.7 million in other expenses. Inclusive of the currency effect, which accounted for a $1.7 million decrease, selling, general and administrative expense decreased $6.3 million to $15.5 million for the year ended December 31, 2009 from $21.8 million for the year ended December 31, 2008.

Brazil: Brazil selling, general and administrative expense, exclusive of the currency effect, decreased $0.5 million to $3.5 million, or 21.6% of net revenue, for the year ended December 31, 2009 from $4.0 million, or 39.8% of net revenue, for the year ended December 31, 2008. The decrease is attributable to a $0.6 million decrease in salaries and benefits and a $0.3 million decrease in sales and marketing offset in part by a $0.3 million increase in all other expenses. Inclusive of the currency effect, which accounted for a $0.3 million decrease, selling, general and administrative expense decreased $0.9 million to $3.1 million for the year ended December 31, 2009 from $4.0 million for the year ended December 31, 2008.

Corporate: Corporate selling, general and administrative expense decreased $0.3 million to $10.8 million for the year ended December 31, 2009 from $11.1 million for the year ended December 31, 2008. The decrease is primarily due to a decrease in salaries and benefits.

Depreciation and amortization expense: Depreciation and amortization expense was $51.9 and $32.8 million for the years ended December 31, 2009 and 2008, respectively. This change occurred as a result of the fair valuing of fixed and intangible assets per Fresh-Start accounting which was implemented effective July 1, 2009. See “Note 4—Fresh-Start Accounting” in our consolidated financial statements for further detail.

Interest expense and accretion (amortization) on debt discount/premium: Interest expense and accretion (amortization) on debt discount/premium, net decreased $22.0 million to $31.3 million for the year ended December 31, 2009 from $53.3 million for the year ended December 31, 2008. The decrease was due to the lower debt levels primarily resulting from the cancellation of certain indebtedness through the Plan of Reorganization, effective as of July 1, 2009.

Gain (loss) from contingent value rights valuation. The value of the contingent value rights decreased $2.8 million during 2009 due to the change of the fair market value. The Company determined these contingent value rights to be derivative instruments to be accounted for as liabilities and were marked to fair value, (and in future periods will be marked to fair value), at each balance sheet date. Upon issuance of the contingent value rights, the Company recorded a liability of $2.6 million in other liabilities as part of fresh-start accounting, and we will adjust this liability quarterly to its then estimated fair value, (which in future periods potentially could be substantially greater than the initial recorded liability balance). The change in fair value of the liability is reflected in our Statements of Operations as other income (expense). Estimates of fair value represent the Company’s best estimates based on a Black-Scholes pricing model.

Interest income and other (expense). Interest income and other (expense) decreased $2.3 million to $1.0 million for the year ended December 31, 2009 from $3.3 million expense for the year ended December 31, 2008.

Foreign currency transaction gain (loss): Foreign currency transaction gain increased $87.1 million to a gain of $39.5 million for the year ended December 31, 2009 from a loss of $47.6 million for the year ended December 31, 2008. The gains are attributable to the impact of foreign currency exchange rate changes on intercompany debt balances and on receivables and payables denominated in a currency other than the subsidiaries’ functional currency.

Reorganization items, net. Reorganization items reflect the favorable impact of $439.5 million for the year ended December 31, 2009 due to fresh-start accounting and revaluation of assets and liabilities ($188.6 million), gain on extinguishment of debt ($243.2 million), and reversal of future interest payments recorded as long-term obligations ($20.4 million), offset in part principally by the incurrence of professional fees as a result of the Chapter 11 Cases ($12.6 million).

 

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Income tax benefit (expense): Income tax benefit (expense) is a $6.1 million benefit for the year ended December 31, 2009 compared to a $0.4 million benefit for the year ended December 31, 2008. The benefit includes expenses consisting of foreign withholding tax on intercompany interest, the release of certain “ASC 740” liabilities as a result of the expiration of the statute of limitations and charges for uncertain tax positions under ASC No. 740, “Income Taxes.” The foreign tax expense was offset by a significant benefit from the release of deferred tax liabilities related to amortization of certain fresh-start adjustments to fixed assets and intangibles as discussed in “Note 8—Income Taxes,” to our consolidated audited financial statements.

Results of operations for the year ended December 31, 2008 as compared to the year ended December 31, 2007

Net revenue: Net revenue, exclusive of the currency effect, decreased $4.2 million, or 0.5%, to $891.8 million for the year ended December 31, 2008 from $896.0 million for the year ended December 31, 2007. Inclusive of the currency effect, which accounted for an increase of $4.1 million, net revenue decreased $0.1 million to $895.9 million for the year ended December 31, 2008 from $896.0 million for the year ended December 31, 2007.

 

    Exclusive of Currency Effect           Inclusive of Currency Effect  
    Year Ended                       Year Ended
December 31, 2008
 
    December 31, 2008     December 31, 2007     Year-over-Year          

(in thousands)

  Net
Revenue
  % of
Total
    Net
Revenue
  % of
Total
    Variance     Variance %     Currency
Effect
    Net
    Revenue    
  % of
    Total    
 
                 

Canada

  $ 258,066   28.9   $ 262,200   29.3   $ (4,134   -1.6   $ 2,768      $ 260,834   29.1

Australia

    272,090   30.5     284,935   31.8     (12,845   -4.5     4,323        276,414   30.9

Wholesale

    200,729   22.5     170,450   19.0     30,279      17.8     (3,451     197,278   22.0

United States

    86,578   9.7     101,583   11.3     (15,005   -14.8     —          86,579   9.7

Europe

    64,680   7.3     68,943   7.7     (4,263   -6.2     (51     64,629   7.2

Brazil

    9,662   1.1     7,918   0.9     1,744      22.0     469        10,129   1.1
                                                         

Total Revenue

  $ 891,805   100.0   $ 896,029   100.0   $ (4,224   -0.5   $ 4,058      $ 895,863   100.0
                                                         

Canada: Canada net revenue, exclusive of the currency effect, decreased $4.1 million, or 1.6%, to $258.1 million for the year ended December 31, 2008 from $262.2 million for the year ended December 31, 2007. The revenue decrease is primarily attributable to a decrease of $10.4 million in retail voice services, and a decrease of $1.1 million in prepaid voice services offset, in part, by an increase of $3.2 million in local service, an increase of $3.2 million in Internet, data and hosting, an increase of $0.7 million in VoIP and an increase of $0.2 million in wireless. Inclusive of the currency effect, which accounted for a $2.8 million increase, net revenue decreased $1.4 million to $260.8 million for the year ended December 31, 2008 from $262.2 million for the year ended December 31, 2007.

Australia: Australia net revenue, exclusive of the currency effect, decreased $12.8 million, or 4.5%, to $272.1 million for the year ended December 31, 2008 from $284.9 million for the year ended December 31, 2007. The revenue decrease is primarily attributable to a decrease of $16.9 million in Internet services, a decrease of $2.5 million in residential voice and, a decrease of $0.6 million in broadband services offset, in part, by increases of $5.4 million in business services, $0.9 million in wireless services and $0.9 million in VoIP and all other. Inclusive of the currency effect, which accounted for a $4.3 million increase, net revenue decreased $8.5 million to $276.4 million for the year ended December 31, 2008 from $284.9 million for the year ended December 31, 2007.

Wholesale: Wholesale net revenue, exclusive of the currency effect, increased $30.2 million, or 17.8%, to $200.7 million for the year ended December 31, 2008 from $170.5 million for the year ended December 31, 2007. Inclusive of the currency effect which accounted for a $3.5 million decrease, net revenue increased $26.8 million to $197.3 million for the year ended December 31, 2008, from $170.5 million for the year ended December 31, 2007.

 

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United States: U.S. net revenue decreased $15.0 million, or 14.8%, to $86.6 million for the year ended December 31, 2008 from $101.6 million for the year ended December 31, 2007. The decrease is primarily attributable to a decrease of $13.4 million in retail voice services (for residential and small businesses), a decrease of $1.5 million in Internet services and a decrease of $0.1 million in VoIP services.

Europe: Europe net revenue, exclusive of the currency effect, decreased $4.2 million, or 6.2%, to $64.7 million for the year ended December 31, 2008 from $68.9 million for the year ended December 31, 2007. The decrease is primarily attributable to a decrease of $3.9 million in retail voice, a decrease of $1.5 million in wireless services and a decrease of $0.6 million in other services, offset in part by an increase of $1.8 million in VoIP services. Inclusive of the currency effect, which had no impact, net revenue decreased $4.3 million to $64.6 million for the year ended December 31, 2008 from $68.9 million for the year ended December 31, 2007.

Brazil: Brazil net revenue, exclusive of the currency effect, increased $1.7 million, or 21.9%, to $9.7 million for the year ended December 31, 2008 from $7.9 million for the year ended December 31, 2007. The revenue increase is due primarily to an increase in VoIP services. Inclusive of the currency effect which accounted for a $0.5 million increase, net revenue increased $2.2 million to $10.1 million for the year ended December 31, 2008 from $7.9 million for the year ended December 31, 2007.

Cost of revenue: Cost of revenue, exclusive of the currency effect, increased $19.1 million to $570.4 million, or 64.0% of net revenue, for the year ended December 31, 2008 from $551.3 million, or 61.5% of net revenue, for the year ended December 31, 2007. Inclusive of the currency effect, which accounted for a $0.6 million decrease, cost of revenue decreased $18.6 million to $569.9 million for the year ended December 31, 2008 from $551.3 million for the year ended December 31, 2007.

Canada: Canada cost of revenue, exclusive of the currency effect, decreased $2.7 million to $113.6 million, or 44.0% of net revenue, for the year ended December 31, 2008 from $116.3 million, or 44.3% of net revenue, for the year ended December 31, 2007. The decrease is primarily attributable to a decrease in net revenue of $4.3 million. Inclusive of the currency effect, which accounted for a $0.8 million increase, cost of revenue decreased $1.9 million to $114.4 million for the year ended December 31, 2008 from $116.3 million for the year ended December 31, 2007.

Australia: Australia cost of revenue, exclusive of the currency effect, decreased $7.8 million to $167.4 million, or 61.5% of net revenue, for the year ended December 31, 2008 from $175.2 million, or 61.5% of net revenue, for the year ended December 31, 2007. The decrease is primarily attributable to a $12.8 million decrease in net revenue. Inclusive of the currency effect, which accounted for a $2.0 million increase, cost of revenue decreased $5.8 million to $169.4 million for the year ended December 31, 2008 from $175.2 million for the year ended December 31, 2007.

Wholesale: Wholesale cost of revenue, exclusive of the currency effect, increased $29.7 million to $193.6 million, or 96.4% of net revenue, for the year ended December 31, 2008 from $163.9 million, or 96.3% of net revenue, for the year ended December 31, 2007. The increase is primarily attributable to an increase in net revenue of $30.5 million. Inclusive of the currency effect, which accounted for a $3.4 million decrease, cost of revenues increased $26.3 million to $190.2 million for the year ended December 31, 2008 from $163.9 million for the year ended December 31, 2007.

United States: United States cost of revenue decreased $1.2 million to $45.4 million, or 52.5% of net revenue, for the year ended December 31, 2008 from $46.6 million, or 45.8% of net revenue, for the year ended December 31, 2007. The decrease was primarily due to a $1.9 million decrease in retail voice services and a $0.5 million decrease in Internet services partially offset by a $1.3 million increase in retail VoIP services.

Europe: Europe cost of revenue, exclusive of the currency effect, decreased by $1.0 million to $44.4 million, or 68.6% of net revenue, for the year ended December 31, 2008 from $45.4 million, or 65.8% of net revenue, for

 

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the year ended December 31, 2007. The decrease is primarily due to a decrease in net revenue of $4.3 million offset, in part, by slightly lower costs, as a percentage of net revenue. Inclusive of the currency effect, which accounted for a $0.2 million decrease, cost of revenue decreased $1.3 million to $44.1 million for the year ended December 31, 2008 from $45.4 million for the year ended December 31, 2007.

Brazil: Brazil cost of revenue, exclusive of the currency effect, increased $2.1 million to $6.1 million, or 63.2% of net revenue, for the year ended December 31, 2008 from $4.0 million, or 50.7% of net revenue, for the year ended December 31, 2007. The increase is primarily attributable to an increase in net revenue of $1.7 million and higher costs as a percentage of net revenue. Inclusive of the currency effect, which accounted for a $0.3 million increase, cost of revenue increased $2.4 million to $6.4 million for the year ended December 31, 2008 from $4.0 million for the year ended December 31, 2007.

Selling, general and administrative expenses: Selling, general and administrative expenses, exclusive of the currency effect, decreased $23.6 million to $257.4 million, or 28.9% of net revenue, for the year ended December 31, 2008 from $281.0 million, or 31.4% of net revenue, for the year ended December 31, 2007. Inclusive of the currency effect, which accounted for a $3.1 million increase, selling, general and administrative expenses decreased $20.6 million to $260.4 million for the year ended December 31, 2008 from $281.0 million for the year ended December 31, 2007.

Canada: Canada selling, general and administrative expense, exclusive of the currency effect, decreased $3.5 million to $96.7 million, or 37.5% of net revenue, for the year ended December 31, 2008 from $100.2 million, or 38.2% of net revenue, for the year ended December 31, 2007. The decrease is attributable to a decrease of $6.2 in advertising costs and $0.9 million in salaries and benefits offset, in part, by increases of $2.5 million in sales and marketing expenses and $1.2 million in general and administrative and all other expenses. Inclusive of the currency effect, which accounted for a $1.2 million increase, selling, general and administrative expenses decreased $2.3 million to $97.9 million for the year ended December 31, 2008 from $100.2 million for the year ended December 31, 2007.

Australia: Australia selling, general and administrative expense, exclusive of the currency effect, decreased $1.6 million to $80.3 million, or 29.5% of net revenue, for the year ended December 31, 2008 from $81.9 million, or 28.7% of net revenue, for the year ended December 31, 2007. The decrease is attributable to a decrease of $1.9 million in salaries and benefits, a decrease a decrease of $1.2 million in professional fees and a decrease of $0.2 million in general and administrative and all other expenses offset in part by increases of $1.2 million in advertising expenses and $0.5 million in occupancy costs. Inclusive of the currency effect, which accounted for a $1.9 million increase, selling, general and administrative expense increased $0.3 million to $82.2 million for the year ended December 31, 2008 from $81.9 million for the year ended December 31, 2007.

Wholesale: Wholesale selling, general and administrative expense, exclusive of the currency effect, decreased $0.4 million to $8.5 million, or 4.2% of net revenue, for the year ended December 31, 2008 from $8.9 million, or 5.2% of net revenue, for the year ended December 31, 2007. Inclusive of the currency effect, which accounted for a $0.1 million decrease, selling, general and administrative expense decreased $0.5 million to $8.4 million for the year ended December 31, 2008 from $8.9 million for the year ended December 31, 2007.

United States: United States selling, general and administrative expense decreased $5.3 million to $35.2 million, or 40.6% of net revenue, for the year ended December 31, 2008 from $40.5 million, or 39.8% of net revenue, for the year ended December 31, 2007. The decrease is attributable to a decrease of $2.5 million in salaries and benefits expense due to staff reduction efforts, a decrease of $1.7 million professional fees as the first quarter 2007 included significant expenses for litigation defense and the FIN No. 48 implementation, a decrease of $0.9 million in sales and marketing expenses and a decrease of $1.2 million in general and administrative expense offset, in part, by an increase of $1.0 million in advertising.

 

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Europe: Europe selling, general and administrative expense, exclusive of the currency effect, decreased $10.2 million to $22.0 million, or 34.0% of net revenue, for the year ended December 31, 2008 from $32.2 million, or 46.7% of net revenue, for the year ended December 31, 2007. The decrease is attributable to decreases of $4.1 in sales and marketing, $2.6 in occupancy costs, $1.1 million in salaries and benefits, and $2.4 million of general and administrative and all other expenses. Inclusive of the currency effect, which accounted for a $0.2 million decrease, selling, general and administrative expense decreased $10.4 million to $21.8 million for the year ended December 31, 2008 from $32.2 million for the year ended December 31, 2007.

Brazil: Brazil selling, general and administrative expense, exclusive of the currency effect, increased $0.8 million to $3.8 million, or 38.9% of net revenue, for the year ended December 31, 2008 from $3.0 million, or 37.7% of net revenue, for the year ended December 31, 2007. Inclusive of the currency effect, which accounted for a $0.3 million decrease, selling, general and administrative expense increased $1.0 million to $4.0 million for the year ended December 31, 2008 from $3.0 million for the year ended December 31, 2007.

Corporate: Corporate selling, general and administrative expense decreased $3.5 million to $11.1 million for the year ended December 31, 2008 from $14.6 million for the year ended December 31, 2007. The decrease is primarily due to a decrease in salaries and benefits.

Depreciation and amortization expense: Depreciation and amortization expense increased $2.3 million to $32.8 million for the year ended December 31, 2008 from $30.5 million for the year ended December 31, 2007. The increase consists of an increase in depreciation expense of $2.9 million for assets placed in service as we enhanced our network infrastructure and expanded our data centers.

(Gain) loss on sale or disposal of assets: (Gain) loss on sale or disposal of assets was a $6.0 million gain for the year ended December 31, 2008 compared to a $1.5 million loss for the year ended December 31, 2007. In the year ended December 31, 2008, we recognized a gain of $0.8 million associated with the sale of certain surplus fiber assets in the U.S., a gain of $1.7 million associated with a sale of a minority equity investment in a Japanese entity, and a gain of $4.6 million associated with the sale of primarily WiMAX spectrum assets, offset by a loss of $0.9 million associated with disposal of equipment owned by a minority equity investment in Canada.

Interest expense and accretion (amortization) on debt discount/premium: Interest expense and accretion on debt premium (discount), net decreased $8.5 million to $53.3 million for the year ended December 31, 2008 from $61.8 million for the year ended December 31, 2007. There was an increase of $3.4 million mainly resulting from issuance and exchange of our Original Second Lien Notes, offset by a $10.9 million decrease mainly resulting from reductions in principal outstanding balances of Group’s 12 3/4% senior notes due 2009 (the “12 3/4% Senior Notes”), Group’s step up convertible subordinated debentures due 2009 (the “Debentures”), the U.S. issuer’s 8% senior notes due 2014 (the “8% Senior Notes”), the 5% Exchangeable Senior Notes, and Group’s 3 3/4% convertible senior notes due 2010 (the “3 3/4% Convertible Senior Notes”) and from a decreased interest rate on our variable rate Term Loan Facility.

Gain (loss) on early extinguishment or restructuring of debt: Gain (loss) on early extinguishment or restructuring of debt was a $36.9 million gain for the year ended December 31, 2008 compared to a $7.7 million loss for the year ended December 31, 2007. In the second quarter of 2008, we exchanged $49.0 million principal amount of our 8% Senior Notes, $33.0 million principal amount of our 5% Exchangeable Senior Notes, $43.1 million principal amount of our 3 3/4% Convertible Senior Notes, $5.3 million principal amount of our 12 3/4% Senior Notes for $67.1 million principal amount of our newly issued Original Second Lien Notes and $4.7 million of cash, resulting in a gain on restructuring of debt of $32.3 million including the expensing of related financing costs. We made open market purchases of $0.8 million principal amount of our 12 3/4% Senior Notes, $13.8 million principal amount of our Debentures, and $2.1 million principal amount of our Original Second Lien Notes, resulting in a $4.2 million gain on early extinguishment of debt including the write-off of related deferred financing costs.

 

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In 2007, we converted $5.0 million principal amount of our Debentures to 6.0 million shares of our common stock, resulting in an induced debt conversion expense of $2.3 million, which includes deferred financing cost and discount write-offs. In first quarter of 2007, we issued in a private transaction $57.2 million principal amount of the Original Second Lien Notes in exchange for $40.7 million principal amount of the outstanding 12 3/4% Senior Notes and $23.6 million in cash. This exchange was deemed a debt modification, resulting in a $5.1 million loss on restructuring of debt for financing costs incurred. The remaining $0.9 million of expense in the three months ended June 30, 2007, resulted from costs related to the early retirement of a Canadian credit facility. The losses were offset by our open market purchases of $10.5 million principal amount of our 12 3/4% Senior Notes resulting in a $0.3 million gain on early extinguishment of debt including the write-off of related deferred financing costs and a $0.5 million gain on forgiveness of equipment financing in Brazil.

Interest and other income: Interest and other income of $0.1 million for the year ended December 31, 2008 was mainly interest income, offset by minority interest expense recognized for the gain from the sale of the Canadian WiMAX spectrum assets.

Foreign currency transaction gain (loss): Foreign currency transaction gain (loss) was $47.6 million loss for the year ended December 31, 2008 as compared to $32.7 million gain for the year ended December 31, 2007. The gain and loss are attributable to the impact of foreign currency exchange rate changes on intercompany debt balances and on receivables and payables denominated in a currency other than the subsidiaries’ functional currency.

Income tax benefit (expense): Income tax benefit (expense) was a benefit of $0.4 million for year ended December 31, 2008 as compared to a benefit of $9.2 million for the year ended December 31, 2007. In 2008, we closed certain federal and provincial income tax examinations in Canada for the years 2000 through 2005 (federal) and 2001 through 2005 (provincial) with all assessments being received. We also concluded an examination in the Netherlands for the years 2002, 2003, 2004, 2005 and 2006. Based on the final settlement, we reversed our remaining liability in the fourth quarter of 2008.

Liquidity and Capital Resources

Important Long-Term Capital Structure Developments:

In the fourth quarter 2009, we completed a private offering of $130 million in 13% Senior Secured Notes due 2016. Net proceeds, after deducting underwriting and transactional expenses, of $123.5 million were used principally to fully repay and terminate our $94.8 million senior secured term loan facility and $27.0 million Canadian credit facility, each of which were due in 2011. In connection with the July 2009 Reorganization and our December 2009 issuance of 13% Notes, we significantly adjusted our capital structure, our debt agreements’ covenants and terms, our debt service obligations and our long-term debt maturities. We believe these efforts have better aligned our capital structure with our business’s cash flow and liquidity expectations.

Changes in Cash Flows

Our principal liquidity requirements arise from cash used in operating activities, purchases of network equipment including switches, related transmission equipment and capacity, development of back-office systems, expansion of data center facilities, interest and principal payments on outstanding debt and other obligations and income taxes. We have financed our growth and operations to date through public offerings and private placements of debt and equity securities, vendor financing, capital lease financing and other financing arrangements.

Net cash provided by operating activities was $29.0 million for the year ended December 31, 2009 as compared to net cash provided by operating activities of $8.8 million for the year ended December 31, 2008. For the year ended December 31, 2009, net income, net of non-cash operating activity, provided $61.6 million of cash. In addition, cash was increased by a reduction in accounts receivable of $12.5 million, a reduction in

 

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prepaid expenses and other current assets of $2.3 million, a reduction in other assets of $4.3 million and an increase in accrued interest of $0.4 million. For the year ended December 31, 2009, we used, $20.5 million to reduce our accounts payable, $9.0 million to reduce our accrued income taxes, $2.6 million to reduce our accrued expenses, deferred revenue, other current liabilities and other liabilities, net, and $7.8 million to reduce our accrued interconnection costs. Cash effect of reorganization items was $12.2 million. Net cash provided by operating activities was $8.8 million for the year ended December 31, 2008 as compared to net cash provided by operating activities of $11.5 million for the year ended December 31, 2007. For the year ended December 31, 2008, net loss, net of non-cash operating activity, provided $34.1 million of cash. In addition, cash was increased by a reduction in prepaid expenses and other current assets of $10.2 million, a reduction in other assets of $1.9 million, and an increase in accrued interconnection costs of $2.2 million. In 2008, $15.7 million was used by an increase to accounts receivable. We used $5.9 million to reduce accounts payable, $10.6 to reduce our accrued income tax, $5.6 million to reduce deferred revenue, accrued expenses, and other liabilities and $1.8 million to reduce accrued interest.

Net cash used in investing activities was $15.1 million for the year ended December 31, 2009 compared to $18.7 million for the year ended December 31, 2008. Net cash used in investing activities during the year ended December 31, 2009 included $15.1 million of capital expenditures. Net cash used in investing activities was $18.7 million for the year ended December 31, 2008 compared to $39.5 million for the year ended December 31, 2007. Net cash used in investing activities during the year ended December 31, 2008 included $25.4 million of capital expenditures and $0.6 million for a customer list acquisition in Australia, offset by $4.9 million from the sale of certain primarily rural Canadian WiMAX spectrum assets (the cash proceeds from which can be used for operations within the variable interest entity but requires unanimous shareholder consent for a dividend distribution), $1.7 million net cash proceeds from the disposition of a minority equity investment in Japan and $0.8 million from the disposition of surplus fiber assets. Net cash used in investing activities during the year ended December 31, 2007 included $44.7 million of capital expenditures, $0.7 million to increase restricted cash, and $0.2 million to acquire an additional 39% of a subsidiary, offset by $6.1 million net cash proceeds from the disposition of our Australian Planet Domain subsidiary and a German subsidiary.

Net cash used in financing activities was $12.7 million for the year ended December 31, 2009 compared to $28.1 million for the year ended December 31, 2008. During the year ended December 31, 2009, $35.0 million was used to retire in full our Canadian Credit Facility, $96.3 million was used to retire in full the Senior-Secured Term Loan Facility, $4.9 million was used to reduce the principal amounts outstanding on capital leases, leased fiber capacity, financing facilities and other long-term obligations. Net cash proceeds received from the issuance of the Senior Secured Notes was $123.5 million. Net cash used in financing activities was $28.1 million for the year ended December 31, 2008 as compared to $41.5 million provided by financing activities for the year ended December 31, 2007. During the year ended December 31, 2008, $11.5 million was used to purchase and retire $0.8 million principal amount of our 12 3/4% Senior Notes, $13.8 million principal amount of our Debentures and $2.1 million principal amount of our Original Second Lien Notes. We also used $16.5 million for payments on capital leases, leased fiber capacity, financing facilities and other long-term obligations. During the year ended December 31, 2007, net cash provided by financing activities consisted of $102.7 million from the issuance of debt, net of issuance costs, which was comprised of $75.2 million principal amount of Original Second Lien Notes for $69.2 million in net cash, and $35.0 million from a credit facility with a financial institution (less $1.5 million in financing costs), and $19.2 million from the sale of 22.5 million shares of our registered common stock; partially offset by the retirement in full of $22.7 million principal amount of our 2000 convertible subordinated debentures, the retirement of $10.5 million principal amount of our 12 3/4% Senior Notes, the repayment in full of a $29.9 million Canadian Credit Facility and a $4.9 million capital lease financing, and $12.4 million principal payments of capital leases, leased fiber capacity, financing facilities and other long-term obligations.

 

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Short- and Long-Term Liquidity Considerations and Risks

As of December 31, 2009, we had $42.5 million of unrestricted cash and cash equivalents. We believe that our existing cash and cash equivalents will be sufficient to fund our debt service requirements, other fixed obligations (such as capital leases, vendor financing and other long-term obligations), and other cash needs for our operations for at least the next twelve months.

As of December 31, 2009, we have $24.8 million in future minimum purchase obligations, $64.2 million in future operating lease payments and $259.5 million of indebtedness. At December 31, 2009, approximately $89.7 million of unrecognized tax benefits have been recorded as liabilities in accordance with ASC No. 740; however, we are uncertain as to if or when such amounts may be settled, so we have not included these amounts in the table below.

The obligations reflected in the table below reflect the contractual payments of principal and interest that existed as of December 31, 2009:

 

(in thousands)

Year Ending December 31,

   Vendor
Financing
and Other
    13% Senior
Secured
Notes
    14 1 /4% Senior
Subordinated
Secured Notes
    Purchase
Obligations
   Operating
Leases
   Total  

2010

   $ 4,815      $ 16,665      $ 17,595      $ 17,719    $ 17,028    $ 73,822   

2011

     1,239        16,900        17,595        4,305      14,231      54,270   

2012

     329        16,900        17,595        2,761      12,546      50,131   

2013

     102        16,900        132,269        —        9,060      158,331   

2014

     28        16,900        —          —        3,727      20,655   

Thereafter

     20        163,847        —          —        7,578      171,445   
                                              

Total Minimum Principal & Interest Payments

     6,533        248,112        185,054        24,785      64,170      528,654   

Less: Amount

              

Representing Interest

     (546     (118,112     (61,582     —        —        (180,240
                                              

Total Long-Term Obligations

   $ 5,987      $ 130,000      $ 123,472      $ 24,785    $ 64,170    $ 348,414   
                                              

The foregoing table assumes that the 14 1/4% Notes are refinanced before January 21, 2013 and holders of 13% Notes do not accept any Excess Cash Flow Offer to purchase 13% Notes. In this regard, the Company must extend an offer to repurchase to the holders of the 13% Notes an applicable amount, (equal to 50% of Excess Cash Flow), of the 13% Notes at par, in the event the Company and certain subsidiaries have excess cash flow (as defined in Note 7 — Long Term Obligations.) for any fiscal year commencing with the fiscal year ending December 31, 2010. See Item 1A. “Risks Associated with our Liquidity Needs and Debt Securities.” for certain risks and uncertainties related thereto.

We have contractual obligations to utilize network facilities from certain carriers with terms greater than one year. We generally do not purchase or commit to purchase quantities in excess of normal usage or amounts that cannot be used within the contract term. We have minimum annual purchase obligations of $17.7 million, $4.3 million, and $2.8 million remaining in 2010, 2011 and 2012, respectively.

Newly Adopted Accounting Principles

Effective July 1, 2009, the Company adopted ASC No. 105, “Generally Accepted Accounting Principles.” ASC No. 105 establishes the FASB Accounting Standards Codification as the source of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements. The adoption did not have a material impact on its results of operations, financial position and cash flows.

Effective April 1, 2009, the Company adopted ASC No. 855, “Subsequent Events.” ASC No. 855 establishes principles and requirements for evaluating and reporting subsequent events and distinguishes which subsequent events should be recognized in the financial statements versus which subsequent events should be disclosed in the financial statements. The adoption did not have a material effect on the Company’s results of operations, financial position or cash flows.

 

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Effective January 1, 2009, the Company adopted ASC No. 810, “Consolidation.” This statement changes the presentation of outstanding noncontrolling interests in one or more subsidiaries or the deconsolidation of those subsidiaries. The adoption did not have a material effect on the Company’s results of operations, financial position or cash flows.

Effective January 1, 2009, the Company adopted ASC No. 470-20, “Debt with Conversion and Other Options.” ASC No. 470-20 requires issuers of convertible debt securities to separate securities into a debt component and an equity component, resulting in the debt component being recorded at fair value without consideration given to the conversion feature. Issuance costs are also allocated between the debt and equity components. ASC No. 470-20 requires that convertible debt within its scope reflect a company’s nonconvertible debt borrowing rate when interest expense is recognized. The adoption did not have a material effect on the Company’s results of operations, financial position or cash flows.

Effective January 1, 2009, the Company adopted ASC No. 805, “Business Combinations.” ASC No. 805 establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. The Company applied this standard on July 1, 2009 to the Fresh Start Balance Sheet, (See Note 4 “Fresh Start Accounting” for further detail).

In February 2008, the FASB issued ASC No. 820, “Fair Value Measurements.” The provisions of ASC No. 820 provide guidance for, among other things, the definition of fair value and the methods used to measure fair value, were adopted January 1, 2008 for financial instruments. The provisions adopted in 2008 did not have a material impact on the Company’s financial statements. ASC No. 820 delayed the effective date for all nonrecurring fair value measurements of nonfinancial assets and liabilities (except for those that are recognized or disclosed at fair value in the financial statements on a recurring basis) until financial years beginning after November 15, 2008, and changed the scope of ASC No. 820. On January 1, 2009, the Company adopted the remaining provisions of ASC No. 820 for nonrecurring fair value measurements of nonfinancial assets and liabilities. The provisions adopted in the first quarter 2009 did not have an impact on the Company’s financial statements as the Company did not have any fair value measurements of nonfinancial assets and liabilities for the year ended December 31, 2009.

The valuation techniques required by ASC No. 820 are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. These two types of inputs create the following fair value hierarchy:

Level 1: Quoted prices for identical instruments in active markets.

Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3: Significant inputs to the valuation model are unobservable.

The Company had a cross-currency principal and interest rate agreement with Lehman Brothers Special Financing, Inc., who entered bankruptcy in October 2008 and ceased performing on the agreement. The Company estimated the value to be zero, requiring a write-off of $1.2 million in 2008, and moved the instrument from Level 2 to Level 3 because the counter party’s credit risk is not observable.

In March 2008, the FASB issued ASC No. 815, “Derivatives and Hedging.” ASC No. 815 amends and expands the disclosure requirements with the intent to provide users of financial statements with an enhanced

 

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understanding of the use of derivative instruments, how derivative instruments and related hedged items are accounted for, and how derivative instruments and related hedged items affect an entity’s financial statements. ASC No. 815 is effective for financial statements issued for fiscal years interim periods beginning after November 15, 2008. In addition the Company accounted for the Contingent Value Rights Distribution Agreement in accordance with ASC No. 815, “Derivatives and Hedging” as well as related interpretations of this standard. The change in value of the Contingent Value Rights Distribution Agreement is reflected in our Statements of Operations as other income (expense), (see Note 2—Emergence from Voluntary Reorganization Under Chapter 11 of the Bankruptcy Code,” for further detail). The adoption of ASC No. 815 on January 1, 2009 did not have a material impact on the Company’s results of operations, financial position and cash flows.

New Accounting Pronouncements

In June 2009, the FASB issued ASC No. 810-10, “Consolidation,” which amends the definition of the primary beneficiary of a variable interest entity and will require the Company to assess each reporting period if any of the Company’s variable interests give it a controlling financial interest in the applicable variable interest entity. The provisions of ASC No. 810-10 will become effective for financial statements issued for fiscal years and interim periods begin after November 15, 2009. The Company is currently evaluating the impact the provisions of ASC No. 810-10 on its financial statements.

In May 2008, the FASB issued ASC No. 470-20, “Debt with Conversion and Other Options.” ASC No. 470-20 requires issuers of convertible debt securities to separate securities into a debt component and an equity component, resulting in the debt component being recorded at fair value without consideration given to the conversion feature. Issuance costs are also allocated between the debt and equity components. ASC No. 470-20 requires that convertible debt within its scope reflect a company’s nonconvertible debt borrowing rate when interest expense is recognized. ASC No. 470-20 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. The Company is currently evaluating the impact of ASC No. 470-20 on its financial statements, but does not believe there will be a material impact.

In April 2008, the FASB issued ASC No. 852-10, “Reorganizations”. ASC No. 852-10 nullifies certain requirements regarding changes in accounting principles that will be applicable to the financial statements of an entity emerging from bankruptcy. Any changes in accounting principles required within the twelve months following the implementation of fresh start accounting by such an entity are no longer required to be adopted at the time fresh start accounting is implemented. Entities emerging from bankruptcy that implement fresh start accounting should only follow accounting standards in effect at the date fresh start accounting is implemented, including any standards eligible for early adoption.

 

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Special Note Regarding Forward Looking Statements

Certain statements in this Report on Form 10-K and elsewhere concerning strategic objectives and initiatives, prospects, future liquidity, cost savings initiatives and related matters constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are based on current expectations, and are not strictly historical statements. In some cases, you can identify forward-looking statements by terminology such as “if,” “may,” “should,” “believe,” “anticipate,” “future,” “forward,” “potential,” “estimate,” “reinstate,” “opportunity,” “goal,” “objective,” “exchange,” “growth,” “outcome,” “could,” “expect,” “intend,” “plan,” “strategy,” “provide,” “commitment,” “result,” “seek,” “pursue,” “ongoing,” “include” or in the negative of such terms or comparable terminology. These forward-looking statements inherently involve certain risks and uncertainties, although they are based on our current plans or assessments which are believed to be reasonable as of the date of this filing. Forward-looking statements include, without limitation, statements set forth in this document and elsewhere regarding, among other things:

 

   

our financial condition, financing requirements, prospects and cash flow;

 

   

expectations of future growth, creation of shareholder value, revenue, foreign revenue contributions and net income, as well as income from operations, margins, earnings per share, cash flow and cash sufficiency levels, working capital, network development, customer migration and related costs, spending on and success with growth products, including broadband Internet, VOIP, wireless, local, data and hosting services, traffic development, capital expenditures, selling, general and administrative expenses, income tax and withholding tax expense, fixed asset and goodwill impairment charges, service introductions, cash requirements and potential asset sales;

 

   

increased competitive pressures, declining usage patterns, and our growth products, bundled service offerings, the pace and cost of customer migration onto our networks, the effectiveness and profitability of the growth products;

 

   

financing, refinancing, debt extension, de-leveraging, restructuring, exchange or tender plans or initiatives, and potential dilution of existing equity holders from such initiatives;

 

   

liquidity and debt service forecast;

 

   

assumptions regarding currency exchange rates;

 

   

timing, extent and effectiveness of cost reduction initiatives and management’s ability to moderate or control discretionary spending;

 

   

management’s plans, goals, expectations, guidance, objectives, strategies, and timing for future operations, acquisitions, asset dispositions, product plans, performance and results;

 

   

management’s assessment of market factors and competitive developments, including pricing actions and regulatory rulings; and

 

   

ability to generate net cash proceeds from the disposition of selective assets without material impairment to profitability.

Factors and risks that could cause actual results or circumstances to differ materially from those set forth or contemplated in forward looking statements include those set forth in “Risk Factors” as well as, without limitation:

 

   

the occurrence of a default or event of default under our indentures or other financing agreements;

 

   

an inability to fully fund and repurchase holder acceptances of offers to repurchase 13% Notes that we are obligated to make annually, subject to certain limitations, in connection with Excess Cash Flow Offers;

 

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an inability to fully fund and repurchase holder acceptances of offers to repurchase debt securities that we may be obligated to make following certain change in control developments affecting Group and certain of its subsidiaries;

 

   

customer, vendor, carrier and third-party responses to our completed Reorganization;

 

   

changes in business conditions causing changes in the business direction and strategy by management;

 

   

heightened competitive pricing and bundling pressures in the markets in which we operate;

 

   

the ability to service substantial indebtedness;

 

   

accelerated decrease in minutes of use on wireline phones;

 

   

fluctuations in the exchange rates of currencies, particularly of the USD relative to foreign currencies of the countries where we conduct our foreign operations;

 

   

adverse interest rate developments affecting our variable interest rate debt;

 

   

difficulty in maintaining or increasing customer revenues and margins through our product initiatives and bundled service offerings, and difficulties in migrating and provisioning broadband and local customers to digital subscriber line (DSL) networks;

 

   

inadequate financial resources to promote and to market product initiatives, whether due to acceptances of Excess Cash Flow Offers or otherwise;

 

   

fluctuations in prevailing trade credit terms or revenues due to the adverse impact of, among other things, further telecommunications carrier bankruptcies or adverse bankruptcy related developments affecting our large carrier customers;

 

   

the possible inability to raise additional capital when needed, on attractive terms, or at all;

 

   

possible claims under our existing debt instruments which could impose constraints and limit our flexibility;

 

   

the inability to service substantial indebtedness and to reduce, refinance, extend, exchange, tender for or restructure debt significantly, or in amounts sufficient to conduct regular ongoing operations;

 

   

the impact of the delisting of our common stock from the Nasdaq Capital Market which may impair our ability to raise capital;

 

   

further changes in the telecommunications or Internet industry, including rapid technological changes, regulatory and pricing changes in our principal markets and the nature and degree of competitive pressure that we may face;

 

   

adverse tax or regulatory rulings from applicable authorities;

 

   

enhanced broadband, DSL, Internet, wireless, VOIP, date and hosting and local and long distance voice telecommunications competition;

 

   

changes in financial, capital market and economic conditions;

 

   

changes in service offerings or business strategies, including the need to modify business models if performance is below expectations;

 

   

difficulty in retaining existing long distance wireline and dial-up ISP customers;

 

   

difficulty in migrating or retaining customers associated with acquisitions of customer bases, or integrating other assets;

 

   

difficulty in selling new services in the marketplace;

 

   

difficulty in providing broadband, DSL, local, VOIP, data and hosting or wireless services;

 

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changes in the regulatory schemes or requirements and regulatory enforcement in the markets in which we operate;

 

   

restrictions on our ability to execute certain strategies or complete certain transactions as a result of our inexperience with new products, or limitations imposed by available cash resources, our capital structure or debt covenants;

 

   

risks associated with our limited DSL, Internet, VOIP, data and hosting and wireless experience and expertise, including effectively utilizing new marketing channels such as interactive marketing employing the Internet;

 

   

entry into developing markets;

 

   

aggregate margin contribution from the new products is not sufficient in amount or timing to offset the margin decline in our legacy long distance voice and dial-up ISP businesses;

 

   

the possible inability to hire and/or retain qualified executive management, sales, technical and other personnel;

 

   

risks and costs associated with our effort to locate certain activities and functions off-shore;

 

   

risks associated with international operations;

 

   

dependence on effective information and billing systems;

 

   

possible claims for patent infringement on products or processes employed in providing our services;

 

   

dependence on third parties for access to their networks to enable us to expand and manage our global network and operations and to offer broadband, DSL, local, VOIP and wireless services, including dependence upon the cooperation of incumbent carriers relating to the migration of customers;

 

   

dependence on the performance of our global standard asynchronous transfer mode and Internet-based protocol (ATM+IP) communications network; risks associated with maintaining and upgrading networks; and

 

   

adverse regulatory rulings or actions affecting our operations, including the imposition of taxes and fees, the imposition of obligations upon VOIP providers to provide enhanced 911 (E911) services and restricting access to broadband networks owned and operated by others, including the development of a national broadband network in Australia.

As such, actual results or circumstances may vary materially from such forward looking statements or expectations. Readers are also cautioned not to place undue reliance on these forward looking statements which speak only as of the date these statements were made. We are not obligated to update or revise any forward looking statements, whether as a result of new information, future events or otherwise.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our primary market risk exposures relate to changes in foreign currency exchange rates, valuations of derivatives and to changes in interest rates.

Foreign currency can have a major impact on our financial results. Currently about 82% of our net revenue is derived from sales and operations outside the U.S. The reporting currency for our consolidated financial statements is the USD. The local currency of each country is the functional currency for each of our respective entities operating in that country. In the future, we expect to continue to derive the majority of our net revenue and incur a significant portion of our operating costs from outside the U.S., and therefore changes in exchange rates have had and may continue to have a significant, and potentially adverse, effect on our results of operations. Our primary risk of loss regarding foreign currency exchange rate risk is caused primarily by fluctuations in the following exchange rates: USD/CAD, USD/AUD, USD/GBP, and USD/EUR. Due to the large percentage of our revenue derived outside of the U.S., changes in the USD relative to one or more of the foregoing currencies could have an adverse impact on our future results of operations. We have agreements with certain subsidiaries for repayment of a portion of the investments and advances made to these subsidiaries. As we anticipate repayment in the foreseeable future, we recognize the unrealized gains and losses in foreign currency transaction gain (loss) on the consolidated statements of operations. We historically have not engaged in hedging transactions.

We are exposed to financial statement gains and losses as a result of translating the operating results and financial position of our international subsidiaries. We translate the local currency statements of operations of our foreign subsidiaries into USD using the average exchange rate during the reporting period. Changes in foreign exchange rates affect the reported profits and losses and cash flows and may distort comparisons from year to year. By way of example, when the USD strengthens compared to the EUR, there could be a negative or positive effect on the reported results for Europe, depending upon whether Europe is operating profitably or at a loss. It takes more profits in EUR to generate the same amount of profits in USD and a greater loss in EUR to generate the same amount of loss in USD. The opposite is also true. For instance, when the USD weakens there is a positive effect on reported profits and a negative effect on reported losses for Europe.

In the year ended December 31, 2009, as compared to the year ended December 31, 2008, the USD was stronger on average as compared to the AUD, CAD, and GBP; and weaker on average to the EUR. As a result, our revenue of the subsidiaries whose local currency is AUD, CAD, GBP and EUR increased (decreased) (5)%, (7)%, 24% and 7% in local currency compared to the year ended December 31, 2008, but increased (decreased) (12)%, (14)%, 6% and 2% in USD, respectively.

In the year ended December 31, 2008, as compared to the year ended December 31, 2007, the USD was weaker on average as compared to the AUD, CAD, and EUR, and stronger on average as compared to the GBP. As a result, our revenue of the subsidiaries whose local currency is AUD, CAD, GBP and EUR increased (decreased) (5)%, (2)%, 8% and (0)% in local currency compared to the year ended December 31, 2007, but increased (decreased) (3)%, (1)%, (2)% and 7% in USD, respectively.

Interest rates—The Senior Secured Notes and Senior Subordinated Secured Notes are at a fixed interest rate of 13.00% and 14.25%, respectively. We are exposed to interest rate risk as debt refinancing may be required. Our primary exposure to market risk stems from fluctuations in interest rates.

The interest rate sensitivity table below summarizes our market risks associated with fluctuations in interest rates for the year ended December 31, 2009 in USD, which is our reporting currency. The table presents principal cash flows and related weighted average interest rates by year of expected maturity for our Senior Secured Notes, Senior Subordinated Secured Notes, leased fiber capacity, and other long-term obligations in effect at December 31, 2009.

 

    Year of Maturity            
    2010     2011     2012     2013     2014     Thereafter     Total     Fair Value
    (in thousands, except percentages)

Fixed Rate

  $ 4,472      $ 1,142      $ 307      $ 123,566      $ 28      $ 130,005      $ 259,519      $ 250,729

Average Interest Rate

    12.4     10.8     8.8     14.2     4.0     13.0     13.6  

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

     Page

Management’s Report on Internal Control Over Financial Reporting

   F-2

Report of Independent Registered Public Accounting Firm

   F-3

Consolidated Financial Statements

  

Consolidated Statements of Operations for the years ended December 31, 2009, 2008 and 2007

   F-4

Consolidated Balance Sheets as of December 31, 2009 and 2008

   F-5

Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December  31, 2009, 2008 and 2007

   F-6

Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008 and 2007

   F-7

Consolidated Statements of Comprehensive Income (Loss) for the years ended December  31, 2009, 2008 and 2007

   F-8

Notes to the Consolidated Financial Statements

   F-9

 

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, as a result of the material weakness described below, our principal executive officer and our principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were not effective. Disclosure controls and procedures mean our controls and other procedures that are designed to ensure that information required to be disclosed by us in our reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Evaluation of Internal Control Over Financial Reporting.

As part of our compliance efforts relative to Section 404 of Sarbanes-Oxley Act of 2002, management assessed the effectiveness of internal control over financial reporting as of December 31, 2009. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on this assessment, management identified a material weakness in our internal controls over accounting for foreign currency transaction gain (loss) on inter-company balances. In March 2010, the Company determined that an error existed related to accounting for foreign currency transaction gain (loss) on certain inter-company balances. Specifically, this error related to activity in the third quarter 2009 resulting in the Company amending its Form 10-Q for the quarter ended September 30, 2009. Management concluded that, as of December 31, 2009, our internal controls over financial reporting were not effective based on the criteria set forth by COSO.

Management’s report on internal control over financial reporting as of December 31, 2009 appears on page F-2 and is incorporated herein by reference. 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 Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

Changes in Internal Control.

Our accounting for income taxes has significant complexity due to the nature of our business, our varied types of refinancing and debt transactions, the significant number of foreign subsidiary legal entities and various tax planning strategies. To address this complexity, on May 27, 2009, we re-hired our former Corporate Tax Director to provide oversight of the domestic, foreign and consolidated income tax responsibilities and on July 6, 2009 a new Manager of Taxation in our Canadian operating unit. Our Corporate Tax Director originally held this position from October 1, 2007—September 5, 2008. Additionally, we established procedures for foreign finance personnel to communicate regularly any tax concerns with the Corporate Tax Director, we purchased and implemented tax provision software and we developed quarterly tax documentation formats. We believe that the personnel hired have the appropriate knowledge, experience and skills related to accounting for income taxes and we have implemented

 

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and maintained the proper controls over accounting for income taxes. As a result of these changes in control, our management concluded as of December 31, 2009 that the controls surrounding accounting for income taxes are effective. See Item 1A, “Risk Factors; Risks Associated with our Financial Statements.”

As a result of the Company’s determination that the controls in place over the process of translating certain inter-company balances did not operate effectively as of December 31, 2009, the Company has designed new procedures and is implementing new controls to address the control failure that occurred, including: (a) performing additional recalculations and analysis of the foreign currency transaction gain (loss) recorded on inter-company balances; (b) implementing an improved process for assessing the reasonableness of foreign currency transaction gain (loss) recorded on these inter-company balances; and (c) confirming inter-company settlements related to these balances at a transactional level. Management believes that these corrective actions, taken as a whole, will successfully mitigate the material weakness described above, and the Company will continue to perform the enhanced procedures as part of the normal accounting process.

Other than the changes in accounting for income taxes and foreign currency transactions noted above, there have been no changes in our internal control over financial reporting or in other factors that could significantly affect internal controls over financial reporting, that occurred during the year ended December 31, 2009, that have materially affected, or is reasonably likely to affect materially, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

None.

 

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PART III

Certain of the information required by Part III will be provided in our definitive proxy statement for our 2010 annual meeting of stockholders, which definitive proxy statement will be filed pursuant to Regulation 14A not later than April 30, 2010 (“2010 Proxy Statement”), and is incorporated herein by this reference.

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information relating to our directors is set forth under the caption entitled “Election of Directors” in our 2010 Proxy Statement and is incorporated herein by reference. Information relating to our executive officers is set forth in our 2010 Proxy Statement under the caption “Executive Officers, Directors and Key Employees” and is incorporated herein by reference.

Section 16(a) Beneficial Ownership Reporting Compliance

Our executive officer, directors and 10% stockholders are required under the Securities Exchange Act of 1934 to file with the Securities and Exchange Commission reports of ownership and changes in ownership in their holdings in our stock. Based solely on an examination of these reports, all such reports have been timely filed.

Code of Ethics

We have adopted a Code of Ethics applicable to all directors, officers and employees, including the chief executive officer, senior financial officers and other persons performing similar functions. The Code of Ethics is a statement of business practices and principles of behavior that support our commitment to conducting business while maintaining the highest standards of business conduct and ethics. Our Code of Ethics covers topics including, but not limited to, compliance resources, conflicts of interest, compliance with laws, rules and regulations, internal reporting of violations and accountability for adherence to the Code. A copy of the Code of Ethics is available on our website at www.primustel.com. Any amendment of the Code of Ethics or any waiver of its provisions for a director, executive officer or senior financial officer must be approved by the Board of Directors. We will publicly disclose any such waivers or amendments pursuant to applicable SEC and the Over-the-Counter Bulletin Board regulations.

 

ITEM 11. EXECUTIVE COMPENSATION

The information regarding compensation of our officers and directors is set forth under the caption entitled “Executive Compensation” in our 2010 Proxy Statement and is incorporated herein by reference.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information regarding ownership of certain of our securities is set forth under the captions entitled “Security Ownership of Certain Beneficial Owners” and “Security Ownership of Management” in our 2010 Proxy Statement and is incorporated herein by reference.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Information regarding certain relationships and related transactions with us is set forth under the caption entitled “Certain Relationships and Related Transactions” in our 2010 Proxy Statement and is incorporated herein by reference.

 

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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The following table summarizes the aggregate fees paid by us to Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective affiliates (in thousands):

 

     2009    2008

Audit fees (a)

   $ 4,432.8    $ 2,902.5

Audit-related fees

     63.9      —  

Tax fees (b)

     595.7      629.4

All other fees (c)

     40.3      9.9
             

Total

   $ 5,132.7    $ 3,541.8
             

 

(a) Fees for audit services include audit of annual financial statements, as required by the Sarbanes-Oxley Act of 2002, Section 404, reviews of quarterly financial statements, statutory and regulatory audits, comfort letters, consents and other matters related to SEC filings.
(b) Fees for tax services include corporate tax compliance and tax planning and advice.
(c) Fees for other services include fees billed for permitted non-audit services.

In considering the nature of the services provided by Deloitte & Touche LLP, the Audit Committee determined that such services are compatible with the provision of independent audit services. The Audit Committee discussed these services with the independent registered public accounting firm and management to determine that they are permitted under the rules and regulations concerning auditor independence promulgated by the SEC to implement the Sarbanes-Oxley Act of 2002, as well as the American Institute of Certified Public Accountants.

Pre-Approval Policy

The services performed by the independent registered public accounting firm in 2009 were pre-approved in accordance with the pre-approval policy and procedures adopted by the Audit Committee at its February 4, 2004 meeting, as amended at its February 9, 2005 meeting. This policy describes the permitted audit, audit-related, tax, and other services (collectively, the “Disclosure Categories”) that the independent auditor may perform.

On a quarterly basis, the Audit Committee reviews a description of services (the “Service List”) expected to be performed by the independent registered public accounting firm in each of the Disclosure Categories, the status of services and fees incurred year-to-date against the original Service List and pre-approval limits and the forecast of remaining services and fees for the fiscal year.

Services provided by the independent registered public accounting firm during the year and included in the Service List were pre-approved in accordance with the policies and procedures of the Audit Committee.

Any requests for audit, audit-related, tax, and other services contemplated on the Service List must be submitted to the Audit Committee for specific pre-approval and cannot commence until such approval has been granted. Normally, pre-approval is provided at regularly scheduled meetings. However, the authority to grant specific pre-approval between meetings, as necessary, has been delegated to the Chairman of the Audit Committee. The Chairman must update the Audit Committee at the next regularly scheduled meeting of any services that were granted specific pre-approval.

 

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PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE

a) Financial Statements and Schedules

The financial statements as set forth under Item 8 of this report on Form 10-K are incorporated herein.

 

Financial Statement Schedules:

   Page

(II) Valuation and Qualifying Accounts

   S-1

All other financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.

b) Exhibit listing

 

Exhibit

Number

  

Description

2.11    Joint Plan of Reorganization of Primus Telecommunications Group, Incorporated and its Affiliate Debtors, as filed by the Debtors with the Bankruptcy Court on June 12, 2009.
3.12    Second Amended and Restated Certificate of Incorporation of Primus Telecommunications Group, Incorporated
3.22    Amended and Restated By-Laws of Primus Telecommunications Group, Incorporated
4.13    Class A Warrant Agreement, dated as of July 1, 2009, by and between Primus Telecommunications Group, Incorporated and StockTrans, Inc., as Warrant Agent
4.23    Class B Warrant Agreement, dated as of July 1, 2009, by and between Primus Telecommunications Group, Incorporated and StockTrans, Inc., as Warrant Agent
4.33    Contingent Value Rights Distribution Agreement of Primus Telecommunications Group, Incorporated
4.44    Indenture, dated as of December 22, 2009, by and among Primus Telecommunications Holding, Inc., Primus Telecommunications Canada Inc., the Guarantors party thereto, The Bank of New York Mellon, as Trustee, U.S. Bank National Association, as U.S. Collateral Trustee, and Computershare Trust Company of Canada, as Canadian Collateral Trustee, relating to Units, each Unit comprised of $653.85 principal amount of 13% Senior Secured Notes due 2016 issued by Primus Telecommunications Holding, Inc. (the “13% Holding Notes”) and $346.15 principal amount of 13% Senior Secured Notes due 2016 issued by Primus Telecommunications Canada Inc. (the “13% Canadian Notes”).
4.54    Form of Unit comprised of $653.85 principal amount of 13% Senior Secured Notes due 2016 issued by Primus Telecommunications Holding, Inc. and $346.15 principal amount of 13% Senior Secured Notes due 2016 issued by Primus Telecommunications Canada Inc. (included in Exhibit 4.1).
4.64    Form of 13% Senior Secured Note due 2016 issued by Primus Telecommunications Holding, Inc. (included in Exhibit 4.4).
4.74    Form of 13% Senior Secured Notes due 2016 issued by Primus Telecommunications Canada Inc. (included in Exhibit 4.4).
4.83    Specimen of Common Stock
4.93    Supplemental Indenture, dated as of July 1, 2009, by and among Primus Telecommunications IHC, Inc., the Guarantors thereto and U.S. Bank National Association, as Trustee

 

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Exhibit

Number

  

Description

  4.105    Intercreditor Agreement, dated as of February 26, 2007 (as amended), by and among Primus Telecommunications IHC, Inc., Primus Telecommunications Group, Incorporated, Primus Telecommunications Holding, Inc., and the parties thereto
  4.115    Collateral Agreement pursuant to the 14 1/4% Notes Indenture, dated as of February 26, 2007 (as amended), by and among Primus Telecommunications IHC, Inc., and the parties thereto
  4.12*    Collateral Agreement, dated as of December 22, 2009, made by Primus Telecommunications Holding, Inc. and certain of its Affiliates in favor of U.S. Bank National Association, as Collateral Trustee in respect of the 13% Holding Notes
  4.13*    Canadian Collateral Agreement, dated as of December 22, 2009, made by Primus Telecommunications Canada Inc. and certain of its Affiliates in favor of Computershare Trust Company of Canada, as Canadian Collateral Trustee in respect of the 13% Canadian Notes
  4.14*    New Debt Notice and Joinder Agreement, dated as of December 22, 2009
10.13    Separation Agreement by and between John F. DePodesta and Primus Telecommunications Group, Incorporated, dated as of July 1, 2009
10.23    Separation Agreement by and between Thomas R. Kloster and Primus Telecommunications, Inc., dated as of July 1, 2009
10.33    Primus Telecommunications Group, Incorporated Management Compensation Plan
10.43    Form of Restricted Stock Unit Agreement between Grantee and Primus Telecommunications Group, Incorporated, dated as of July 1, 2009
10.53    Form of Nonqualified Stock Option Agreement between Grantee and Primus Telecommunications Group, Incorporated, dated as of July 1, 2009
10.63    Form of Performance Nonqualified Stock Option Agreement between Grantee and Primus Telecommunications Group, Incorporated, dated as of July 1, 2009
10.76    Employment Agreement, dated April 26, 2007, between Primus Telecommunications Group, Incorporated and K. Paul Singh
10.87    401(k) Plan, as amended
12.1*    Ratio of Earnings to Fixed Charges
21.1*    Subsidiaries of the Registrant
23.1*    Consent of Independent Registered Public Accounting Firm
31*    Certifications.
328    Certification.

 

1

Incorporated by reference to the Registrant’s Form 8-K, filed with the Commission on June 15, 2009.

2

Incorporated by reference to the Registrant’s Registration Statement on Form 8-A, filed with the Commission on July 1, 2009.

3

Incorporated by reference to the Registrant’s Form 8-K, filed with the Commission on July 1, 2009.

4

Incorporated by reference to the Registrant’s Form 8-K, filed with the Commission on December 24, 2009.

5

Incorporated by reference to the Registrant’s Form 8-K/A dated March 16, 2007.

6

Incorporated by reference to the Registrant’s incorporated by reference to Registrant’s annual report on Form 10-K for the year ended December 31, 2007.

7

Incorporated by reference to Registrant’s Registration Statement on Form S-8 (No. 333-35005) and as amended on Post Effective Amendment No. 1 to Form S-8 filed with the SEC on March 26, 2003.

 

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8

Furnished Herewith. This certification is being “furnished” and will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act (15 U.S.C. 78r) and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the registrant specifically incorporates it by reference.

* Filed herewith.

 

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SIGNATURES

Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on April 5, 2010.

 

PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED
By:  

/s/    K. PAUL SINGH        

 

K. Paul Singh

Chairman of the Board, President and

Chief Executive Officer

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints K. Paul Singh, Thomas R. Kloster and James C. Keeley, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities to sign any and all amendments to this Form 10-K of the Securities and Exchange Commission for the fiscal year of Primus Telecommunications Group, Incorporated ended December 31, 2009, and to file the same, with all exhibits thereto, and other documents in connection therewith, with authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.

 

Signature

  

Title

 

Date

/s/    K. PAUL SINGH        

K. Paul Singh

  

Chairman, President and Chief Executive Officer (Principal Executive Officer) and Director

  April 5, 2010

/s/    THOMAS R. KLOSTER        

Thomas R. Kloster

  

Chief Financial Officer
(Principal Financial Officer)

  April 5, 2010

/s/    JAMES C. KEELEY        

James C. Keeley

  

Vice President, Corporate Controller
(Principal Accounting Officer)

  April 5, 2010

/s/    PETER D. AQUINO        

Peter D. Aquino

  

Director

  April 5, 2010

/s/    JOHN B. SPIRTOS        

John B. Spirtos

  

Director

  April 5, 2010

/s/    NEIL S. SUBIN        

Neil S. Subin

  

Director

  April 5, 2010

 

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Table of Contents

INDEX TO FINANCIAL STATEMENTS AND SCHEDULE

 

     Page

Management’s Report on Internal Control Over Financial Reporting

   F-2

Report of Independent Registered Public Accounting Firm

   F-3

Consolidated Financial Statements:

  

Consolidated Statements of Operations for the six months ended December 31, 2009, and July 1, 2009, and for the years ended December 31, 2008 and 2007

   F-4

Consolidated Balance Sheets as of December 31, 2009 and 2008

   F-5

Consolidated Statements of Stockholders’ Equity (Deficit) for the six months ended December 31, 2009, and July 1, 2009, and for the years ended December 31, 2008 and 2007

   F-6

Consolidated Statements of Cash Flows for the six months ended December 31, 2009, and July 1, 2009, and for the years ended December 31, 2008 and 2007

   F-7

Consolidated Statements of Comprehensive Income (Loss) for the six months ended December 31, 2009, and July 1, 2009, and for the years ended December 31, 2008 and 2007

   F-8

Notes to Consolidated Financial Statements

   F-9

Consolidated Financial Statement Schedule:

  

Schedule II. Valuation and Qualifying Accounts

   S-1

 

F-1


Table of Contents

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Primus Telecommunications Group, Incorporated (“Primus” or the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control system over financial reporting is 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. The Company’s internal control over financial reporting includes those policies and procedures that:

1. pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

2. provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with United States generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

3. provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in condition, or that the degree of compliance with the policies or procedures may deteriorate.

The Company’s management assessed the effectiveness of its internal control over financial reporting as of December 31, 2009. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on management’s assessment and those criteria, management concludes that Primus did not maintain effective internal control over financial reporting as of December 31, 2009, due to the material weakness in the Company’s internal control over accounting for foreign currency translation gain (loss) (details provided in Item 9A, Controls and Procedures of the Company’s Annual Report on Form 10-K for the period ended December 31, 2009). This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

 

/s/    K. PAUL SINGH        

  April 5, 2010

K. Paul Singh

Chairman, President and Chief

Executive Officer and Director

 

/s/    THOMAS R. KLOSTER

  April 5, 2010

Thomas R. Kloster

Chief Financial Officer

(Principal Financial Officer)

 

 

F-2


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Primus Telecommunications Group, Incorporated and subsidiaries

McLean, VA

We have audited the accompanying consolidated balance sheet of Primus Telecommunications Group, Incorporated and subsidiaries (the “Company” and “Successor”) as of December 31, 2009 and the related consolidated statements of operations, stockholders’ equity (deficit), cash flows, and comprehensive income (loss) for the six months ended December 31, 2009. We have also audited the accompanying balance sheet of Primus Telecommunications Group, Incorporated and subsidiaries (the “Company” and “Predecessor”) as of December 31, 2008 and the related consolidated statements of operations, stockholders’ equity (deficit), cash flows and comprehensive income (loss) for the six months ended July 1, 2009 and for the years ended December 31, 2008 and 2007. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule 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 audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Successor as of December 31, 2009 and the results of its operations and its cash flows for the six months ended December 31, 2009 and the financial position of the Predecessor as of December 31, 2008 and the results of its operations and its cash flows for the six months ended July 1, 2009 and for the years ended December 31, 2008 and 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Notes 2 and 4 to the consolidated financial statements, during 2009 the Company and certain subsidiaries filed for reorganization under Chapter 11 of the United States bankruptcy code, and emerged from bankruptcy under a plan of reorganization. As a consequence, the Company adopted fresh-start accounting in accordance with Accounting Standards Codification (“ASC”) No. 852, Reorganizations.

As discussed in Notes 3 and 8 to the consolidated financial statements, in 2007 the Company changed its method of accounting for uncertain tax positions to conform to ASC No. 740, Income Taxes (formerly Financial Accounting Standards Board Interpretation No. 48).

/s/ Deloitte & Touche LLP

McLean, Virginia

April 5, 2010

 

F-3


Table of Contents

PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

    Successor          Predecessor  
    Six Months
Ended
December 31,
2009
         Six Months
Ended
July 1,
2009
    Year
Ended
December 31,
2008
    Year
Ended
December 31,
2007
 

NET REVENUE

  $ 424,334          $ 391,216      $ 895,863      $ 896,029   

OPERATING EXPENSES

           

Cost of revenue (exclusive of depreciation included below)

    278,417            255,288        569,865        551,303   

Selling, general and administrative

    102,911            95,836        260,430        281,010   

Depreciation and amortization

    39,530            12,346        32,791        30,529   

(Gain) loss on sale or disposal of assets

    181            (43     (6,028     1,463   
                                   

Total operating expenses

    421,039            363,427        857,058        864,305   
                                   

INCOME FROM OPERATIONS

    3,295            27,789        38,805        31,724   

INTEREST EXPENSE

    (17,323         (14,135     (53,888     (61,347

ACCRETION (AMORTIZATION) ON DEBT PREMIUM/DISCOUNT, net

    (3         189        583        (449

GAIN (LOSS) ON EARLY EXTINGUISHMENT OR RESTRUCTURING OF DEBT

    (4,146         —          36,872        (7,652

LOSS FROM CONTINGENT VALUE RIGHTS VALUATION

    (2,804         —          —          —     

INTEREST AND OTHER INCOME

    564            396        3,279        5,665   

FOREIGN CURRENCY TRANSACTION GAIN (LOSS)

    18,384            21,121        (47,563     32,699   
                                   

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE REORGANIZATION ITEMS AND INCOME TAXES

    (2,033         35,360        (21,912     640   

REORGANIZATION ITEMS, net

    (562         440,094        —          —     
                                   

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

    (2,595         475,454        (21,912     640   

INCOME TAX BENEFIT (EXPENSE)

    10,041            (3,907     366        9,232   
                                   

INCOME (LOSS) FROM CONTINUING OPERATIONS

    7,446            471,547        (21,546     9,872   

LOSS FROM DISCONTINUED OPERATIONS, net of tax

    (271         (676     (326     (268

GAIN (LOSS) FROM SALE OF DISCONTINUED OPERATIONS, net of tax

    (110         251        —          6,132   
                                   

NET INCOME (LOSS)

    7,065            471,122        (21,872     15,736   

Less: Net (income) loss attributable to the noncontrolling interest

    (333         32        (3,159     —     
                                   

NET INCOME (LOSS) ATTRIBUTABLE TO PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED

  $ 6,732          $ 471,154      $ (25,031   $ 15,736   
                                   

BASIC INCOME (LOSS) PER COMMON SHARE:

           

Income (loss) from continuing operations attributable to Primus Telecommunications Group, Incorporated

  $ 0.74          $ 3.30      $ (0.17   $ 0.07   

Loss from discontinued operations

    (0.03         (0.00     (0.01     (0.00

Gain (loss) from sale of discontinued operations

    (0.01