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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 2004
COMMISSION FILE NUMBER: 000-28063
DELTATHREE, INC.
(Exact name of registrant as specified in charter)
Delaware 13-4006766
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
75 Broad Street, 31St Floor
New York, New York 10004 10004
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(Address of principal executive offices) (Zip code)
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Registrant's Telephone Number, Including Area Code: (212) 500-4850
Securities Registered Pursuant to Section 12(B) of the Act:
None.
Securities Registered Pursuant to Section 12(G) of the Act:
Name of Each Exchange on Which the
Title of Each Class Securities are Registered
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Class A Common Stock, par value $0.001 per share Nasdaq SmallCap Market
Indicate by a check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
The aggregate market value of the Class A common stock held by
non-affiliates of the Registrant based upon the closing price of the Class A
common stock as reported by The Nasdaq Stock Market on June 30, 2004 was
$37,185,159. Solely for purposes of this calculation, shares beneficially owned
by directors and officers of the Registrant and persons owning 5% or more of the
Registrant's Class A common stock have been excluded, in that such persons may
be deemed to be affiliates of the Registrant. Such exclusion should not be
deemed a determination or admission by the Registrant that such individuals or
entities are, in fact, affiliates of the Registrant.
The number of shares outstanding of the Registrant's capital stock as of
March 29, 2005 is as follows:
Title of Each Class Number of Shares Outstanding
At March 29, 2005
Class A Common Stock, $0.001 par value 29,961,086
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DELTATHREE, INC.
2004 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PAGE
PART I
ITEM 1. Business.......................................................... 4
ITEM 2. Properties........................................................ 15
ITEM 3. Legal Proceedings................................................. 16
ITEM 4. Submission of Matters to a Vote of Security Holders............... 17
PART II
ITEM 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities................. 18
ITEM 6. Selected Financial Data........................................... 20
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................... 21
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk........ 36
ITEM 8. Financial Statements and Supplementary Data....................... 36
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.......................................... 37
ITEM 9A Controls and Procedures........................................... 37
ITEM 9B Other Information................................................. 37
PART III
ITEM 10. Directors and Executive Officers of the Registrant................ 38
ITEM 11. Executive Compensation............................................ 42
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters................................... 50
ITEM 13. Certain Relationships and Related Transactions.................... 51
ITEM 14. Principal Accounting Fees and Service............................. 51
PART IV
ITEM 15. Exhibits, Financial Statement Schedules........................... 53
Index to Consolidated Financial Statement F-1
DELTATHREE, INC.
2004 ANNUAL REPORT ON FORM 10-K
The statements in this annual report that are not descriptions of
historical facts may be forward-looking statements. Those statements involve
substantial risks and uncertainties. You can identify those statements by the
fact that they contain words such as "anticipate," "believe," "estimate,"
"expect," "intend," "project" or other terms of similar meaning. Those
statements reflect management's current beliefs, but are based on numerous
assumptions, which we cannot control and that may not develop as we expect.
Consequently, actual results may differ materially from those projected in the
forward--looking statements. Among the factors that could cause actual results
to differ materially are: uncertainty of financial estimates and projections,
the competitive environment for Internet telephony, our limited operating
history, changes of rates of all related telecommunications services, the level
and rate of customer acceptance of new products and services, legislation that
may affect the Internet telephony industry, rapid technological changes, and the
risks, uncertainties and other matters discussed below under "Risk Factors" and
elsewhere in this annual report and in our other periodic reports filed with the
U.S. Securities and Exchange Commission.
PART I
ITEM 1. BUSINESS
General
We are a provider of integrated Voice over Internet Protocol (VoIP)
telephony services. We were founded in 1996 to capitalize on the growth of the
Internet as a communications tool by commercially offering Internet Protocol
(IP) telephony services. IP telephony is the real time transmission of voice
communications in the form of digitized "packets" of information over the
Internet or a private network, similar to the way in which e-mail and other data
is transmitted. Our business currently includes: the provision of enhanced
Web-based and other communications services to individual consumers under our
iConnectHere brand name; the provision of enhanced Web-based and other
communications services to international resellers, under either their own brand
name, a white-label brand, and/or our iConnectHere brand name; the provision of
a "Hosted Communications Solution" that enables resellers, corporate customers
and service providers to offer private label telecommunications to their
customer bases, and the transmission of voice and data traffic for
communications carriers.
We have built a privately-managed, global network using IP technology and
offer our customers a unique suite of IP telephony products, including
PC-to-Phone and Broadband Phone products. We differentiate ourselves from our
competitors by providing a robust set of value-added services that enables us to
effectively address the challenges that have traditionally made the provision of
telecommunications services difficult, and we offer our products and services to
a global customer base in a fashion that meets the disparate needs of this
diverse customer set. These operations management tools include: account
provisioning; e-commerce based payment processing systems; billing and account
management; and customer care. We are able to provide our services at a cost to
users that is generally lower than that charged by traditional carriers because
we minimize our network costs by using efficient packet-switched technology and
we generally avoid local access charges and bypass international settlement
charges by routing international long distance calls over our privately-managed
network.
4
Prior to 1999, our focus was to build a privately-managed, global network
utilizing IP technology, and our business primarily consisted of carrying and
transmitting traffic for communications carriers over our network. Beginning in
1999, we began to diversify our offerings by layering enhanced IP telephony
services over our network. These enhanced services were targeted at consumers
and were primarily accessible through our consumer Web site. During 2000, we
began offering services on a co-branded or private-label basis to service
providers and other businesses to assist them in diversifying their product
offerings to their customer bases. In 2001, we continued to enhance our unique
strengths through our pioneering work with the Session Initiation Protocol
(SIP), an Internet Engineering Task Force standard that has been embraced by
industry leaders such as Microsoft and the 3rd Generation Partnership Project
(3GPP), which is a global cooperation between six organizational partners who
are recognized as the world's major standardization bodies from the United
States, Europe, China, Japan and Korea. In 2001, we also announced the launch of
our state-of-the-art SIP (Session Initiation Protocol) infrastructure, and we
became one of the first service providers to have built an end-to-end SIP
network. During 2002, our continuing SIP efforts resulted in our launch of our
SIP-based dialer, and in 2003 we continued to add new devices, new features and
new calling plans to our offerings. As a result of these activities, by 2003 our
role is primarily that of a solutions' provider and the provision of wholesale
minutes to carriers in no longer a meaningful revenue source and our efforts
continue to position us as one of the leading providers of VoIP services. During
2004 we continued our efforts to develop, market and manage current and new
consumer oriented VoIP solutions and secured new and expanded current agreements
with resellers and service providers, including agreements to provide our
services to Verizon and SBC to assist them in their provision of consumer VoIP
to their end-users.
Recent Developments
As disclosed in an amended Schedule 13D filing with the SEC, in connection
with its periodic review of its portfolio investments, Atarey Hasharon Chevra
Lepituach Vehashkaot Benadlan (1991) Ltd. ("Atarey") has since November 25, 2003
disposed of an aggregate amount of 8,257,725 shares of our Class A common stock.
All of the sales of common stock executed after December 15, 2003 were
undertaken in accordance with a Rule 10b5-1 Sales Plan of Atarey and 6,000,000
of such shares were sold pursuant to an effective registration statement under
the Securities Act of 1933, as amended (the "Securities Act"). As of the date
hereof, Atarey beneficially holds 12,397,677 shares of our common stock,
representing approximately 41.9% of our issued and outstanding shares of common
stock.
The Increasing Significance of IP Communications
Historically, the communications services industry has transmitted voice
and data over separate networks using different technologies. Traditional
carriers have typically built telephone networks based on circuit switching
technology, which establishes and maintains a dedicated path for each telephone
call until the call is terminated. Although a circuit-switched system reliably
transmits voice communications, circuit switching does not efficiently utilize
transmission capacity. When a telephone call is placed, a circuit is
established, and the circuit remains dedicated for transmission of the call and
is therefore unavailable to transmit any other call.
Data networks have typically been built utilizing packet switching
technology, such as IP, which divides signals into packets that are
simultaneously routed over different channels to a final destination where they
are reassembled in the original order in which they were transmitted. Packet
switching provides for more efficient use of the capacity in the network because
the network does not establish dedicated circuits and does not require a fixed
amount of bandwidth to be reserved for each transmission. As a result,
substantially greater traffic can be transmitted over a packet-switched network,
such as the Internet, than a circuit-switched network.
Traditional telecommunications carriers have historically avoided the use
of packet switching for transmitting voice calls due to poor sound quality
attributable to delays and lost packets which prevent real-time transmission.
However, recent improvements in packet switching, compression and broadband
access technologies, improved hardware and the use of privately-managed networks
(such as our network) have significantly improved the quality of packet-switched
voice calls, allowing for real-time transmission. Service providers that use
privately-managed networks are able to reduce packet loss and latency, or delay,
because they are able to control the amount, timing and route of data
transmitted.
As a result, packet switching technology enables service providers to
converge their traditional voice and data networks and more efficiently utilize
their networks by carrying voice, fax and data traffic over the same network.
The improved efficiency of packet-switching technology creates network cost
savings that can be passed on to the consumer in the form of lower long distance
rates. In addition, international telephone calls carried over the Internet or
private IP networks are less expensive than similar calls carried over
circuit-switched networks primarily because they bypass the international
settlement process, which represents a significant portion of international long
distance tariffs.
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Frost & Sullivan, a market research firm, estimates that VoIP
communications services will grow to represent approximately 75% of worldwide
voice services and revenues from the VoIP marketplace will surpass $171 billion
by the end of 2007. Beyond cost savings, we believe that advanced IP
communications technologies will further the potential for the Internet to
become the preferred medium of communications and commerce.
Limitations of Existing IP Communications Solutions
Although the growth of IP telephony historically has been limited by poor
sound quality attributable to delays and packet loss, ongoing technological
advancements have continued to significantly improve the quality of
packet-switched telephone calls. As a result, several large long distance
carriers, including AT&T and Sprint, have announced IP telephony service
offerings.
In addition, many smaller service providers have begun to offer low-cost
Internet telephony services from PCs to telephones and from telephones to
telephones. Many of these service providers, however, offer their services only
in certain geographic areas and provide limited services. In addition, many of
these service providers rely solely on the public Internet for transmission,
rather than a privately-managed IP network. In using only the public Internet
rather than a privately-managed IP network for transmission, these service
providers have less control over the network management and monitoring functions
that are necessary to ensure quality of service.
Our Products and Services
Products.
We have built a privately-managed, global network using IP technology and
offer our customers a unique suite of IP telephony products. Our enhanced IP
communication products (which represented 96.0% and 92.1% of our revenues in
2004 and 2003, respectively) include:
PC-to-Phone. Our PC-to-Phone offering enables a user to conveniently and
inexpensively place a call to a standard telephone anywhere in the world
directly from a personal computer while remaining on-line. In order to use this
product, a user need only download our software from our Web site and have
access to the Internet. Once our software is downloaded, the user is able to
place a call from the user's personal computer and, while browsing the Web,
speak to a party who uses a standard telephone. Alternatively, users of a
variety of third-party "soft-phone" software can access our PC-to-Phone product
without the need to download any other software.
We are able to provide our PC-to-Phone offering at rates generally lower
than those charged for traditional circuit switched calls. We are able to charge
lower rates because our service utilizes packet-switched technology and because
it routes calls directly from the user's Internet connection onto our
privately-managed IP network and to the called destination, thus avoiding access
and settlement rates associated with traditional international and domestic long
distance telecommunications services. PC-to-phone is currently our most popular
product offering.
Broadband Phone. In early 2001, we successfully deployed the world's first
commercially available Broadband Phone offering. Our Broadband Phone product is
a complete phone replacement solution available to business and consumer
customers over the "last mile" through broadband connections via cable modem,
DSL or fixed wireless. Broadband Phone challenges the traditional public
switched telephone network (PSTN) and circuit switched networks with a full VoIP
solution. With our high call quality, "always on" reliability and increased
functionality provided by the high bandwidth access line, we are able to offer
potential partners and their customers some of the most sophisticated VoIP
solutions available in the market through a highly scalable, low-cost and easily
implemented product. Broadband Phone is designed to take advantage of how people
communicate, building on the current customer experience by allowing them to use
their existing phone. In addition to offering traditional telecommunications
capabilities, Broadband Phone enables a user to conveniently retrieve e-mail,
voice mail and faxes, from a single source. For our potential partners, the
turnkey solution is delivered with our full back-end infrastructure, including
customer service for end users, customer service for service providers, pricing
information, billing and provisioning and fraud services. Additionally,
Broadband Phone is a technology-neutral solution, easily integrated (a variety
of devices are available to plug directly into a PC or IP network) so as to
allow broadband providers to begin delivering our voice solution rapidly.
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Virtual Roaming Service. This "phone-to-phone" offering enables a user to
inexpensively place a call or send a fax from a standard telephone or a fax
machine to anywhere in the world. Such calls originate and terminate on the
PSTN, but travel primarily over our privately-managed IP network. Similar to our
PC-to-Phone product, this product is generally less expensive than services of
traditional carriers. Users can access this product by dialing a local or
toll-free access number and entering their account number. This service enables
users to utilize their PC-to-Phone and/or Broadband Phone account when they are
away from their computer or broadband device, and we currently offer toll-free
access numbers in 33 countries, including Austria, Canada, Finland, France,
Germany, Hong Kong, Italy, Sweden, Switzerland, the United Kingdom and the
United States. Users are charged for toll and long distance calls on a
per-minute basis. We and our private-label partners receive payment for these
calls by debiting pre-paid user accounts that are created when the user signs up
from PC-to-Phone or Broadband Phone service.
Carrier transmission services. In addition to our enhanced IP
communication products, in order to maximize the use of our available network
capacity, we offer carrier transmission services over our privately-managed IP
network to telecommunications carriers. During 2004, this service generated an
immaterial amount of revenue and we anticipate that this service will continue
to irrelevant going forward.
Services.
We differentiate ourselves from our competitors by providing a robust set
of value-added services that enables us to effectively address the challenges
that have traditionally made the provision of telecommunications services
difficult. These operations management tools include the following:
o account provisioning: we provide our reseller and service provider
customers with a dedicated Web page through which they can order
additional services or accounts, generate and activate PINs and
perform other customary implementation functions;
o payment processing systems: we provide our customers with a fraud
detection and prevention system to permit secure credit card
transactions over the Web;
o billing and account management: we provide our customers with
real-time, Web-based access to billing records to check billing and
usage information or to increase prepaid accounts; and
o customer care: we have moved and consolidated traditional first tier
customer care functions onto the Web for ease and flexibility and
support this with second tier customer care via toll-free access.
iConnectHere
We began marketing our on-line consumer offering under the iConnectHere
brand name in September 2000 in connection with the formal roll-out of our
Hosted Communications Solution. At that time, we also decided to move away from
a business model focused on consumers with a high acquisition cost. We have
positioned iConnectHere as a powerful showcase and test facility for our current
and future products and services, and as a leverage point for reseller and
service provider sales. iConnectHere demonstrates our products, services and
hosting capabilities to our reseller customers and service providers. Through
iConnectHere, an account holder can access all of our product offerings,
including PC-to-Phone and Broadband Phone and our marketing, customer care and
support teams utilize the full range of our back-end infrastructure and support
in servicing iConnectHere customers. Additionally, iConnectHere permits us to
collect usage information on our products and services and enables us to provide
our partners with key information and recommendations regarding implementation
of our products and services.
7
Through iConnectHere, consumer users can:
o sign up for any of our services, including PC-to-Phone, and
Broadband Phone;
o download our software and/or order IP-based Broadband Phone devices;
o recharge their accounts, either by entering their credit card
information or authorizing automatic recharging;
o send a PC-to-phone call;
o check real-time billing and usage information;
o communicate by e-mail with a customer service representative, and;
o view answers to frequently-asked questions.
iConnectHere Marketing, Advertising and Promotional Programs
We have developed and will continue to develop low-cost, diversified
marketing, advertising and promotional programs to stimulate demand for our
iConnectHere services. Our marketing, advertising and promotional programs
include:
On-line "Affiliate" Agent Commission Program. We have developed a
Web-based agent program that allows for rapid agent enrollment and agent account
maintenance. Agents may devise their own marketing programs, including
Web-links, direct mail campaigns or co-branding of our services in select
markets. Agents receive as commissions a percentage of revenue generated from
end users who sign up for our services through the agent's Web site. We believe
that providing our agents with easy, on-line access to these marketing tools
helps us to maximize the number of agents selling our services while
significantly reducing the resources needed to recruit agents.
Off-line "Affiliate" Agent Commission Program. Our off-line agent
commission program allows non-Web agents to design their own marketing programs
to solicit sales of our services. Off-line agents market and advertise through
traditional channels such as newspaper and magazine advertisements, direct mail
campaigns and telemarketing campaigns. Off-line agents receive a percentage of
revenue generated from users who sign up for our services through the agent's
programs.
Our Reseller and Service Provider Solutions
We have developed and will continue to develop high-value, globally
relevant solutions for the large number of resellers and service providers that
are focused on providing their customers with VoIP telephony products and
services. Our reseller and service provider offerings include:
Reseller Program. We offer individuals and businesses the opportunity to
become resellers of our services through our reseller program. Resellers are
able to purchase account numbers in bulk at reseller specific rates that they
are then able to resell these accounts to private individuals under the
iConnectHere brand, their own brand, or as "white-label" product (i.e., no brand
name is indicated). We allow these resellers to develop their own unique price
plans and service bundles and they utilize our online toolsets to manage this
process. We also enable them to utilize our web-based customer care tools to
provide customer service to the end-users through their own customer service
team.
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Our Hosted Communications Solution. Our "Hosted Communications Solution"
leverages our VoIP expertise and delivers to our resellers, corporate customers
and service providers a highly customizable, private-label suite of VoIP
products and services. Using our infrastructure, we enable these enterprises to
offer their customers any combination of our basic products and services,
accessible through a single account. We believe that our Hosted Communications
Solution brings our customers the value-added services they need to leverage
their strong customer bases and generate new revenues. We have dedicated
significant resources to this area of our business and anticipate significant
growth in the number of businesses to which we provide our Hosted Communications
Solution.
With each new module that is added to our suite of VoIP products and
services, customers can realize new revenue streams from their existing customer
base and make their own offering even more powerful in attracting new customers.
The products and services delivered under our Hosted Communications Solution are
operative 24 hours a day, 7 days a week and are supported at all times by our
Network Operations Center ("NOC") and our customer care center.
Future Products--broadband Focus
The market for broadband access services is projected to grow
significantly over the next several years. Broadband access alone, however, is
not a complete solution. As infrastructure pipes become commodities, maintaining
margin and profitability on them is becoming increasingly difficult for service
providers. We believe that broadband market success will be determined by the
ability to layer high-margin enhanced services and applications over the
infrastructure. Market leaders will need innovative, value-added solutions to
maintain customers, reduce churn and grow their customer base.
We have continued to develop a suite of next-generation Broadband Phone
products that we believe will encompass a rich sub-set of the voice-related
services broadband providers will seek to deploy in the near-term. These
products will build on our original Broadband Phone offering, and include a more
diverse set of devices (both hardware devices as well as "soft-phones") along
with additional value-added functionality and features that will appeal to a
wide potential customer-base.
Our Network
In order to deliver unique VoIP services, we operate a privately-managed
IP telephony network. By managing our network, we have the ability to regulate
traffic volumes and to directly control the quality of service from each
originating point of presence ("POP") to the termination point via a variety of
termination options. Our ability to interconnect to a wide variety of
termination options increases the diversity and robustness of our network,
minimizes and eliminates single points of failure, and simultaneously allows us
to benefit from pricing differences between vendors to the same termination
points. In addition, our network allows us to avoid the significant transmission
delays associated with the Internet, which may impede delivery of high quality,
reliable services to our users. Since the protocols used by the network are
highly standard protocols, our IP network has a tight connection to the public
Internet, allowing us to use the Internet as a backup facility. This unique
situation, where our IP network is considered a high-quality extension of the
Internet, allows our customers to enjoy best-of-breed functionality: high
quality, low jitter and low connection delay, on the one hand, and global reach
and universal access, on the other hand.
During 2001, in conjunction with our relationships with Microsoft and
Cisco and over 12 months of work, we rolled out our state of the art SIP
(Session Initiation Protocol) infrastructure. Our SIP network currently powers
the majority of our offerings. The SIP protocol is one of the most advanced VoIP
protocols and unlike its predecessors, which were modeled after traditional
telephony protocols, SIP has the ability to scale with a distributed
architecture and at a lower cost. SIP's superior attributes also include faster
and more cost effective development and lower hardware requirements, which
allows us to incur lower capital expenditure costs. During 2005, we intend to
continue to expand our offerings on this network.
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Backbone
Our network is built around a redundant, high availability backbone that
connects New York, London, Los Angeles, Chicago, and Atlanta. In each of these
locations there are multiple interconnections or peering arrangements with
Internet backbone providers. These points are strategically located to allow
access from our network to and from the Internet with the best performance. The
backbone is based on a variety of equipment, including Cisco routing equipment,
and HP servers utilizing Hot Standby Routing Protocol. In order to achieve
maximum redundancy, our network has several connections to the public Internet.
While operating as a private extension of the Internet, the backbone has a high
level of security designed to isolate it from security threats found on the
public Internet.
Origination Access
Access to our network is possible through several points. Users may access
services through PSTN connections (toll free and local access). Carrier
transmission access is aggregated through our switch in New York or through any
one of our POPs directly. Call origination is possible from the PC-to-Phone
product, using our downloadable software client, third-party "soft-phones", a
Web browser, or Broadband Phone devices. These calls enter our network from the
Internet through our interconnect points with the Internet. We carefully manage
each originating port and utilize innovative capacity planning tools and
techniques to provide the best and most cost effective service to customers.
Termination
Our network can terminate calls through any of our POPs and termination
providers' POPs. Termination decisions are based on a sophisticated Least Cost
Routing system which applies routing rules based on origination point, time of
day, termination cost and other factors. These rules are constantly updated to
ensure maximum economic and quality efficiency. Our network has termination
facilities that enable us to interconnect with multiple carriers. This allows us
to refile traffic to our own switch, giving us the ability to route calls to
virtually anywhere in the world. Each termination port is carefully managed with
innovative capacity planning tools and techniques to provide the best and most
cost effective service to customers, along with multiple termination options to
ensure the highest possible levels of redundancy.
Network Services
Our network supports several application building services on the network
level, including:
Programmable Interactive Voice Response (PIVR). Our network is capable of
playing a configurable voice prompt to enable it to provide applications such as
pre-paid calling cards. PIVR services are highly programmable and can be
customized to fulfill a variety of customer needs. The configuration of the PIVR
is controlled from a central location, enabling efficient management and faster
maintenance in the event of malfunctions.
Real Time AAA. We are able to authenticate, authorize and account (AAA)
for inbound services through the network's real time radius protocol. Whether
services are pre-paid or post-paid, the network will disconnect the call when
the user's account balance runs out. These protocols interface with the billing
system to rate the calls correctly and allow access to permitted services only.
Authentication may be customized to utilize numbers, textual strings, credit
card numbers and more.
Reporting Tools. All network services are accounted for in real time,
generating Call Detail Records. These records are aggregated in real time to
both the billing systems, for rating, and to the data warehouse, which provides
access to the information by the marketing, financial, capacity planning and
operational groups through a client or Web interface using advanced OLAP cubes.
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the Network Operations Center (NOC). Our NOC monitors and manages our
network from a central location, seven days a week, 24 hours a day. The NOC
monitors all aspects of our network, including the routers, databases, switches,
leased lines, Internet connections, gatekeepers and gateways, to ensure that
they are functioning at optimal levels. In the event of a failure of any of
these network components, NOC personnel are provided with a real time, systems
generated notification via an instant messaging system consisting of pagers,
cellular phones, screen pop-ups and e-mail, which identifies the malfunction so
that proper measures can be taken to restore service in a timely fashion. Our
NOC utilizes a combination of proprietary and leading industry technologies,
including Hewlett-Packard Open View software and Ericsson IPT management
console, as well as unique applications developed by us. The NOC serves all of
the different parts of our operations environment, including network nodes, Web
servers and specific applications.
Customer Care. Our services are supported by our on-line interactive
customer service and billing center, which enables an end user to set up an
account, receive an account number and a PIN, pay by credit card for services,
find answers to frequently asked questions and contact customer service
representatives. Once a user has established an account, the user can prepay for
additional usage by credit card as well as access real-time detailed information
such as call logs and transaction records. Through the on-line billing system, a
user can personalize the billing information to select the data most relevant to
them. This on-line interactive customer service and billing center is supported
by a human customer care contact center that provides voice and e-mail support
to the customers.
Proprietary Rights
We rely and expect to be able to rely on trademark and trade secret laws,
confidentiality agreements and other contractual arrangements with our
employees, strategic partners and others to protect our proprietary rights.
We have registered trademarks for "deltathree(TM)" and
"iConnectHere.com(TM)" in the United States. However, these trademarks may not
provide adequate protection against competitive technology and may not be held
valid and enforceable if challenged. We do not own any registered copyrights.
To further safeguard our intellectual property, we have a policy that
requires our employees to execute confidentiality and technology ownership
agreements when they begin their relationships with us.
Regulatory Environment
Regulation of IP Telephony
The use of the Internet and private IP networks to provide telephone
service is a relatively recent market development. While the provision of voice
communication services over the Internet and private IP networks is currently
permitted under United States law, some foreign countries have laws or
regulations that may prohibit voice communications over the Internet or using
private IP networks. Increased regulation of the Internet may slow its growth,
particularly if many countries impose restrictive regulations. Increased
regulation of the Internet and/or IP telephony providers or the prohibition of
Internet and IP telephony in one or more countries, more aggressive enforcement
of existing regulations in such countries or our failure or the failure of our
network partners to comply with applicable regulations could materially
adversely affect our business, financial condition, operating results and future
prospects.
United States. Based on information users provide to us when they signed
up to use our services, we estimate that approximately 20% of our IP
communications services are provided to carriers or users in the United States.
We believe that, under United States law, based on specific regulatory
classifications and recent regulatory decisions, the IP communications services
that we provide constitute information services (as opposed to regulated
telecommunications services). As such, our services are not currently regulated
by the Federal Communications Commission (FCC) or state agencies charged with
regulating telecommunications carriers. Nevertheless, aspects of our operations
may be subject to state or federal regulation, including regulation governing
universal service funding, payment of access charges, disclosure of confidential
communications and tax issues. We cannot assure you that our services will not
be regulated in the future. Several efforts have been made or are currently
being considered in the United States to enact federal legislation that would
either regulate or exempt from regulation communications services provided over
the Internet.
11
In addition, the FCC is currently considering reforms to universal service
funding and may consider whether to impose various types of charges, other
common carrier regulations and/or additional operational burdens upon some
providers of Internet and IP telephony. Additionally, the FCC is currently
considering reforms to both emergency services provisioning (i.e., "911 and E911
services) and law-enforcement agency regulations (i.e., CALEA) and may consider
whether to impose various types of charges, other common carrier regulations
and/or additional operational burdens upon some providers of Internet and IP
telephony. The FCC has stated that the development of new technologies, such as
IP telephony, may increase the strain on universal service funding and emergency
services provisioning and hinder law enforcement agencies activities. In that
regard, the FCC is currently reviewing whether to extend universal service,
emergency services provisioning, and/or law-enforcement agency assistance
obligations to non-traditional providers such as facilities-based and
non-facilities-based providers of broadband Internet services.
Several other carriers have asked the FCC to make definitive rulings
regarding the classification of their IP telephony services. In response to one
of those requests, the FCC determined that a particular free, peer-to-peer IP
application is an interstate information service. The FCC's ruling applies only
to that particular application and does not affect the regulatory classification
of the services we offer. The FCC also has determined that IP-enabled services
with certain characteristics are interstate services subject to federal
jurisdiction, rather than state regulation. We cannot predict, however, that our
services would be found by the FCC to meet the characteristics established by
the FCC. In addition, the FCC has initiated a generic proceeding to investigate
the legal and regulatory framework for all IP-enabled services, including IP
telephony services. Thus, the regulatory classification issue is now before the
FCC. Any ruling by the FCC on the regulatory considerations affecting Internet
and IP telephony services will affect our operations and revenues.
If the FCC were to determine that certain services are subject to FCC
regulations as telecommunications services, the FCC might require providers of
Internet and IP telephony services to be subject to traditional common carrier
regulation, make universal service contributions, implement new hardware and/or
software to aid emergency services provision and aid law enforcement agencies
and/or pay access charges. It is also possible that the FCC may adopt a
regulatory framework other than traditional common carrier regulation, which
would apply to Internet and IP telephony providers.
Despite the FCC's actions, state regulatory authorities may also retain
jurisdiction to regulate the provision of, and impose charges on, intrastate
Internet and IP telephony services. Several state regulatory authorities have
initiated proceedings to examine the regulation of such. Many of the states that
have looked at the regulation of IP telephony services have deferred
consideration of the issue pending the outcome of the FCC's proceedings.
Although, at least one state has ordered that access charges apply to the
termination of IP telephony calls provided by a particular carrier and another
state has ordered an IP telephony provider to submit to state regulation. The
latter decision later was overturned in federal district court and the district
court's decision was upheld by a federal court of appeals. Another federal
district court also issued a preliminary injunction in response to another
state's attempt to force an IP telephony provider to submit to state regulation.
A permanent injunction currently is being reviewed by the federal district
court. In addition, several state commissions have participated in the FCC's
proceedings and have advocated imposing traditional common carrier regulation on
Internet and IP telephony providers. Rulings by the state commissions on the
regulatory considerations affecting Internet and IP telephony services could
affect our operations and revenues.
International. The regulatory treatment of Internet and IP telephony outside of
the United States varies widely from country to country. A number of countries
that currently prohibit competition in the provision of voice telephony may also
prohibit Internet and IP telephony. Other countries permit, but regulate
Internet and IP telephony. Some countries will evaluate proposed Internet and IP
telephony service on a case-by-case basis and determine whether it should be
regulated as a voice service or as another telecommunications service. Finally,
in many countries Internet and IP telephony has not yet been addressed by
legislation or regulatory action.
12
In 2003, the European Commission adopted directives for a new framework for
electronic communications regulation that, in part, attempt to harmonize the
regulations that apply to services regardless of the technology used by the
provider. Under the New Regulatory Framework, there is no distinction in
regulation made based upon technology between switched or packet-based networks.
As a result, some types of IP telephony services may be regulated like
traditional telephony services while others may remain free from regulation. The
European Commission currently is reviewing how IP telephony services fit into
the New Regulatory Framework. Although it has been suggested that a "light
touch" to regulation be taken, we cannot predict what future actions the
European Commission and courts reviewing the New Regulatory Framework may take
regarding IP telephony and related matters, or what impact, if any, such actions
may have on our business.
Based on the Commission's current position, we believe that most providers
of IP telephony should be subjected to no more than a general authorization or
declaration requirement by the European Union Member States, subject to the
European Commission's current review of the issue. The Member States of the
European Union are: Austria, Belgium, Denmark, Finland, France, Germany, Greece,
Ireland, Italy, Luxembourg, The Netherlands, Portugal, Spain, Sweden and the
United Kingdom. However, since the Commission's findings on IP telephony are not
binding on the Member States, we cannot assure you that the services provided
over our network will not be deemed "voice telephony" subject to heightened
regulation by one or more EU Member States. For example, the United Kingdom has
opened a proceeding to review the regulation of Internet-based voice services.
As we make our services available in foreign countries, and as we
facilitate sales by our network partners to end users located in foreign
countries, such countries may claim that we are required to qualify to do
business in the particular foreign country. Such countries may also claim that
we are subject to regulation, including requirements to obtain authorization for
the provision of voice telephony or other telecommunications services, or for
the operation of telecommunications networks. It is also possible that such
countries may claim that we are prohibited in all cases from providing our
services or conducting our business as conducted in those countries.
Our network partners may also currently be, or in the future may become,
subject to requirements to qualify to do business in a particular foreign
country, comply with regulations, including requirements to obtain
authorizations for the provision of voice telephony or other telecommunications
services or for the operation of telecommunications networks, or to cease
providing services or conducting their business as conducted in that country. We
cannot be certain that our network partners either are currently in compliance
with any such requirements, will be able to comply with any such requirements,
and/or will continue in compliance with any such requirements.
Other Regulation Affecting the Internet
United States. Congress has recently adopted legislation that affects certain
aspects of the Internet, including on-line content, user privacy, national
security and taxation. For example, the extension of the Internet Tax Freedom
Act prohibited certain taxes on Internet uses through November 1, 2003. Congress
extended the prohibition to 2007, subject to some exceptions. Congress, however,
specifically stated that nothing in the recent legislation affects the
imposition of taxes on voice or other similar services utilizing Internet
Protocol or any successor protocol. We cannot predict whether substantial new
taxes will be imposed on our services. In addition, Congress, the FCC and other
federal entities are considering other legislative and regulatory proposals that
would further affect the Internet, including with regard to broadband networks
used to support high-speed Internet access services. Congress is, for example,
currently considering legislation on a wide range of issues including Internet
spamming, database privacy, gambling, pornography and child protection, Internet
fraud and privacy. Various states have adopted and are considering
Internet-related legislation.
International. The European Union has also enacted several directives relating
to the Internet. The European Union has, for example, adopted a directive on
data protection that imposes restrictions on the processing of personal data.
Under the directive, personal data may not be collected, processed, used for
other purposes or transferred outside the European Union unless certain
specified conditions are met. In addition, persons whose personal data is
processed within the European Union are guaranteed a number of rights. The
directive may affect companies that collect or transmit information over the
Internet from individuals in the European Union Member States. In particular,
companies with establishments in the European Union may not be permitted to
transfer personal data to countries that do not maintain adequate levels of data
protection.
13
In addition, the European Union has adopted a separate, complementary
privacy directive that pertains to the telecommunications sector. This directive
establishes certain requirements with respect to, among other things, the
confidentiality, processing and retention of subscriber traffic and billing
data, security of services and networks, subscriber rights to non-itemized
bills, and the presentation and restriction of calling and connected line
identification. In addition, a number of European countries outside the European
Union have adopted, or are in the process of adopting, rules similar to those
set forth in the European Union directives. Although we do not engage in the
collection of data for purposes other than routing calls and billing for our
services, the data protection directives are quite broad and the European Union
privacy standards are stringent. Accordingly, the potential effect of these data
protection rules on the development of our business is uncertain. In addition,
the European Union continues to review these rules, and thus, we cannot predict
how these rules will change in the future.
Competition
We compete primarily in the market for enhanced IP communications
services. This market is highly competitive and has numerous service providers.
The market for enhanced Internet and IP communications services is new and
rapidly evolving. We believe that the primary competitive factors determining
our success in the Internet and IP communications market are:
o quality of service;
o the ability to meet and anticipate customer needs through multiple
service offerings and feature sets;
o responsive customer care services, and;
o price.
Future competition could come from a variety of companies both in the
Internet and telecommunications industries. These industries include major
companies who have greater resources and larger subscriber bases than we have,
and have been in operation for many years. We also compete in the growing market
of discount telecommunications services including "pure play" VOIP service
providers, calling cards, prepaid cards, call-back services, dial-around or
10-10 calling and collect calling services. In addition, some Internet service
providers have begun to aggressively enhance their real time interactive
communications, including instant messaging, PC-to-PC and PC-to-Phone services,
and Broadband phone services.
IP Telephony Providers. Many companies provide, or are planning to provide,
certain portions of the complete communications solution we offer, including,
iBasis, Inc., Net2Phone, and Vonage.
Traditional Telecommunications Carriers and Broadband Services Providers.
Several traditional telecommunications companies, including industry leaders
such as AT&T, Sprint, Deutsche Telekom, WorldCom and Qwest Communications
International, and established broadband services providers, such a Time Warner,
Comcast, and Cablevision have announced enhanced Internet and IP communications
services and products and/or their intention to offer such products and services
in both the United States and internationally. All of these competitors are
significantly larger than we are and have:
o substantially greater financial, technical and marketing resources;
o larger networks;
o a broader portfolio of services;
14
o stronger name recognition and customer loyalty;
o well-established relationships with many of our target customers,
and;
o an existing user base to which they can cross-sell their services.
These and other competitors may be able to bundle services and products
that are not offered by us together with enhanced Internet and IP communications
services, which could place us at a significant competitive disadvantage. Many
of our competitors enjoy economies of scale that can result in lower cost
structure for transmission and related costs, which could cause significant
pricing pressures within the industry. At the same time, we see these potential
competitors as potential customers, and have organized our various reseller and
service provider products and services to meet the emergent needs of these
companies.
Revenues and Assets by Geographic Area
For the year ended December 31, 2004, approximately $4.2 million, or
79.9%, of our revenue was derived from international customers, and $16.9, or
20.1%, was derived from customers in the United States. Most of our long-lived
assets are located in the United States. For more detailed information
concerning our geographic segments, see Note 11 to our financial statements
included elsewhere in this annual report.
Employees
As of December 31, 2004, we employed 105 full-time and 31 part-time
employees, of which 117 were located in Israel, and 19 were located in New York.
We consider our relationship with our employees to be good. None of our
employees is covered by collective bargaining agreements.
Generally, all male adult citizens and permanent residents of Israel under
the age of 41 are, unless exempt, obligated to perform up to 36 days of military
reserve duty annually. Additionally, all such residents are subject to being
called to active duty at any time under emergency circumstances. Some of our
officers and employees are currently obligated to perform annual reserve duty.
While we have operated effectively under these requirements since we began
operations, no assessment can be made as to the full impact of such requirements
on our workforce or business if conditions should change, and no prediction can
be made as to the effect on us of any expansion of such obligations.
Available Information
Our Internet address is www.deltathree.com. Our annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments to those reports, are available to you free of charge through the
Investor Relations section of our website as soon as reasonably practicable
after such materials have been electronically filed with, or furnished to, the
Securities and Exchange Commission.
ITEM 2. PROPERTIES
We maintain our executive offices at 75 Broad Street, New York, New York
under a lease with an annual rent of approximately $650,000, increasing annually
to $815,000 during the final year of the lease. The lease term extends until
July 2010, with an option to extend the lease for an additional five years. In
October 2003 we entered into a sub-lease agreement with a third party to
sub-lease approximately 30% of the overall the New York office space. The annual
sub-lease income was approximately $150,000 for 2004, increasing annually to
$168,000 during the final year of the lease and extends until July 2010.
15
We lease a 1,056 square meter office, which houses our research and
development facilities, at the Jerusalem Technology Park, Jerusalem, Israel at
an annual cost of $202,000. The Company signed an extension agreement on the
lease, commencing February 2003 that extends the lease until February 2006.
ITEM 3. LEGAL PROCEEDINGS
Final settlement documentation for litigation relating to a number of
initial public offerings, including our own, is in the process of being
approved. We do not presently expect to make any payments under the pending
settlement. The history of this litigation is as follows:
We, as well as certain of our former officers and directors, have been
named as defendants in a number of purported securities class actions in Federal
District Court for the Southern District of New York, arising out of our initial
public offering in November 1999 (the "IPO"). Various underwriters of the IPO
also are named as defendants in the actions. The complaints allege, among other
things, that the registration statement and prospectus filed with the Securities
and Exchange Commission for purposes of the IPO were false and misleading
because they failed to disclose that the underwriters allegedly (i) solicited
and received commissions from certain investors in exchange for allocating to
them shares of our stock in connection with the IPO and (ii) entered into
agreements with their customers to allocate such stock to those customers in
exchange for the customers agreeing to purchase additional shares in the
aftermarket at predetermined prices.
On August 8, 2001, the court ordered that these actions, along with
hundreds of IPO allocation cases against other issuers, be transferred to Judge
Scheindlin for coordinated pre-trial proceedings. In July 2002, omnibus motions
to dismiss the complaints based on common legal issues were filed on behalf of
all issuers and underwriters. On February 19, 2003, the Court issued an opinion
granting in part and denying in part those motions to dismiss. The complaint
against the Company was not dismissed as a matter of law. These cases remain at
a preliminary stage and no discovery proceedings have taken place. We believe
that the claims asserted against us in these cases are without merit and intend
to defend ourselves vigorously against them. Final settlement documentation is
in the process of being approved. Under the terms of the proposed settlement
agreement, we are not conceding any liability and we will not bear any expenses
associated with the settlement, other than legal fees we may incur.
We are not a party to any other material litigation and are not aware of
any other pending or threatened litigation that could have a material adverse
effect on us or our business taken as a whole.
16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual Meeting of Stockholders (the "Meeting") on
November 8, 2004. The following matters were submitted to our stockholders for
their vote, and the results of the votes taken at the Meeting were as follows:
(1) Eight Directors were elected for a term of one year:
(a) Noam Bardin 26,985,488 votes for; 62,408 votes against;
(b) Noam Ben-Ozer 26,984,373 votes for; 63,523 votes against;
(c) Ilan Biran 26,984,388 votes for; 63,508 votes against;
(d) Amir Gera 26,971,368 votes for; 76,528 votes against;
(e) Joshua Maor 26,986,473 votes for; 61,423 votes against;
(f) Lior Samuelson 26,995,488 votes for; 62,408 votes against; and
(g) Shimmy Zimels 26,973,696 votes for; 74,200 votes against;
(2) The appointment of Brightman Almagor & Co., a member firm of Deloitte
& Touche Tohmatsu, as our independent auditors for the fiscal year ending
December 31, 2004 was ratified by the following vote: 26,984,622 votes for;
42,600 votes against; and 20,634 abstentions.
(3) The adoption of the proposed 2004 Stock Incentive Plan was ratified by
the following vote: 16,485,158 votes for; 292,138 votes against; and 24,746
abstentions.
(4) The adoption of the proposed 2004 Non-Employee Director Stock Option
Plan was ratified by the following vote: 16,511,770 votes for; 261,926 votes
against; and 28,346 abstentions.
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Our common stock is currently listed on the Nasdaq SmallCap Market under
the symbol "DDDC". The listing of our common stock was transferred from the
Nasdaq National Market to the Nasdaq SmallCap Market effective on September 17,
2002. Our common stock had traded on the Nasdaq National Market under the symbol
"DDDC" since November 22, 1999. We currently meet all criteria for continued
inclusion in the Nasdaq SmallCap Market.
The following table sets forth the per share range of high and low closing
sales prices of our common stock for the periods indicated:
High Low
---- ---
Year Ended December 31, 2002
First quarter $ 1.25 $ 0.75
Second quarter 1.08 0.60
Third quarter 0.63 0.34
Fourth quarter 0.90 0.37
Year Ended December 31, 2003
First quarter 0.68 0.48
Second quarter 0.80 0.53
Third quarter 1.95 0.62
Fourth quarter 4.26 1.53
Year Ended December 31, 2004
First quarter 3.43 2.17
Second quarter 2.69 1.27
Third quarter 3.19 1.78
Fourth quarter 3.70 1.95
Year Ended December 31, 2004
First quarter (through March 29th, 2005) 3.20 6.67
On March 29, 2005, the last reported sale price for our common stock on
the Nasdaq SmallCap Market was $3.70 per share. The market price for our stock
is highly volatile and fluctuates in response to a wide variety of factors.
Holders
As of March 29, 2005, we had approximately 125 holders of record of the
29,961,086 outstanding shares of our common stock. This does not reflect persons
or entities that hold their stock in nominee or "street" name through various
brokerage firms.
18
Dividend Policy
We have never declared or paid any cash dividends on our capital stock. We
do not anticipate paying any cash dividends on our capital stock in the
foreseeable future. We currently intend to retain future earnings, if any, to
finance our operations and to expand our business. Any future determination to
pay cash dividends will be at the discretion of our board of directors and will
be dependent upon our financial condition, operating results, capital
requirements and other factors that our board of directors considers
appropriate.
Recent Sales of Unregistered Securities
None.
Use of Proceeds
On November 22, 1999, we offered 6,000,000 shares of our common stock in
an initial public offering. These shares were registered with the Securities and
Exchange Commission on a registration statement on Form S-1 (file no.
333-86503), which became effective on November 22, 1999. We received net
proceeds of approximately $96,255,000 from the sale of 6,900,000 shares at the
initial public offering price of $15.00 per share after deducting underwriting
commissions and discounts and expenses of approximately $6,300,000. The managing
underwriters for our initial public offering were Lehman Brothers Inc., Merrill
Lynch & Co., U.S. Bancorp Piper Jaffray, Lazard Freres & Co. LLC and Fidelity
Capital Markets.
Through December 31, 2004, we used approximately $38 million of the net
proceeds for sales, marketing and promotional activities, $26 million for
capital expenditures and $18 million for general corporate purposes. Pending use
of the remaining net proceeds, we have invested the remaining net proceeds in
interest-bearing, investment-grade instruments, certificates of deposit, or
direct or guaranteed obligations of the United States.
Issuer Purchases of Equity Securities
None.
19
ITEM 6. SELECTED FINANCIAL DATA
You should read the selected consolidated financial data together with our
consolidated financial statements and related notes and the section of this
annual report entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations." Brightman Almagor & Co., a member firm of
Deloitte Touche, independent certified public accountants, audited our
historical financial statements since inception and as of and for the years
ended December 31, 2000, 2001, 2002, 2003 and 2004. Their report appears
elsewhere in this annual report. The selected financial data for each of the
years in the three year period ended December 31, 2004, and as of December 31,
2003 and 2004 is derived from our consolidated financial statements that have
been included in this annual report. The selected financial data as of December
31, 2000, 2001 and 2002, and for the years ended December 31, 2000 and 2001, is
derived from consolidated financial statements that have not been included in
this annual report.
Year Ended December 31,
-----------------------
2000 2001 2002 2003 2004
---- ---- ---- ---- ----
(In Thousands)
Statement of Operations Data:
Revenues:
Affiliates ............................................... $ 13,977 $ 1,669 $ -- $ -- $ --
Non-affiliates ........................................... 16,399 13,991 12,929 13,162 21,069
Total revenues ............................................. 30,376 15,660 12,929 13,162 21,069
Costs and operating expenses:
Cost of revenues ......................................... (24,932) (13,486) (8,934) (8,393) (13,791)
Research and development expenses ........................ (6,625) (5,648) (3,435) (2,326) (2,531)
Selling and marketing expenses ........................... (20,548) (7,800) (3,910) (3,325) (3,274)
General and administrative expenses (exclusive of non-cash (6,694) (6,982) (2,158) (2,062) (2,186)
compensation expense shown below)
Non-cash compensation expense ............................ (6,331) (825) (270) -- --
Depreciation and amortization ............................ (7,919) (8,996) (6,606) (5,584) (2,739)
Write-down of fixed assets .............................. -- (1,003) -- -- --
Expenses due to cancellation of supplier agreement ...... -- (3,628) -- -- --
Impairment of goodwill ................................... (8,905) (4,151) -- -- --
Total costs and operating expenses ......................... (81,954) (52,519) (25,313) (21,690) (24,521)
Loss from operations ....................................... (51,578) (36,859) (12,384) (8,528) (3,452)
Interest income, net ....................................... 3,632 1,677 448 245 269
Income taxes ............................................... (311) (552) (141) (57) (66)
Net loss ................................................... $(48,257) $(35,734) $(12,077) $ (8,340) $ (3,249)
Net loss per share - basic and diluted .................... $ (1.67) $ (1.23) $ (0.42) $ (0.29) $ (0.11)
Weighted average shares outstanding - basic and diluted ... 28,833 29,035 28,888 28,989 29,316
December 31,
------------
2000 2001 2002 2003 2004
---- ---- ---- ---- ----
(In Thousands)
Balance Sheet Data:
Cash and cash equivalents $ 20,857 $ 13,583 $ 5,681 $ 1,682 $ 13,755
Short-term investments...................................... 30,542 14,192 15,552 16,442 2,723
Working capital............................................. 43,538 23,374 17,675 14,820 11,380
Total assets................................................ 86,169 45,869 32,197 23,643 22,273
Total stockholder's equity.................................. 72,479 38,921 27,114 19,141 16,025
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read together with our consolidated financial statements
and the related notes thereto included in another part of this annual report.
This discussion contains certain forward-looking statements that involve
substantial risks and uncertainties. When used in this report the words
"anticipate," "believe," "estimate," "expect" and similar expressions as they
relate to our management or us are intended to identify such forward-looking
statements. Our actual results, performance or achievements could differ
materially from those expressed in, or implied by, these forward-looking
statements. Historical operating results are not necessarily indicative of the
trends in operating results for any future period.
Overview
We are a provider of integrated Voice over Internet Protocol (VoIP)
telephony services. We were founded in 1996 to capitalize on the growth of the
Internet as a communications tool by commercially offering Internet Protocol
(IP) telephony services. IP telephony is the real time transmission of voice
communications in the form of digitized "packets" of information over the
Internet or a private network, similar to the way in which e-mail and other data
is transmitted. Our business currently includes: the provision of enhanced
Web-based and other communications services to individual consumers under our
iConnectHere brand name; the provision of enhanced Web-based and other
communications services to international resellers, under either their own brand
name, a white-label brand, and/or our iConnectHere brand name; the provision of
a "Hosted Communications Solution" that enables resellers, corporate customers
and service providers to offer private label telecommunications to their
customer bases, and; the transmission of voice and data traffic for
communications carriers.
Prior to 1999, our focus was to build a privately-managed, global network
utilizing IP technology, and our business primarily consisted of carrying and
transmitting traffic for communications carriers over our network. Beginning in
1999, we began to diversify our offerings by layering enhanced IP telephony
services over our network. These enhanced services were targeted at consumers
and were primarily accessible through our consumer Web site. During 2000, we
began offering services on a co-branded or private-label basis to service
providers and other businesses to assist them in diversifying their product
offerings to their customer bases. In 2001, we continued to enhance our unique
strengths through our pioneering work with the Session Initiation Protocol
(SIP), an Internet Engineering Task Force standard that has been embraced by
industry leaders such as Microsoft and the 3rd Generation Partnership Project
(3GPP), which is a global cooperation between six organizational partners who
are recognized as the world's major standardization bodies from the United
States, Europe, China, Japan and Korea. In 2001, we also announced the launch of
our state-of-the-art SIP (Session Initiation Protocol) infrastructure, and we
became one of the first service providers to have built an end-to-end SIP
network. During 2002, our continuing SIP efforts resulted in our launch of our
SIP-based dialer, and in 2003 we continued to add new devices, new features and
new calling plans to our offerings. As a result of these activities, by 2003 our
role is primarily that of a solutions' provider and the provision of wholesale
minutes to carriers in no longer a meaningful revenue source and our efforts
continue to position us as one of the leading providers of VoIP services. During
2004 we continued our efforts to develop, market and manage current and new
consumer oriented VoIP solutions and secured new and expanded current agreements
with resellers and service providers, including agreements to provide our
services to Verizon and SBC to assist them in their provision of consumer VoIP
to their end-users.
Factors Affecting Future Results
Industry and Economic Factors: Our operations and earnings are affected by
local, regional and global events or conditions that affect supply and demand
for telecommunications products and services. These events or conditions are
generally not predictable and include, among other things, general economic
growth rates and the occurrence of economic recessions; the development of new
supply sources; supply disruptions; technological advances, including advances
in telecommunications technology and advances in technology relating to
telecommunications usage; changes in demographics, including population growth
rates and consumer preferences; and the competitiveness of alternative
telecommunications sources or product substitutes.
21
Competitive Factors: The telecommunications industry is highly competitive.
There is competition within the traditional telecommunications marketplaces
(landline and wireless) and also with other emergent "next generation"
telecommunications providers, including IP telecommunications providers in
supplying the overall telecommunications needs of businesses and individual
consumers, and several of the larger traditional telecommunications companies
have announced intentions to merge, which will create even larger competitors.
We compete with other telecommunications firms in the sale and purchase of
various products and services in many national and international markets and
employ all methods of competition which are lawful and appropriate for such
purposes. A key component of our competitive position, particularly given the
commodity-based nature of many of our products, is our ability to manage
operating expenses successfully, which requires continuous management focus on
reducing unit costs and improving efficiency.
Political Factors: Our operations and earnings have been, and may in the future
be, affected from time to time in varying degree by political instability and by
other political developments and laws and regulations, such as forced
divestiture of assets; restrictions on production, imports and exports; war or
other international conflicts; civil unrest and local security concerns that
threaten the safe operation of company facilities; price controls; tax increases
and retroactive tax claims; expropriation of property; cancellation of contract
rights; and telecommunications regulations. Both the likelihood of such
occurrences and their overall effect upon us vary greatly from country to
country and are not predictable.
Project Factors: In addition to the factors cited above, the advancement, cost
and results of particular projects depend on the outcome of negotiations with
potential partners, governments, suppliers, customers or others; changes in
operating conditions or costs; and the occurrence of unforeseen technical
difficulties.
Risk Factors: See "--Risk Factors" below for discussion of the impact of market
risks, financial risks and other uncertainties.
Revenues
Revenues consist of revenues from end-users of our enhanced IP
communications services, including PC-to-Phone, and Broadband Phone, which are
generated by our both our consumer offering, iConnectHere, and our reseller and
service provider offerings, including our Hosted Communications Solution, and
revenues from carriers for carrier transmission services. All revenues are
recognized as the services are performed. The provision of enhanced IP
communications services (primarily PC-to-Phone) through iConnectHere accounted
for 33.96% and 47.1% of our total revenues in 2004 and 2003, respectively, while
the provision of enhanced IP communications services through our reseller and
service provider sales efforts (including sales of our Hosted Communications
Solution) accounted for 61.2% and 45% of our total revenues in 2004 and 2003,
respectively. Carrier transmission services accounted for 0.86% and 3.9% of our
total revenues in 2004 and 2003, respectively.
Costs and Operating Expenses
Costs and operating expenses consist of cost of revenues, research and
development expenses, selling and marketing expenses, general and administrative
expense, depreciation and amortization of goodwill, non-cash stock compensation,
write-down of fixed assets, expenses due to cancellation of agreement with a
supplier and impairment of goodwill related expenses.
22
o Cost of revenues consist primarily of access, termination and
transmission costs paid to carriers that we incur when providing
services and fixed costs associated with leased transmission lines.
The term of our contracts for leased transmission lines is generally
one year or less, and either party can terminate with prior notice.
o Research and development expenses consist primarily of costs
associated with establishing our network and the initial testing of
our services and compensation expenses of software developers
involved in new product development and software maintenance. In the
future, these expenses may fluctuate as a percentage of revenue
depending on the project undertaken during the reporting period.
Since our inception, we have expensed all research and development
costs in each of the periods in which they were incurred.
o Selling and marketing expenses consist primarily of advertising and
promotional expenses incurred to attract potential consumer users of
iConnectHere and expenses associated with our direct sales force
incurred to attract potential reseller, corporate, and service
provider customers (including sales of our Hosted Communications
Solution). We anticipate that as we add new paid users we will be
able to spread these costs over a larger revenue base and
accordingly improve our operating margins.
o General and administrative expenses consist primarily of
compensation and benefits for management, finance and administrative
personnel, occupancy costs and legal and accounting fees, as well as
the expenses associated with being a public company, including the
costs of directors' and officers' insurance.
We have not recorded any income tax benefit for net losses and credits
incurred for any period from inception to December 31, 2004. The utilization of
these losses and credits depends on our ability to generate taxable income in
the future. Because of the uncertainty of our generating taxable income, we have
recorded a full valuation allowance with respect to these deferred assets.
We recognized $270,000 in non-cash compensation expense in 2002, $0 in
2003, and $0 in 2004.
Critical Accounting Policies
The Securities and Exchange Commission defines critical accounting
policies as those that are, in management's view, most important to the
portrayal of a company's financial condition and results of operations and most
demanding on their calls on judgment, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain and may
change in subsequent periods. We believe our most critical accounting policies
relate to:
Revenue recognition and deferred revenue: We record revenue from Internet
telephony services based on minutes (or fractions thereof) of customer
usage. We record payments received in advance for prepaid services and
services to be supplied under contractual agreements as deferred revenue
until such related services are provided. We estimate the allowance for
doubtful accounts by reviewing the status of significant past due
receivables and analyzing historical bad debt trends and we then reduce
accounts receivables by such allowance for doubtful accounts to expected
net realizable value.
Long-lived Assets: Property and equipment are stated at cost. Depreciation
is calculated using the straight-line method over the estimated useful
lives of the depreciable assets, which range from two to five years.
Improvements are capitalized, while repair and maintenance costs are
charged to operations as incurred. Our long-lived assets are reviewed for
impairment on a quarterly basis and whenever events or changes in
circumstances occur indicating that the net carrying amount may not be
recoverable. We review for impairment by comparing the carrying value of
the long-lived asset to the estimated undiscounted future cash flows
expected to result from the use of the long-lived assets (and their
eventual disposition). If the sum of the expected undiscounted future cash
flows is less than the carrying amount of assets, we would recognize an
impairment loss. The impairment loss, if determined to be necessary, would
be measured as the amount by which the carrying amount of the long-lived
asset exceeds the fair value of the long-lived asset based on estimated
future discounted cash flows.
23
Results of Operations
The following table sets forth the statement of operations data presented
as a percentage of revenues for the periods indicated:
Year Ended December 31,
2002 2003 2004
---- ---- ----
Revenues:
Total revenues ........................................... 100.0 100.0 100.0
Costs and operating expenses:
Cost of revenues ......................................... 69.1 63.8 65.5
Research and development expenses ........................ 26.6 17.7 12.0
Selling and marketing expenses ........................... 30.2 25.3 15.5
General and administrative expenses (exclusive of non-cash
compensation expense) ............................... 16.7 15.7 10.4
Non-cash compensation expense ............................ 2.1 0.0 0.0
Depreciation and amortization ............................ 51.1 42.4 13.0
----- ----- -----
Total costs and operating expenses ......................... 195.8 164.9 116.4
----- ----- -----
Loss from operations ....................................... (95.8) (64.9) (16.4)
Interest income, net ....................................... 3.5 1.9 1.3
Income taxes ............................................... (1.1) (0.4) (0.3)
----- ----- -----
Net Loss ................................................... (93.4)% (63.4)% (15.4)%
===== ===== =====
Comparison of 2004 and 2003
Revenues
Revenues increased approximately $7.9 million or 60% to approximately
$21.1 million in 2004 from approximately $13.2 million in 2003. Revenues from
enhanced IP communications services (primarily PC-to-Phone) through iConnectHere
increased approximately $0.9 million or 14.5% to approximately $7.1 million in
2004 from approximately $6.2 million in 2003 due primarily to a greater number
of PC-to-Phone and Broadband Phone calls being placed by an increasing user
base. Revenues from enhanced IP communications services through our reseller and
service provider sales efforts (including sales of our Hosted Communications
Solution) increased approximately $7.0 million or 118.6% to approximately $12.9
million in 2004 from approximately $5.9 million in 2003, due primarily to a
greater number of PC-to-Phone and Broadband Phone calls being placed by an
increasing user base.
Revenues from carrier transmission services for telecommunications
carriers decreased by approximately $0.3 million or 60% to approximately $0.2
million in 2004 from approximately $0.5 million in 2003, due primarily to
decreased demand from a smaller customer base. Three "Master Resellers"
accounted for approximately 16.36% and 9.44% and 5.35% of our sales,
respectively, during 2004.
Costs and Operating Expenses
Cost of revenues. Cost of revenues increased by $5.4 million or 64.3% to
$13.8 million in 2004 from $8.4 million in 2003, due primarily to an increase in
the amount of traffic being terminated.
24
Research and development expenses. Research and development expenses
increased by $0.2 million or 8.7% to $2.5 million in 2004 from $2.3 million in
2003, due to increased personnel costs associated with the development of new
services and enhancements to our existing services.
Selling and marketing expenses. Selling and marketing expenses decreased
by $0.1 million or 3.0% to $3.2 million in 2004 from $3.3 million in 2003, due
to a decrease in branding and promotional activities.
General and administrative expenses. General and administrative expenses
increased by $0.1 million or 4.8% to $2.2 million in 2004 from $2.1 million in
2003, primarily due to increased personnel and occupancy costs.
Depreciation and amortization. Depreciation and amortization decreased by
$2.9 million or 51.8% to $2.7 million in 2004 from $5.6 million in 2003, due to
a lower relative level of capital expenditures in the first three quarters of
2004 compared to prior years, somewhat offset by a higher relative level of
capital expenditures in the fourth quarter of 2004, and a lower level of certain
assets purchased in prior years being included in the computation of
depreciation expense in 2004 compared to 2003 as they have already been fully
depreciated in prior periods.
Loss from Operations
Loss from operations decreased by $5 million or 59.5% to $3.5 million in
2004 from $8.5 million in 2003, due primarily to the decrease in costs and
operating expenses, including selling and marketing expenses.
Interest Income, Net
We earned interest income of $0.3 million in 2004 compared to $0.2 million
in 2003 due primarily to moderately higher interest rates earned on the
moderately reduced balance of the remaining proceeds from our initial public
offering.
Income Taxes, Net
We paid net income taxes of $0.1 million in 2004 compared to $0.1 million
in 2003.
Net Loss
Net loss decreased $5.1 million or 61% to $3.2 million in 2004 from $8.3
million in 2003, due to the foregoing factors.
Comparison of 2003 and 2002
Revenues
Revenues increased approximately $0.3 million or 2.3% to approximately
$13.2 million in 2003 from approximately $12.9 million in 2002. Revenues from
enhanced IP communications services (including our Hosted Communications
Solution) increased by approximately $1.1 million or 9.6% to approximately $12.6
million in 2003 from approximately $11.5 million in 2002, due to a greater
number of iConnectHere, reseller, corporate and service provider customers,
yielding a greater number of calls being placed by an increasing user base.
25
Revenues from carrier transmission services for telecommunications
carriers decreased by approximately $0.9 million or 64.3% to approximately $0.5
million in 2003 from approximately $1.4 million in 2002, due primarily to
decreased demand from a smaller customer base. One "Master Reseller" accounted
for approximately 19% of our sales in aggregate in 2003.
Costs and Operating Expenses
Cost of revenues. Cost of revenues decreased by $0.5 million or 5.6% to
$8.4 million in 2003 from $8.9 million in 2002, due to both a decrease in the
amount of carrier traffic being terminated and lower pricing from suppliers.
Research and development expenses. Research and development expenses
decreased by $1.1 million or 32.4% to $2.3 million in 2003 from $3.4 million in
2002, due to lower personnel costs associated with the development of new
services and enhancements to our existing services.
Selling and marketing expenses. Selling and marketing expenses decreased
by $0.6 million or 15.4% to $3.3 million in 2003 from $3.9 million in 2002, due
to a decrease in branding and promotional activities.
General and administrative expenses. General and administrative expenses
decreased by $0.1 million or 4.5% to $2.1 million in 2003 from $2.2 million in
2002, primarily due to decreased personnel and occupancy costs, somewhat offset
by increased professional fees.
Non-cash compensation expenses. There were no non-cash compensation
expenses in 2003 compared to approximately $270,000 in 2002, due to the
completed amortization of costs incurred during 1998 and 1999 related to the
grants of options and warrants below the then fair market value during those
periods.
Depreciation and amortization. Depreciation and amortization decreased by
$1.0 million or 15.2% to $5.6 million in 2003 from $6.6 million in 2002, due to
a lower relative level of capital expenditures in 2003, and certain assets have
been fully depreciated in 2002.
Loss from Operations
Loss from operations decreased by $3.9 million or 31.5% to $8.5 million in
2003 from $12.4 million in 2002, due primarily to the decrease in costs and
operating expenses, including selling and marketing expenses.
Interest Income, Net
Interest income decreased by $0.2 million or 50.0% to $0.2 million in 2003
from $0.4 million in 2002, due primarily to lower interest rates earned on a
reduced balance of remaining proceeds from our initial public offering.
Income Taxes, Net
We paid net income taxes of $0.1 million in 2003 compared to $0.1 million
in 2002.
Net Loss
Net loss decreased $3.8 million or 31.4% to $8.3 million in 2003 from
$12.1 million in 2002, due to the foregoing factors.
26
Liquidity and Capital Resources
Since our inception in June 1996, we have incurred significant operating
and net losses due in large part to the start-up and development of our
operations. As of December 31, 2003, we had an accumulated deficit of
approximately $147.9 million.
As of December 31, 2004, we had cash and cash equivalents of approximately
$13.8 million, marketable securities and other short-term investments of
approximately $2.7 million and working capital of approximately $11.4 million.
We generated positive cash flow from operating activities of approximately $0.5
million during 2004 compared with negative cash flow from operating activities
of $3.2 million during 2003. Accounts receivable were approximately $0.3 million
and $0.4 million at December 31, 2004 and December 31, 2003, respectively. Net
cash used in investing activities increased from $325,000 during 2003 to
$2,321,000 in 2004.
Our capital expenditures increased from approximately $368,000 in the year
ended December 31, 2003 compared to approximately $2,323,000 in the year ended
December 31, 2004, as better utilization of our existing domestic and
international network infrastructure, was offset by increased investment in
equipment to support our increasing revenue base and anticipated expansion
needs.
Short-term, we obtain our funding from our utilization of the remaining
proceeds from our initial public offering offset by positive or negative cash
flow from our operations. These proceeds are maintained as cash and cash
equivalents with an original maturity of three months or less. Based on current
trends in our operations, these funds will be sufficient to meet our working
capital requirements, including operating losses, and capital expenditure
requirements for at least the next fiscal year, assuming that our business plan
is implemented successfully, and that:
o our recent revenue trends, which reflected an increase in our
higher-margin (primarily PC-to-Phone) products and services
continues to increase;
o our expense trends remain at or near the rates of our fourth quarter
2004 rates, which were somewhat reduced compared to the previous the
year through reductions in personnel, curtailment of discretionary
expenditures, and reduced network rent and termination rates from
our carriers; and
o our net cash-burn rate, which was significantly reduced compared to
the previous year due to the foregoing factors to approximately $0.8
million in the fourth quarter of 2004, continues to improve
throughout 2005 and beyond.
To the extent that these trends do not remain steady or if in the
longer-term we are not able to successfully implement our business strategy we
may be required to raise additional funds for our ongoing operations. Additional
financing may not be available when needed or, if available, such financing may
not be on terms favorable to us. If additional funds are raised through the
issuance of equity securities, our existing stockholders may experience
significant dilution. If addition funds are raised the issuance of debt
instruments, we cannot assure you that any third party will be willing or able
to provide additional capital on favorable terms or at all.
27
Contractual Obligations and Commercial Commitments
The following table sets forth our future contractual obligations and
commercial commitments in total, for each of the next five years and thereafter.
Contractual obligations Payments due by period (in thousands)
Total Less than 1-3 3-5 More than 5
1 year years years years
Real Estate Leases 5,046 1,122 1,694 1,721 509
Auto Leases 546 213 264 69 --
Other Operating Leases 25 25 -- -- --
Capital Lease Obligations -- -- -- -- --
Purchase Obligations 63 63 -- -- --
Other Commercial Commitments -- -- -- -- --
Other Long-Term Liabilities
Reflected on the Registrant's -- -- -- -- --
Balance Sheet under GAAP
Total 5,680 1,423 1,958 1,790 509
Risk Factors
In addition to the other information included in this annual report, you
should consider the following risk factors. This annual report contains
forward-looking statements covered by the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. These forward-looking statements
involve risks and uncertainties that may affect our business and prospects. Our
results may differ significantly from the results discussed in the
forward-looking statements as a result of certain factors that are listed below
or discussed elsewhere in this annual report and our other filings with the
Securities and Exchange Commission.
Risks Related to Our Company
We have a history of losses and negative cash flow and we anticipate they may
continue.
We have incurred significant losses since inception, and we may continue
to incur significant losses for the foreseeable future. We reported net losses
of approximately $3.2 million in 2004, approximately $8.3 million in 2003, and
approximately $12.1 million in 2002. As of December 31, 2004, our accumulated
deficit was approximately $151.1 million. We generated positive cash flow from
operations of approximately $0.5 million during 2004 and negative $3.2 million
during 2003. As a percentage of revenues, our net loss was 15.4% in 2004, 63.4%
in 2003 and 93.4% in 2002. Our revenues may not grow or even continue at their
current level. As a result, while we believe we have sufficient funds to meet
our working capital requirements for at least the next fiscal year (see -
Liquidity and Capital Resources), we will need to increase our revenues to
become profitable. In order to increase our revenues, we need to attract and
maintain customers to increase the fees we collect for our services. If our
revenues do not increase as much as we expect or if our expenses increase at a
greater pace than revenues, we may never be profitable or, if we become
profitable, we may not be able to sustain or increase profitability on a
quarterly or annual basis.
28
We may need additional capital to finance our operations in the future.
We intend to continue to enhance and expand our network in order to
maintain our competitive position and meet the increasing demands for service
quality, capacity and competitive pricing. Also, the introduction of new
products and/or service will require significant marketing and promotional
expenses that we often incur before we begin to receive the related revenue.
While we believe we have sufficient funds to meet our working capital
requirements for at least the next fiscal year (see - Liquidity and Capital
Resources), if our cash flow from operations is not sufficient to meet our
capital expenditure and working capital requirements, we will need to raise
additional capital to continue our operations. We may not be able to raise
additional capital, and if we are able to raise additional capital through the
issuance of additional equity, our current investors could experience dilution.
If we are unable to obtain additional capital, we may be required to reduce the
scope of our business or our anticipated growth, which would reduce our
revenues.
We have a limited operating history upon which you can evaluate us.
We have only a limited operating history upon which you can evaluate our
business and prospects. We commenced operations in June 1996. You should
consider our prospects in light of the risks, expenses and difficulties we may
encounter as an early stage company in the new and rapidly evolving market for
IP communications services. These risks include our ability:
o to increase acceptance of our enhanced IP communications services
(including our Hosted Communications Solution), thereby increasing
the number of users of our IP telephony services;
o to compete effectively, and;
o to develop new products and keep pace with developing technology.
In addition, because we expect an increasing percentage of our revenues to
be derived from our enhanced IP communications services (including our Hosted
Communications Solution), our past operating results may not be indicative of
our future results.
We may not be able to expand our revenue and achieve profitability.
Our business strategy is to expand our revenue sources to include the
provision of enhanced IP communications services to several different customer
groups. We can neither assure you that we will be able to accomplish this nor
that this strategy will be profitable. Currently, our revenues are primarily
generated by sales of enhanced IP communications services through our direct
consumer offering, iConnectHere, and our reseller and service provider sales
channel (including sales of our Hosted Communications Solutions). Enhanced IP
communications services from these channels generated 96.02%, 92.1%, and 60.2%
of our total revenues in 2004, 2003 and 2002, respectively. The provision of
enhanced IP communications services has not been profitable to date and may not
be profitable in the future.
In the future, we intend to generate increased revenues from enhanced
IP communications services, from multiple sources, many of which are unproven,
including the commercial sale of our Hosted Communications Solutions. We expect
that our revenues for the foreseeable future will be dependent on, among other
factors:
o sales of enhanced IP communications services, including sales of our
Hosted Communications Solutions;
o acceptance and use of IP telephony;
o expansion of service offerings;
o traffic levels on our network;
o the effect of competition, regulatory environment, international
long distance rates and access and transmission costs on our prices,
and;
o continued improvement of our global network quality.
29
We may not be able to sustain our current revenues or successfully
generate additional revenues from the sale of enhanced IP communications
services, including Hosted Communications Solutions or carrier transmission
services.
We cannot assure you that a market for our services will develop.
We are uncertain whether a market will develop for our enhanced IP
communications services, including our Hosted Communications Solutions. Our
market is new and rapidly evolving. Our ability to sell our services may be
inhibited by, among other factors, the reluctance of some end users to switch
from traditional communications carriers to IP communications carriers and by
concerns with the quality of IP telephony and the adequacy of security in the
exchange of information over the Internet, and the reluctance of our resellers
and service providers to utilize outsourced solutions providers. End users in
markets serviced by recently deregulated telecommunications providers are not
familiar with obtaining services from competitors of these providers and may be
reluctant to use new providers, such as us. We will need to devote substantial
resources to educate customers and end users about the benefits of IP
communications solutions in general and our services in particular. If
enterprises and their customers do not accept our enhanced IP communications
services as a means of sending and receiving communications, we will not be able
to increase our number of paid users or successfully generate revenues in the
future.
Our future success depends on the growth in the use of the internet as a means
of communications.
If the market for IP communications, in general, and our services in
particular, does not grow at the rate we anticipate or at all, we will not be
able to increase our number of users or generate revenues we anticipate. To be
successful, IP communications requires validation as an effective, quality means
of communication and as a viable alternative to traditional telephone service.
Demand and market acceptance for recently introduced services are subject to a
high level of uncertainty. The Internet may not prove to be a viable alternative
to traditional telephone service for reasons including:
o inconsistent quality or speed of service;
o traffic congestion on the Internet;
o potentially inadequate development of the necessary infrastructure;
o lack of acceptable security technologies;
o lack of timely development and commercialization of performance
improvements, and;
o unavailability of cost-effective, high-speed access to the Internet.
If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it by such growth, or its performance or
reliability may decline. In addition, Web sites may from time to time experience
interruptions in their service as a result of outages and other delays occurring
throughout the Internet network infrastructure. If these outages or delays
frequently occur in the future, Internet usage, as well as usage of our
communications portal and our services, could be adversely affected.
Potential fluctuations in our quarterly financial results may make it difficult
for investors to predict our future performance.
Our quarterly operating results may fluctuate significantly in the future
as a result of a variety of factors, many of which are outside our control. The
factors generally within our control include:
o the rate at which we are able to attract users to purchase our
enhanced IP communications services, including our Hosted
Communications Solutions;
o the amount and timing of expenses to enhance marketing and promotion
efforts and to expand our infrastructure;
o the timing of announcements or introductions of new or enhanced
services by us.
30
The factors outside our control include:
o the timing of announcements or introductions of new or enhanced
services by our competitors;
o technical difficulties or network interruptions in the Internet or
our privately-managed network;
o general economic and competitive conditions specific to our
industry.
The foregoing factors also may create other risks affecting our long-term
success, as discussed in the other risk factors.
We believe that quarter-to-quarter comparisons of our historical operating
results may not be a good indication of our future performance, nor would our
operating results for any particular quarter be indicative of our future
operating results.
Our network may not be able to accommodate our capacity needs.
We expect the volume of traffic we carry over our network to increase
significantly as we expand our operations and service offerings. Our network may
not be able to accommodate this additional volume. In order to ensure that we
are able to handle additional traffic, we may have to enter into long-term
agreements for leased capacity. To the extent that we overestimate our capacity
needs, we may be obligated to pay for more transmission capacity than we
actually use, resulting in costs without corresponding revenues. Conversely, if
we underestimate our capacity needs, we may be required to obtain additional
transmission capacity from more expensive sources. If we are unable to maintain
sufficient capacity to meet the needs of our users, our reputation could be
damaged and we could lose users.
We face a risk of failure of computer and communications systems used in our
business.
Our business depends on the efficient and uninterrupted operation of our
computer and communications systems as well as those that connect to our
network. We maintain communications systems in facilities in New York, Los
Angeles, Chicago, Atlanta, London and Jerusalem. Our systems and those that
connect to our network are subject to disruption from natural disasters or other
sources of power loss, communications failure, hardware or software malfunction,
network failures and other events both within and beyond our control. Any system
interruptions that cause our services to be unavailable, including significant
or lengthy telephone network failures or difficulties for users in communicating
through our network or portal, could damage our reputation and result in a loss
of users.
Our computer systems and operations may be vulnerable to security breaches.
Our computer infrastructure is potentially vulnerable to physical or
electronic computer viruses, break-ins and similar disruptive problems and
security breaches that could cause interruptions, delays or loss of services to
our users. We believe that the secure transmission of confidential information
over the Internet, such as credit card numbers, is essential in maintaining user
confidence in our services. We rely on licensed encryption and authentication
technology to effect secure transmission of confidential information, including
credit card numbers. It is possible that advances in computer capabilities, new
technologies or other developments could result in a compromise or breach of the
technology we use to protect user transaction data. A party that is able to
circumvent our security systems could misappropriate proprietary information or
cause interruptions in our operations. Security breaches also could damage our
reputation and expose us to a risk of loss or litigation and possible liability.
Although we have experienced no security breaches to date of which we are aware,
we cannot guarantee you that our security measures will prevent security
breaches.
31
Third parties might infringe upon our proprietary technology.
We cannot assure you that the steps we have taken to protect our
intellectual property rights will prevent misappropriation of our proprietary
technology. To protect our rights to our intellectual property, we rely on a
combination of trademark and patent law, trade secret protection,
confidentiality agreements and other contractual arrangements with our
employees, affiliates, strategic partners and others. We may be unable to detect
the unauthorized use of, or take appropriate steps to enforce, our intellectual
property rights. Effective copyright and trade secret protection may not be
available in every country in which we offer or intend to offer our services.
Failure to adequately protect our intellectual property could harm our brand,
devalue our proprietary content and affect our ability to compete effectively.
Further, defending our intellectual property rights could result in the
expenditure of significant financial and managerial resources.
Our services may infringe on the intellectual property rights of others.
Third parties may assert claims that we have violated a patent or
infringed a copyright, trademark or other proprietary right belonging to them.
We incorporate licensed third-party technology in some of our services. In these
license agreements, the licensors have agreed to indemnify us with respect to
any claim by a third party that the licensed software infringes any patent or
other proprietary right so long as we have not made changes to the licensed
software. We cannot assure you that these provisions will be adequate to protect
us from infringement claims. Any infringement claims, even if not meritorious,
could result in the expenditure of significant financial and managerial
resources.
Operating internationally exposes us to additional and unpredictable risks.
We intend to continue to enter additional markets in Eastern Europe, Latin
America, Africa and Asia and to expand our existing operations outside the
United States. International operations are subject to inherent risks,
including:
o potentially weaker protection of intellectual property rights;
o political instability;
o unexpected changes in regulations and tariffs;
o fluctuations in exchange rates;
o varying tax consequences, and;
o uncertain market acceptance and difficulties in marketing efforts
due to language and cultural differences.
We have experienced losses as a result of fraud.
We have experienced losses due to fraud. While in 2004, we experienced
losses from fraud of less than 1% of our revenues, callers have obtained our
services without rendering payment by unlawfully using our access numbers and
personal identification numbers. While we have continued to implement anti-fraud
measures in order to control losses relating to these practices, and these
measures have proven to be effective today, these measures may not in the future
be sufficient to effectively limit all of our exposure in the future from fraud
and future losses could rise significantly above current levels.
Intense competition could reduce our market share and harm our financial
performance.
Competition in the market for enhanced IP communications services is
becoming increasingly intense and is expected to increase significantly in the
future. The market for enhanced Internet and IP communications is new and
rapidly evolving. We expect that competition from companies both in the Internet
and telecommunications industries will increase in the future. Our competitors
include both start-up IP telephony service providers and established traditional
communications providers. Many of our existing competitors and potential
competitors have broader portfolios of services, greater financial, management
and operational resources, greater brand-name recognition, larger subscriber
bases and more experience than we have. In addition, many of our IP telephony
competitors use the Internet instead of a private network to transmit traffic.
Operating and capital costs of these providers may be less than ours,
potentially giving them a competitive advantage over us in terms of pricing.
We also compete in the growing market of discount telecommunications
services including calling cards, prepaid cards, call-back services, dial-around
or 10-10 calling and collect calling services. In addition, some Internet
service providers have begun to aggressively enhance their real time interactive
communications, focusing on instant messaging, PC-to-PC and PC-to-phone, and/or
broadband phone services.
32
In addition, traditional carriers, cable companies and satellite
television providers are bundling services and products not offered by
deltathree with internet telephony services. While this provides us with the
opportunity to offer these companies our products and services as a way for them
to offer internet telephony services, it also introduces the risk that they will
introduce these services on their own utilizing other options while at the same
time making it more difficult for us to compete against them with direct to
consumer offerings of our own.
If we are unable to provide competitive service offerings, we may lose
existing users and be unable to attract additional users. In addition, many of
our competitors, especially traditional carriers, enjoy economies of scale that
result in a lower cost structure for transmission and related costs, which cause
significant pricing pressures within the industry. In order to remain
competitive we intend to increase our efforts to promote our services, and we
cannot be sure that we will be successful in doing this.
In addition to these competitive factors, recent and pending deregulation
in some of our markets may encourage new entrants. We cannot assure you that
additional competitors will not enter markets that we plan to serve or that we
will be able to compete effectively.
Decreasing telecommunications rates may diminish or eliminate our competitive
pricing advantage.
Decreasing telecommunications rates may diminish or eliminate the
competitive pricing advantage of our services. International and domestic
telecommunications rates have decreased significantly over the last few years in
most of the markets in which we operate, and we anticipate that rates will
continue to be reduced in all of the markets in which we do business or expect
to do business. Users who select our services to take advantage of the current
pricing differential between traditional telecommunications rates and our rates
may switch to traditional telecommunications carriers as such pricing
differentials diminish or disappear, and we will be unable to use such pricing
differentials to attract new customers in the future. In addition, our ability
to market our carrier transmission services to telecommunications carriers
depends upon the existence of spreads between the rates offered by us and the
rates offered by traditional telecommunications carriers, as well as a spread
between the retail and wholesale rates charged by the carriers from which we
obtain wholesale service. Continued rate decreases will require us to lower our
rates to remain competitive and will reduce or possibly eliminate our gross
profit from our carrier transmission services. If telecommunications rates
continue to decline, we may lose users for our services.
Government regulation and legal uncertainties relating to IP telephony could
harm our business.
Historically, voice communications services have been provided by
regulated telecommunications common carriers. We offer voice communications to
the public for international and domestic calls using IP telephony, and we do
not operate as a licensed telecommunications common carrier in any jurisdiction.
Based on specific regulatory classifications and recent regulatory decisions, we
believe we qualify for certain exemptions from telecommunications common carrier
regulation in many of our markets. However, the growth of IP telephony has led
to close examination of its regulatory treatment in many jurisdictions making
the legal status of our services uncertain and subject to change as a result of
future regulatory action, judicial decisions or legislation in any of the
jurisdictions in which we operate. Established regulated telecommunications
carriers have sought and may continue to seek regulatory actions to restrict the
ability of companies such as ours to provide services or to increase the cost of
providing such services. In addition, our services may be subject to regulation
if regulators distinguish phone-to- phone telephony service using IP
technologies over privately-managed networks such as our services from
integrated PC-to-PC and PC-originated voice services over the Internet. Some
regulators may decide to treat the former as regulated common carrier services
and the latter as unregulated enhanced or information services.
Application of new regulatory restrictions or requirements to us could
increase our costs of doing business and prevent us from delivering our services
through our current arrangements. In such event, we would consider a variety of
alternative arrangements for providing our services, including obtaining
appropriate regulatory authorizations for our local network partners or
ourselves, changing our service arrangements for a particular country or
limiting our service offerings. Such regulations could limit our service
offerings, raise our costs and restrict our pricing flexibility, and potentially
limit our ability to compete effectively. Further, regulations and laws which
affect the growth of the Internet could hinder our ability to provide our
services over the Internet. For a more detailed discussion of the regulation of
IP telephony, see "Business--Regulation of IP Telephony."
33
We may not be able to keep pace with rapid technological changes in the
communications industry
Our industry is subject to rapid technological change. We cannot predict
the effect of technological changes on our business. In addition, widely
accepted standards have not yet developed for the technologies we use. We expect
that new services and technologies will emerge in the market in which we
compete. These new services and technologies may be superior to the services and
technologies that we use, or these new services may render our services and
technologies obsolete.
To be successful, we must adapt to our rapidly changing market by
continually improving and expanding the scope of services we offer and by
developing new services and technologies to meet customer needs. Our success
will depend, in part, on our ability to license leading technologies and respond
to technological advances and emerging industry standards on a cost-effective
and timely basis. We will need to spend significant amounts of capital to
enhance and expand our services to keep pace with changing technologies.
Risks Related to Our Relationship with Atarey
Atarey exercises significant control over all matters submitted to a stockholder
vote.
Atarey owns approximately 41% of the voting power and economic interest in
us, and is the largest shareholder of our stock. As long as Atarey continues to
beneficially own such a significant percentage of our capital stock and there
are no other major shareholders, Atarey will be able to exercise a significant
influence over decisions affecting us, including:
o composition of our board of directors and, through it, our direction
and policies, including the appointment and removal of officers;
o mergers or other business combinations;
o acquisitions or dispositions of assets by us;
o future issuances of capital stock or other securities by us;
o incurrence of debt by us;
o amendments, waivers and modifications to any agreements between us
and Atarey;
o payment of dividends on our capital stock, and;
o approval of our business plans and general business development.
In addition, two of our seven directors are officers and/or directors of
Atarey, or otherwise affiliated with Atarey. As a result, the ability of any of
our other stockholders to influence the management of our company is limited,
which could have an adverse effect on the market price of our stock.
A third party may be deterred from acquiring our company.
Atarey's major ownership could delay, deter or prevent a third party from
attempting to acquire control of us. This may have the effect of discouraging a
third party from making a tender offer or otherwise attempting to obtain control
of us, even though such a change in ownership would be economically beneficial
to us and our stockholders.
34
Risks Related to Our Common Stock
Volatility of our stock price could adversely affect our stockholders.
Since trading commenced in November 1999, the market price of our common
stock has been highly volatile and may continue to be volatile and could be
subject to wide fluctuations in response to factors such as:
o variations in our actual or anticipated quarterly operating results
or those of our competitors;
o announcements by us or our competitors of technological innovations;
o introduction of new products or services by us or our competitors;
o changes in financial estimates by securities analysts;
o conditions or trends in the Internet industry;
o changes in the market valuations of other Internet companies;
o announcements by us or our competitors of significant acquisitions;
o our entry into strategic partnerships or joint ventures, and;
o sales of our common stock by Atarey.
All of these factors are, in whole or part, beyond our control and may
materially adversely affect the market price of our common stock regardless of
our performance.
Investors may not be able to resell their shares of our common stock
following periods of volatility because of the market's adverse reaction to such
volatility. In addition, the stock market in general, and the market for
telecommunications, Internet-related and technology companies in particular, has
been dramatically decreased and is extremely depressed. We cannot assure you
that our common stock will trade at the same levels of other telecommunications
or Internet stocks or that telecommunications or Internet stocks in general will
sustain their current market prices.
The liquidity of our common stock could be adversely affected by changes in our
Nasdaq listing.
Our common stock is currently listed on the Nasdaq SmallCap Market. The
listing of our common stock was transferred from the Nasdaq National Market to
the Nasdaq SmallCap Market effective on September 17, 2002. We currently meet
all criteria for continued inclusion in the Nasdaq SmallCap Market. However,
based on the volatile nature of our stock price, we can make no assurances that
we will continue to do so. Failure to meet these criteria could result in our
delisting from the Nasdaq SmallCap Market. If our shares were to be delisted
from the Nasdaq SmallCap Market, our shares would continue to trade, if at all,
on the OTC Bulletin Board, upon application by the requisite market makers. This
would adversely impact our stock price, as well as the liquidity of the market
for our shares which, as a result, would adversely affect the ability of our
stockholders to purchase and sell their shares in an orderly manner, or at all.
Furthermore, a delisting of our shares could damage our general business
reputation and impair our ability to raise additional funds. Any of the
foregoing events could have a material adverse effect on our business, financial
condition and operating results.
We do not intend to pay dividends.
We have never declared or paid any cash dividends on our common stock. We
intend to retain any future earnings to finance our operations and to expand our
business and, therefore, do not expect to pay any cash dividends in the
foreseeable future.
35
Risks Related to Our Israel-based Office
We may be negatively impacted by changes in political, military and/or economic
conditions.
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors and a state of
hostility, varying from time to time in intensity and degree, has led to
security and economic problems for Israel. A peace agreement between Israel and
Egypt was signed in 1979 and a peace agreement between Israel and Jordan was
signed in 1994. However, as of the date hereof Israel has not entered into any
peace agreement with Syria or Lebanon.
Despite peace related developments, certain countries, companies and
organizations continue to participate in a boycott of Israeli firms. We do not
believe that the boycott has had a material adverse effect on us, but there can
be no assurance that restrictive laws, policies or practices directed towards
Israel or Israeli-based businesses will not have an adverse impact on our
business or financial condition in the future.
Israel's economy has been subject to numerous destabilizing factors,
including a period of rampant inflation in the early- to mid-l980s, low foreign
exchange reserves, fluctuations in world commodity prices and military
conflicts. The Israeli Government has, for these and other reasons, intervened
in the economy by utilizing, among other means, fiscal and monetary policies,
import duties, foreign currency restrictions and control of wages, prices and
exchange rates. The Israeli Government has periodically changed its policies in
all these areas. Although we derive most of our revenues outside of Israel, a
substantial portion of our expenses are incurred in Israel and are affected by
economic conditions in the country.
All of these factors are, in whole or part, beyond our control and may
materially adversely affect on our business, financial condition and operating
results, or market price of our common stock regardless of our performance.
We may be negatively impacted by employees being called for army service
Generally, all male adult citizens and permanent residents of Israel under
the age of 41 are, unless exempt, obligated to perform up to 36 days of military
reserve duty annually. Additionally, all such residents are subject to being
called to active duty at any time under emergency circumstances. Some of our
officers and employees are currently obligated to perform annual reserve duty.
While we have operated effectively under these requirements since we began
operations, no assessment can be made as to the full impact of such requirements
on our workforce or business if conditions should change, and no prediction can
be made as to the effect on us of any expansion of such obligations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Securities and Exchange Commission's rule related to market risk
disclosure requires that we describe and quantify our potential losses from
market risk sensitive instruments attributable to reasonably possible market
changes. Market risk sensitive instruments include all financial or commodity
instruments and other financial instruments (such as investments and debt) that
are sensitive to future changes in interest rates, currency exchange rates,
commodity prices or other market factors. We believe our exposure to market risk
is immaterial. We currently do not invest in, or otherwise hold, for trading or
other purposes, any financial instruments subject to market risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements required by this Item are
included in Item 14 of this report.
36
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our principal
executive officer and principal financial officer, after evaluating the
effectiveness of our disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period
covered by this Annual Report on Form 10-K, have concluded that, based on
such evaluation, our disclosure controls and procedures were adequate and
effective to ensure that material information relating to us, including
our consolidated subsidiaries, was made known to them by others within
those entities, particularly during the period in which this Annual Report
on Form 10-K was being prepared.
(b) Changes in Internal Controls. There were no changes in our
internal control over financial reporting, identified in connection with
the evaluation of such internal control that occurred during the fourth
quarter of our last fiscal year that have materially affected, or are
reasonably likely to materially affect, our internal control over
financial reporting.
ITEM 9B. OTHER INFORMATION
On November 8, 2004, our stockholders approved the 2004 Stock Incentive
Plan and 2004 Non-Employee Director Stock Option Plan at our annual meeting of
stockholders.
On March 29, 2005, the Compensation Committee approved the specific
performance objectives under the Company's 1999 Performance Incentive Plan for
fiscal year 2005. Such performance objectives will include the Company achieving
certain targets for revenues, gross profit and EBITDA as well as signing up a
certain number of additional customers to use the deltathree platform solution.
Listed below are the salaries and bonuses for our named executive officers
that were awarded during fiscal 2004 and the salaries that have been established
for fiscal 2005. Bonuses for fiscal 2005 have not yet been determined.
Executive Officer 2004 Salary(1) 2004 Bonus (2) 2005 Salary (3)
- --------------------------------------------------------------------------------
Shimmy Zimels $180,000 $125,050 $248,800
Chief Executive Officer
and President
Paul C. White $180,000 $ 94,100 $235,300
Chief Financial Officer
(1) Salary shown is the amount actually paid to the executive as salary, and
not the amount employee was entitled to per executives' employment
contracts.
(2) Bonus shown is the aggregate amount of bonuses earned by executive during
2004 and is the sum of: a one-time bonus awarded by the Compensation
Committee in the first-half of 2004, and bonuses awarded in 2005 under our
1999 Performance Incentive Plan for performance during 2004.
(3) Salaries shown are per executives' employment contracts.
37
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Board of Directors
Our Amended and Restated Certificate of Incorporation provides that a
director shall hold office until the annual meeting for the year in which his or
her term expires except in the case of elections to fill vacancies or newly
created directorships. Each director is elected for a one-year term. Each of the
nominees is now serving as director on our Board. Set forth below are the name,
age and the positions and offices held by each of our directors, his principal
occupation and business experience during at least the past five years and the
names of other publicly-held companies of which he serves as a director.
Noam Bardin, 34 - Chairman of the Board. Mr. Bardin co-founded deltathree
and served as Chief Executive Officer and President from July 2000 through June
2002. Mr. Bardin has served as Chairman of the Board since April 2002. Mr.
Bardin served as Vice President of Technology and Chief Technology Officer of
deltathree since June 1997 before being named President and Chief Executive
Officer in April 2000. He served as Global Network Director from November 1996
to May 1997. Prior to founding deltathree, he served as Director of Operations
at Ambient Corporation. Mr. Bardin graduated from the Hebrew University
(Jerusalem) with a BA in Economics and an MPA from Harvard University Kennedy
School in Public Administration.
Noam Ben-Ozer, 41 - Director. Mr. Ben-Ozer was named a director of
deltathree in September 2004. Mr. Ben-Ozer currently serves as a Director, and
is Chairman of the Audit Committee for Equity-One, a NYSE-listed real estate
investment trust. Previously, Mr. Ben-Ozer co-founded iPhrase Technologies,
Inc., a privately-held software company. From 1994 to 1999, Mr. Ben-Ozer served
as a consultant for Bain & Company, a management consulting company. From 1993
to 1994, Mr. Ben-Ozer served as an outside consultant to Lernout & Hauspie
Speech Products. Mr. Ben-Ozer is a certified public accountant in Israel and
received an M.B.A. from the Harvard Business School.
Ilan Biran, 57 - Director. Mr. Biran has served as a director of
deltathree since December 2003. Mr. Biran brings a wealth of business and
management experience from the telecom and defense industries. Since January
2004, Mr. Biran has served as the Chairman of YES Satellite Television, one of
the leading satellite television companies in Israel. From 1999 to 2003, Mr.
Biran served as the President and CEO of Bezeq Ltd. - the Israeli PTT, with
annual sales of over $2 billion and approximately 16,000 employees. Mr. Biran
holds the rank of Major General (res.) in the Israeli Defense Force where, as
Commander of the IDF's Central Command, he played an active role in reaching the
peace agreements with Jordan. From 1996 to 1999, he served as the Director
General of the Israeli Ministry of Defense, and prior to that command, he held a
wide variety of senior-level positions in other Israeli units, since 1964. Mr.
Biran holds a B.A. in Economics and Business Administration from Bar-Ilan
University, and holds an Associate Diploma in Strategy and Political Economic
Research from Georgetown University. He is also a graduate of the U.S. Marine
Corps Command and Staff College. In addition, Mr. Biran's public activities
include: serving as the Israeli Prime Minister's Special Coordinator for POWs
and MIAs; is a member of the Board of Trustees of Haifa University; is a member
of the Shevach-Mofet High School Executive Committee and; since 1996, has served
as the Chairman of the Board of Directors of the Israeli Oil Refineries, Ltd.
Amir Gera, 43 - Director. Mr. Gera has served as a director of deltathree
since June 2001. Since January 2002, Mr. Gera has served as the Chief Executive
Officer of Green Venture Capital Ltd., an investment holding company which
engages primarily in acquiring holdings in venture capital funds, where he had
previously served as the Assistant Director General since January 2001. In
addition, Mr. Gera is also the Chief Executive Officer of Commutech Holding &
Investments Ltd and has served in this capacity since March 2001. From 1993
through 2000, Mr. Gera was the Assistant Director General of Emet Neveh Savion
Ltd., which owns and manages real estate assets.
38
Joshua Maor, 68 - Director. Mr. Maor has served as a director of
deltathree since June 2001. Mr. Maor has served as the Chairman of Commutech
Holding & Investments Ltd., an investment holding company which engages
primarily in investments in high tech companies, since January 2002, and as the
Chairman of the board of Mofet Venture Capital since 2001. Mr. Maor served as
both the Chairman and Chief Executive Officer Green Venture Capital Ltd from
1997 to January 2002. From 1996 through 1997, Mr. Maor was the Chairman of
I.B.M. Israel Ltd., which distributes and provides services for I.B.M. products,
and I.B.M. Science and Technology Ltd., a research and development company. Mr.
Maor served as a member of our Advisory Board from 1997 through 1998.
Lior Samuelson, 55 - Director. Mr. Samuelson has served as a director of
deltathree since August 2001. Since August 1999, Mr. Samuelson has served as a
Co-Founder and Principal of Mercator Capital. His experience includes advising
clients in the Technology, Communications and Consumer sectors on mergers,
acquisitions and private placements. From March 1997 to August 1999, Mr.
Samuelson was the President and CEO of PricewaterhouseCoopers Securities. Prior
to that, he was the President and CEO of The Barents Group, a merchant bank
specializing in advising and investing in companies in emerging markets. Mr.
Samuelson was also the Co-Chairman of Peloton Holdings, a Private Equity
management company. Before that, he was a managing partner with KPMG and a
senior consultant at Booz, Allen & Hamilton. Mr. Samuelson earned B.S. and M.S.
degrees in Economics from Virginia Polytechnic University.
Shimmy Zimels, 39 - President and Chief Executive Officer and Director.
Mr. Zimels has served as Chief Executive Office and President since June 2002,
and served as Vice President of Operations and Chief Operating Officer of
deltathree since June 1997, before being named President and Chief Executive
Officer in June 2002. Prior to joining deltathree, Mr. Zimels was the Controller
and Vice President of Finance at Net Media Ltd., a leading Israel based Internet
Service Provider, from June 1995 to June 1997. From April 1991 to May 1995, Mr.
Zimels was a senior tax auditor for the Income Tax Bureau of the State of
Israel. Mr. Zimels graduated with distinction from Hebrew University with a
degree in Economics and Accounting and holds a Masters in Economics from Hebrew
University.
Our Board has determined that the following members of the Board qualify
as independent under the definition promulgated by the Nasdaq Stock Market: Noam
Ben-Ozer, Ilan Biran, Amir Gera, Joshua Maor and Lior Samuelson.
Executive Officers
Set forth below is a brief description of the present and past business
experience of each of the persons who serve as our executive officers or key
employees who are not also serving as directors.
Paul C. White, 42 - Chief Financial Officer and Secretary. Mr. White has
served as our Chief Financial Officer since September 2000 and is responsible
for corporate finance and all financial aspects of our operations, including
accounting, tax, treasury, financial analysis, billing, internal audit, investor
relations, real estate and procurement functions. Mr. White brings a vast array
of experience in both the telecommunications and Internet industries. Mr. White
cultivated his expertise in both telecommunications and the Internet with senior
level positions at Tangoe Inc. (formerly TelecomRFQ, Inc.,) a leading provider
of enterprise-wide Telecommunications Expense Management software , where he
served as President and Chief Executive Officer, Buyersedge.com, an on-line
consumer services "reverse-auction' company, where he served as Vice President
of Operations & Finance, and at Southern New England Telecommunications (SNET),
the SBC Communications, Inc. subsidiary, where he served as Director of IT
Strategy & Finance, Director of Corporate Development and Director of Finance &
Business Development between 1995 and 1999. Mr. White has also worked in senior
level positions at Ernst & Young, LLP and Arthur Andersen, LLP. Mr. White has a
BBA and an MBA from Hofstra University, as well as a CPA.
Board of Directors and Committees of the Board
Our Amended and Restated Certificate of Incorporation provides that the
number of members of our Board shall be not less than three and not more than
thirteen. There are currently seven directors on the Board. At each annual
meeting of stockholders, directors will be elected to hold office for a term of
one year and until their respective successors are elected and qualified. All of
the officers identified above under "Executive Officers" serve at the discretion
of our Board.
39
The Board had eight regular and no special meetings during the fiscal year
ended December 31, 2004. During the fiscal year ended December 31, 2004, each
member of the Board participated in at least 75% of all Board and applicable
committee meetings held during the period for which he was a director. One of
our directors attended our annual meeting of stockholders held in 2004. The
Board has established an Executive Committee, a Compensation Committee, a
Nominating and Governance Committee and an Audit Committee to devote attention
to specific subjects and to assist the Board in the discharge of its
responsibilities. The functions of these committees and their current members
are set forth below.
The Executive Committee is empowered to act on any matter except those
matters specifically reserved to the full Board by applicable law. The Executive
Committee had no meetings during 2004. Joshua Maor (Chairman), Noam Bardin and
Noam Ben-Ozer are the current members of the Executive Committee.
The Compensation Committee is responsible for evaluating our compensation
policies, determining our executive compensation policies and guidelines and
administering our stock option and compensation plans. The Compensation
Committee is responsible for the determination of the compensation of our Chief
Executive Officer, and shall conduct its decision making process with respect to
that issue without the Chief Executive Officer present. All members of the
Compensation Committee qualify as independent under the definition promulgated
by the Nasdaq Stock Market. The Compensation Committee had two meetings during
2004. Amir Gera (Chairman), Ilan Biran and Joshua Maor are the current members
of the Compensation Committee. Please see also the report of the Compensation
Committee set forth elsewhere in this report.
The Nominating and Governance Committee is responsible for assisting
identifying and recommending qualified candidates for director nominees to the
Board, and leading the Board in its annual review of the Board's performance.
All members of the Nominating Committee qualify as independent under the
definition promulgated by the Nasdaq Stock Market. The Nominating and Governance
Committee had no meetings during 2004. Joshua Maor (Chairman), Amir Gera and
Lior Samuelson are the current members of the Nominating and Governance
Committee. The Nominating and Governance Committee may consider candidates
recommended by stockholders as well as from other sources such as other
directors or officers, third party search firms or other appropriate sources.
For all potential candidates, the Nominating and Governance Committee may
consider all factors is deems relevant, such as a candidate's personal integrity
and sound judgment, business and professional skills and experience,
independence, knowledge of the industry in which we operate, possible conflicts
of interest, diversity, the extent to which the candidate would fill a present
need in the Board, and concern for the long-term interests of the stockholders.
In general, persons recommended by stockholders will be considered on the same
basis as candidates from other sources. If a stockholder wishes to nominate a
candidate to be considered for election as a director at the 2005 Annual Meeting
of Stockholders using the procedures set forth in the Company's By-laws, it must
follow the procedures described in "Nomination of Directors." If a stockholder
wishes simply to propose a candidate for consideration as a nominee by the
Nominating and Governance Committee, it should submit any pertinent information
regarding the candidate to the Chairman of the Nominating and Governance
Committee by mail at 75 Broad Street, New York, New York 10004. A copy of the
Nominating Committee's written charter is publicly available on the Company's
website at www.deltathree.com
The Audit Committee recommends to the Board the appointment of the firm
selected to serve as our independent auditors and our subsidiaries and monitors
the performance of such firm; reviews and approves the scope of the annual audit
and evaluates with the independent auditors our annual audit and annual
financial statements; reviews with management the status of internal accounting
controls; evaluates issues having a potential financial impact on us which may
be brought to the Audit Committee's attention by management, the independent
auditors or the Board; evaluates our public financial reporting documents;
reviews the non-audit services to be performed by the independent auditors, if
any; and considers the effect of such performance on the auditor's independence.
Ilan Biran (Chairman), Noam Ben-Ozer and Lior Samuelson are the current members
of the Audit Committee. All members of the Audit Committee satisfy the current
independence standards promulgated by the Securities and Exchange Commission and
by the Nasdaq Stock Market, as such standards apply specifically to members of
audit committees. The Board has determined that each of Mr. Ben-Ozer, Mr. Biran,
Mr. Erez and Mr. Samuelson are "audit committee financial experts," as the
Securities and Exchange Commission has defined that term in Item 401 of
Regulation S-K. The Audit Committee had four meetings during 2004.
40
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our
directors and executive officers and persons who own more than 10% of a
registered class of our equity securities, to file with the Securities and
Exchange Commission initial reports of ownership and reports of changes in
beneficial ownership of Common Stock and other equity securities of us.
Directors, officers and greater than 10% stockholders are required by SEC
regulations to furnish us with all Section 16(a) forms they file.
To our knowledge, based solely upon our review of the copies of such
reports furnished to us, we believe that all of our directors, officers and
greater than 10% stockholders have complied with the applicable Section 16(a)
reporting requirements except that: an initial report of ownership was filed
late by Noam Ben-Ozer; one report of change in beneficial ownership, covering
one transaction, was filed late by Noam Bardin; one report of change in
beneficial ownership, covering one transaction, was filed late by Shimmy Zimels;
one report of change in beneficial ownership, covering one transaction, was
filed late by Paul White; one report of change in beneficial ownership, covering
one transaction, was filed late by Amir Gera and one report of change in
beneficial ownership, covering one transaction, was filed late by Joshua Maor.
Code of Conduct and Ethics
On March 25, 2004, we adopted a Corporate Code of Conduct and Ethics
applicable to all employees and directors of deltathree, including our principal
executive officer, principal financial and accounting officer and controller.
There were no changes made to the Corporate Code of Conduct and Ethics during
2004. We intend to post on our website and include in a Current Report on Form
8-K filed with the Securities and Exchange Commission any amendments to, or
waivers from, our Code of Conduct and Ethics that apply to our principal
executive officer, principal financial and accounting officer and controller.
41
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth certain summary information concerning the
compensation paid or awarded for services rendered during each of our last three
fiscal years to our chief executive officer and each of our other most highly
compensated executive officers in 2002, 2003 and 2004 whose total salary and
bonus exceeded $100,000. These two executive officers are referred to in this
report as "named executive officers".
Long-Term
Annual Compensation Compensation
------------------------ -------------------------
Securities
Underlying All Other
Name and Principal Position Year Salary ($) Bonus ($) Options (#) Compensation
--------------------------- ---- ---------- ---------- ----------- ------------
Shimmy Zimels (1) ............... 2004 $ 180,000 $ 125,050 80,000 --
President and Chief Executive
Officer and former Chief ..... 2003 180,000 -- 85,000 --
Operating Officer ............ 2002 182,335 -- 100,000 --
2004 $ 180,000 $ 94,100 75,000 --
Paul C. White ................... 2003 180,000 -- 65,000 --
Chief Financial Officer ....... 2002 182,335 -- 100,000 --
Option Grants During 2004
The following table sets forth information regarding each stock option
granted during fiscal year 2004 to each of the named executive officers.
Individual Grants
Potential Realizable
Shares of % of Total Value at
Common Stock Options Exercise Assumed Rates of Stock
Underlying Granted to Price Price
Options Employees in Per Expiration Appreciation for Option
Granted (#)(1) Fiscal Year Share Date Term (2)
($/Sh) 5% 10%
------------------------------------------------------------------------------------------------------
Shimmy Zimels ......... 80,000 20.0% 2.85 12/22/14 $92,819 $216,307
Paul C. White.......... 75,000 18.7% 2.85 12/22/14 $87,018 $202,788
(1) The options were granted pursuant to the Company's 2004 Stock Incentive Plan
(the "Plan"). The options granted to the named executive officers are
non-qualified stock options and vest annually in three equal installments
commencing one year from the date of grant.
(2) The amounts shown in this table represent hypothetical gains that could be
achieved for the respective options if exercised at the end of the option term.
These gains are based on assumed rates of stock appreciation of 5% and 10%
compounded annually from the date the respective options were granted to their
expiration date. The gains shown are net of the option exercise price, but do
not include deductions for taxes or other expenses associated with the exercise.
Actual gains, if any, on stock option exercises will depend on the future
performance of the Common Stock, the optionee's continued employment through the
option period and the date on which the options are exercised.
42
Option Exercises in Fiscal 2004 and Year-End Option Values
The following table sets forth information for the named executive
officers with respect to option exercises during 2004 and the value as of
December 31, 2004 of unexercised in-the-money options held by each of the named
executive officers.
Number of
Securities Value of
underlying Unexercised
Unexercised In-The-Money
Options at Options at
Shares Year End (#) Year-End ($)
Acquired Value Exercisable Exercisable
Name On Exercise (#) Realized ($) /Unexercisable /Unexercisable
- -------------------------------------------------------------------------------------------------
Shimmy Zimels.......... -- -- 478,937/170,001 626,265/203,235
Paul C. White.......... -- -- 248,332/151,668 498,547/179,953
Compensation Committee Interlocks and Insider Participation
Executive compensation decisions in 2004 were made by the Compensation
Committee. During 2004, no interlocking relationship existed between our Board
and the board of directors or compensation committee of any other company.
Director Compensation
At our Annual Meeting on November 8, 2004, each of our non-management
directors (Noam Bardin, Noam Ben-Ozer, Ilan Biran, Amir Gera, Joshua Maor, and
Lior Samuelson) became eligible to receive $10,000 for their services as
directors, through the next Annual Meeting date. We anticipate paying $10,000 to
each outside director in 2005. Directors are reimbursed for the expenses they
incur in attending meetings of the Board and Board committees.
2004 Non-Employee Director Stock Option Plan
The purposes of the 2004 Non-Employee Director Stock Option Plan (the
"Director Plan") are to enable us to attract, maintain and motivate qualified
directors and to enhance a long-term mutuality of interest between our directors
and shareholders of our Common Stock by granting our directors options to
purchase our shares.
The Director Plan provides for the automatic grant of nonstatutory stock
options. Options granted under the Plan are not intended to qualify as
"incentive stock options" within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"). The aggregate number of shares of
Common Stock that may be issued under the Director Plan shall not exceed (a)
351,216 shares, plus (b) such additional shares of Common Stock as are
represented by Options previously granted under the 1999 Directors Plan which
are cancelled or expire after the date of stockholder approval of the Director
Plan without delivery of shares of stock by the Company.
Initial Option Awards. Each director who is not an employee of the Company
will be granted options to acquire 10,000 shares of Common Stock on the date he
or she joins the Board.
Subsequent Option Awards. On the first business day after each annual
meeting of stockholders of the Company occurring during the term of the Plan,
each non-employee director who meets the guidelines for Board service and who
continues to be a non-employee director following such annual meeting shall
automatically be granted an option to purchase 10,000 shares of Common Stock;
provided that no Subsequent Option Award shall be made to any non-employee
director who has not served as a director of the Company, as of the time of such
annual meeting, for at least six months.
43
Committee Chairman Awards. Each non-employee director who is appointed as
chairman of a standing committee of the Board (and has not served as the
chairman of such committee immediately prior to the appointment) shall be
automatically granted an option to purchase 10,000 shares of Common Stock on the
date of such appointment. Each non-employee director who serves as a chairman of
the full Board or of a standing committee of the Board other than the audit
committee, and who meets the guidelines for Board service, immediately following
each annual meeting of the Company's stockholders, shall be granted an option to
purchase an additional 10,000 shares of Common Stock; provided that no Committee
Chairman Award shall be made to: any non-employee director who has not served as
a director of the Company, as of the time of such annual meeting, for at least
six months, and no Committee Chairman Award shall be made to any Eligible
Director who has received a Committee Chairman award for such service on the
same committee within the past six months.
Audit Committee Service Awards. Each non-employee director who is
appointed as a member of the audit committee of the Board (and has not served as
a member of such committee immediately prior to that appointment) shall be
automatically granted an option to purchase 10,000 shares of Common Stock on the
date of such appointment. Each non-employee director who serves as a member of
the audit committee of the Board, and who meets the guidelines for Board
service, immediately following each annual meeting of the Company's
stockholders, shall be granted an option to purchase an additional 10,000 shares
of Common Stock; provided that: no Audit Committee Service Award shall be made
to any non-employee director who has not served as a director of the Company, as
of the time of such annual meeting, for at least six months, and no Audit
Committee Award shall be made to any Eligible Director who has received an Audit
Committee award for such service within the past six months. In addition, the
chairman of the audit committee of the Board shall be granted an additional
option to purchase 5,000 shares of Common Stock.
Notwithstanding the foregoing, a non-employee director shall receive a
maximum of options to purchase 30,000 shares of Common Stock during any single
calendar year. The exercise price per share of Common Stock of each option
granted pursuant to the Plan shall be equal to the fair market value per share
on the date of grant. If not previously exercised, each option shall expire on
the earlier of (i) the tenth anniversary of the date of the grant thereof and
(ii) on the first anniversary of the termination of the non-employee director's
status as a director of the Company. Each option granted under the Plan shall
become fully vested and exercisable on the first anniversary of the date of
grant. In addition, options granted pursuant to the Plan will become exercisable
in full upon a "change in control" as defined in the Plan. The Plan terminates
at the close of business on September 23, 2014, unless sooner terminated by
action of the Board or stockholders of the Company.
Employment Agreements, Termination of Employment and Change-in-Control
Arrangements
We currently have employment agreements in place with Messrs. Zimels and
White, each with the following principal terms:
o The agreements, dated as of April 26, 2004, and are effective until
August 31, 2006, and March 31, 2007, for Messrs. Zimels and White,
respectively, and shall thereafter be automatically extended for the
same duration on the expiration date and on each expiration date
thereafter unless either party provides the other party with written
notice of non-renewal at least 90 days prior to expiration of a
term, provided that the executive provides notice of renewal to the
Compensation Committee six (6) months prior to expiration of the
term.
o Pursuant to the agreements, Mr. Zimels and Mr. White are entitled to
receive a base salary of $239,000 and $226,000, respectively during
2004. Such base salary shall be increased on each January 1,
commencing January 1, 2005, by an amount equal to the base salary
then in effect, multiplied by the applicable cost of living index
during the prior year. The employee's base salary, as adjusted for
cost of living increases, may be further increased at the option and
in the discretion of the Board. As such, in 2005, Mr. Zimels and Mr.
White are entitled to receive a base salary of $248,800 and
$235,300, respectively.
44
o The employee's options are immediately exercisable in full upon a
change of control. The employee's options, following any termination
of the employee's employment, other than for cause, remain
exercisable for the lesser of two years and the remaining term of
the options.
o If employee's employment is terminated by us without cause or by the
employee for good reason (which includes, without limitation, a
reduction in salary and/or bonus opportunity, a change of control
and a material reduction in duties and responsibilities), the
employee is entitled to receive previously earned, but unpaid
salary, vested benefits and a payment equal to their annual base
salary as in effect immediately prior to the termination date.
o If employee dies or is unable to perform his duties, he or his
representative, estate or beneficiary will be paid, in addition to
any previously earned but unpaid salary and vested benefits, 12
months' total base salary reduced, in the case of disability, by any
disability benefits they receive.
On March 31, 2002, Messrs. White and Zimels each took a voluntary pay
reduction for an unspecified time, from their then current salaries of $213,210,
and $213,210, respectively, to $180,000 each. Messrs. Zimels' and White's kept
their voluntary pay reduction in effect at $180,000 each, throughout 2004
whereas their contractual salaries for 2004 were $239,000 and $226,000,
respectively, for 2004.
Compensation Committee Report on Executive Compensation
The Compensation Committee is responsible for recommending to the Board of
Directors the overall executive compensation strategy of the Company and for the
ongoing monitoring of the compensation strategy's implementation. In addition to
recommending and reviewing the compensation of the executive officers, it is the
responsibility of the Compensation Committee to recommend new incentive
compensation plans and to implement changes and improvements to existing
compensation plans, including the 1999 Stock Incentive Plan, the 1999
Performance Incentive Plan, the 1999 Employee Stock Purchase Plan, the 1999
Directors' Plan, the 2004 Stock Incentive Plan, and the 2004 Non-Employee
Director's Plan. The Compensation Committee makes its compensation
determinations based upon its own analysis of information it compiles and the
business experience of its members.
Overall Policy
The Compensation Committee believes that the stability of the Company's
management team, as well as the Company's ability to continue to incentivize
management and to attract and retain highly qualified executives for its
expanding operations, will be a contributing factor to the Company's continued
growth and success. In order to promote stability, growth and performance, and
to attract new executives, the Company's strategy is to compensate its
executives with an overall package that the Company believes is competitive with
those offered by similarly situated companies and which consists of (i) a stable
base salary set at a sufficiently high level to retain and motivate these
officers but generally targeted to be in the lower half of its peer group
comparables, (ii) an annual bonus linked to the Company's overall performance
each year and to the individual executive's performance each year and (iii)
equity-related compensation which aligns the financial interests of the
Company's executive officers with those of the Company's stockholders by
promoting stock ownership and stock performance through the grant of stock
options and stock appreciation rights, restricted stock and other equity and
equity-based interests under the Company's various plans.
Executive officers are also entitled to customary benefits generally
available to all employees of the Company, including group medical and life
insurance. Base salary, bonuses and benefits are paid by the Company and its
subsidiaries.
45
Federal Income Tax Deductibility of Executive Compensation
Section 162(m) of the Internal Revenue Code of 1986, as amended (the
"Code"), limits the amount of compensation a publicly held corporation may
deduct as a business expense for Federal income tax purposes. The limit, which
applies to a company's chief executive officer and the four other most highly
compensated executive officers, is $1 million (the "Deductibility Limit"),
subject to certain exceptions. The exceptions include the general exclusion of
performance-based compensation from the calculation of an executive officer's
compensation for purposes of determining whether his or her compensation exceeds
the Deductibility Limit. The Compensation Committee has determined that
compensation payable to the executive officers should generally meet the
conditions required for full deductibility under section 162(m) of the Code.
While the Company does not expect to pay its executive officers compensation in
excess of the Deductibility Limit, the Compensation Committee also recognizes
that in certain instances it may be in the best interest of the Company to
provide compensation that is not fully deductible.
Base Salary
The base salaries for the named executive officers are based upon
employment agreements between the Company and such officers.
Annual Incentive Bonuses
The Board established the 1999 Performance Incentive Plan to enable the
Company and its subsidiaries to attract, retain, motivate and reward the best
qualified executive officers and key employees by providing them with the
opportunity to earn competitive compensation directly linked to the Company's
performance. The Performance Incentive Plan is effective through and including
the year 2005, unless extended or earlier terminated by the Board of Directors.
As part of the Performance Incentive Plan, the Compensation Committee may
determine that any bonus payable under the Performance Incentive Plan be paid in
cash, in shares of Common Stock or in any combination thereof, provided that at
least 50% of such bonus is required to be paid in cash. In addition, the
Performance Incentive Plan permits a participant to elect to defer payment of
his or her bonus on terms and conditions established by the Compensation
Committee. No more than 400,000 shares of Common Stock may be issued under the
Performance Incentive Plan.
Under the 1999 Performance Incentive Plan, bonuses may be payable if the
Company meets any one or more of the following performance criteria, which are
set annually by the Compensation Committee: (i) revenues; (ii) operating income;
(iii) gross profit margin; (iv) net income; (v) earnings per share; (vi) maximum
capital or marketing expenditures; or (vii) targeted levels of customers.
Under the 1999 Performance Incentive Plan, bonus amounts are determined as
follows: if 100% of such targets are achieved, the bonus potentially payable to
participants will generally equal 35% of their base salary (45% in the case of
the Chief Executive Officer) for such year, if 80% of such targets are achieved,
the bonus potentially payable to participants will generally equal 25% of their
base salary for such year, and if less than 80% of such targets are achieved,
the participants will generally not be entitled to receive any bonus for such
year. To the extent the Company's results exceed 80% of the targets but is less
that 100% of the targets, the amount of the bonus payable to participants will
be adjusted proportionately based on where such results fall within the ranges
set forth above. Any such bonus will consist of two components. Fifty percent of
the amount determined pursuant to the formula described above will be payable if
the targets are achieved. Up to an additional 50% of such amount will be payable
in the discretion of the Compensation Committee. In addition, the 1999
Performance Incentive Plan permits the Compensation Committee to grant
discretionary bonuses to participants, notwithstanding that a bonus would not
otherwise be payable under the 1999 Performance Incentive Plan, to recognize
extraordinary individual performance.
With respect to 2004, bonuses in the amount of $107,550 and $79,100 were
awarded to Mr. Zimels and Mr. White respectively, under the 1999 Performance
Incentive Plan. Pursuant to the terms of the 1999 Performance Incentive Plan,
awards will be paid in the current year, following the completion of the audit
of the Company's 2004 financial statements. In addition, one-time bonuses of
$17,500 and $15,000 were awarded to Mr. Zimels and Mr. White respectively by the
Compensation Committee in the first-half of 2004. Mr. Zimels and Mr. White's
bonuses for 2004 were based on the Company's achievement of certain targets for
revenues, gross profit and EBITDA as well as the signing up a certain number of
additional customers to use the deltathree platform solution.
46
Long-Term Incentive Compensation
The Company reinforces the importance of producing satisfactory returns to
stockholders over the long term through the operation of the 2004 Stock
Incentive Plan and the 2004 Non-Employee Director Stock Option Plan. For a
discussion relating to the Director Plan, refer to the section entitled "2004
Non-Employee Director Option Plan" in this annual report. Grants of stock, stock
options, stock unit awards and stock appreciation rights under such plans
provide executives with the opportunity to acquire an equity interest in the
Company and align the executive's interest with that of the stockholders to
create stockholder value as reflected in growth in the market price of the
Common Stock.
2004 Stock Incentive Plan
The Board of Directors adopted the 2004 Stock Incentive Plan on September
23, 2004 and it was subsequently approved by the stockholders at the annual
meeting on November 8, 2004. The purposes of the 2004 Stock Incentive Plan are
to foster and promote the long-term financial success of the Company and
materially increase stockholder value by (i) motivating superior performance by
means of performance-related incentives, (ii) encouraging and providing for the
acquisition of an ownership interest in the Company by executive officers and
other key employees and (iii) enabling the Company to attract and retain the
services of an outstanding management team upon whose judgment, interest and
special effort the successful conduct of its operations is largely dependent.
Under the 2004 Stock Incentive Plan, the Compensation Committee is
authorized to grant options for 759,732 shares of Common Stock (which represents
4,000,000 shares of Common Stock reserved under the 1999 Stock Incentive Plan
(the "1999 Plan") less the amount of shares represented by awards previously
granted under the 1999 Plan and exercised or outstanding as of September 28,
2004), plus (b) such additional shares of Common Stock as are represented by
awards previously granted under the 1999 Plan which are cancelled or without
delivery of shares of stock by the Company. Options granted under the 2004 Stock
Incentive Plan are to be granted to certain officers of the Company and to other
employees and consultants of the Company. Directors who are non-employees of the
Company are prohibited from participating in the 2004 Stock Incentive Plan.
The 2004 Stock Incentive Plan is administered by the Compensation
Committee and provides for the grant of (i) incentive and non-incentive stock
options to purchase Common Stock; (ii) stock appreciation rights, which may be
granted in tandem with or independently of stock options; (iii) restricted stock
and restricted units; (iv) incentive stock and incentive units; (v) deferred
stock units; and (vi) stock in lieu of cash. The maximum number of shares for
which options or stock appreciation rights may be granted to any one participant
in a calendar year is 500,000. As of December 31, 2004, the Company has
outstanding options to acquire an aggregate of 3,066,939 shares of Common Stock,
of which 2,555,439 were granted under the 1999 Plans and 511,500 were granted
under the 2004 Plans.
47
Chief Executive Officer's Fiscal 2004 Compensation
Mr. Shimmy Zimels was our chief executive officer for all of 2004. Under
the terms of his employment agreement, Mr. Zimels was entitled to receive an
aggregate annual base salary of $239,000. However, during 2004, Mr. Zimels
received an aggregate annual base salary of $180,000, due to his voluntary pay
reduction, a one-time bonus of $17,500 was awarded by the Compensation Committee
in the first-half of 2004 and his participation in the 1999 Performance
Incentive Plan resulted in bonus compensation of $107,550 for 2004.
Submitted by:
The Compensation Committee
Amir Gera
Joshua Maor
48
STOCK PERFORMANCE CHART
The graph depicted below shows a comparison of cumulative total
shareholder returns for our common stock with the cumulative total return on the
total return on The Nasdaq Stock Market (U.S.) Index and the Nasdaq
Telecommunications Index. Shareholder returns over the indicated period are
based on historical data and should not be considered indicative of future
shareholder returns.
[GRAPHIC OMITTED][GRAPHIC OMITTED]
Cumulative Total Return
------------------------------------------------------
12/99 12/00 12/01 12/02 12/03 12/04
--------- -------- -------- -------- -------- --------
deltathree, Inc. $100.00 $ 4.61 $ 3.50 $ 1.84 $ 11.34 $12.89
Nasdaq Stock Market (U.S.) 100.00 60.09 45.44 26.36 38.55 40.87
Nasdaq Telecommunications Market 100.00 52.17 38.29 23.31 41.85 45.52
49
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth information with respect to the beneficial
ownership of shares of our Common Stock as of March 29, 2005 by:
o each person who we know owns beneficially more than 5% of our Common
Stock;
o each of our directors individually;
o each of our named executive officers individually; and
o all of our executive officers and directors as a group.
Unless otherwise indicated, to our knowledge, all persons listed below
have sole voting and investment power with respect to their shares of Common
Stock. Each person listed below disclaims beneficial ownership of their shares,
except to the extent of their pecuniary interests therein. Shares of Common
Stock that an individual or group has the right to acquire within 60 days of
March 29, 2005 pursuant to the exercise of options are deemed to be outstanding
for the purpose of computing the percentage ownership of such person or group,
but are not deemed outstanding for the purpose of calculating the percentage
owned by any other person listed.
Number Percentage(1)
------ -------------
Shares of deltathree Class A Common
Stock Beneficially Owned
------------------------
Principal Stockholder:
Atarey Hasharon Chevra Lepituach Vehashkaot Benadlan
(1991) Ltd. ...................................... 12,397,677 41.4%
7 Giborey Israel St., P.O. Box 8468
South Netanya Industrial Zone 42504, Israel ....
Executive Officers and Directors:
Noam Bardin(2)(3) .................................. 796,304 2.7%
Shimmy Zimels(2)(4) ................................ 713,407 2.4%
Paul C. White(2)(5) ................................ 400,000 1.3%
Noam Ben-Ozer (2)(5) ............................... 24,848 *
Ilan Biran (2)(5) .................................. 49,848 *
Amir Gera (2)(5) ................................... 44,848 *
Joshua Maor (2)(6) ................................. 70,999 *
Lior Samuelson (2)(5) .............................. 54,848 *
All Directors and Executive Officers as a group
(8 persons)(7) ................................... 2,155,102 7.2%
- -----------
* Less than 1%.
(1) Percentage of beneficial ownership is based on 29,961,086 shares of Common
Stock outstanding as of March 29, 2005.
(2) The address for the director or executive officer listed is c/o the
Company.
50
(3) Includes (a) 187,366 shares of Common Stock and (b) options to purchase
608,938 shares of Common Stock.
(4) Includes (a) 64,469 shares of Common Stock and (b) options to purchase
649,938 shares of Common Stock.
(5) Represents options to purchase shares of Common Stock.
(6) Includes (a) 16,151 shares of Common Stock and (b) options to purchase
54,848 shares of Common Stock.
(7) Includes (a) 267,986 shares of Common Stock and (b) options to purchase
1,887,116 shares of Common Stock.
Equity Compensation Plan Information
The following table provides certain aggregate information with respect to
all of our equity compensation plans in effect as of December 31, 2004:
Plan Category Number of Securities to be Weighted Average Exercise Number of Securities
Issued Upon Exercise of Price of Outstanding Remaining Available for
Outstanding Options, Options, Warrants and Future Issuance Under
Warrants and Rights Rights Equity Compensation Plans
(excluding securities
reflected in first column)
- ------------------------- ---------------------------- ---------------------------- -----------------------------
Equity Compensation 3,066,939 $2.50 662,950
Plans Approved by
Security Holders (1)
- ------------------------- ---------------------------- ---------------------------- -----------------------------
Equity Compensation
Plans not Approved by
Security Holders N/A N/A N/A
- ------------------------- ---------------------------- ---------------------------- -----------------------------
Total 3,066,939 $2.50 662,950
- ------------------------- ---------------------------- ---------------------------- -----------------------------
(1) These plans consist of our 1999 Stock Incentive Plan, 1999 Directors'
Plan, and 1999 Employee Stock Purchase Plan, 2004 Stock Incentive Plan and
2004 Non-Employee Director Stock Option Plan.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We are not, and have not been during the last two fiscal years, a party to
any related-party agreements. All transactions between us and our officers,
directors, principal stockholders and affiliates must be reviewed and approved
in advance by the Audit Committee.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table presents fees for professional audit services rendered
by Brightman Almagor & Co. for the audit of the Company's annual financial
statements for the years ended December 31, 2004, and December 31, 2003, and
fees billed for other services rendered by Brightman Almagor & Co. during those
periods.
2004 2003
Audit fees $54,000 $54,000
Audit related fees 3,000 4,000
Tax fees 11,000 --
All Other Fees -- --
--------------------------------------
Total $68,000 $58,000
--------------------------------------
51
In the above table, in accordance with the SEC's definitions and rules,
"audit fees" are fees we paid Brightman Almagor & Co. for professional services
for the audit of our annual financial statements and review of financial
statements included in our quarterly reports filed with the SEC, as well as work
generally only the independent auditor can reasonably be expected to provide,
such as statutory audits and consultation regarding financial accounting and/or
reporting standards; "audit-related fees" are fees billed by Brightman Almagor &
Co. for assurance and related services that are reasonably related to the
performance of the audit or review of our financial statements, "tax fees" are
fees for tax compliance, tax advice and tax planning; and "all other fees" are
fees billed by Brightman Almagor & Co for any services not included in the first
three categories.
Policy on Audit Committee Pre-Approval of Audit and Permissible Non-audit
Services of Independent Auditors
Consistent with SEC policies regarding auditor independence, the Audit
Committee has responsibility for appointing, setting compensation and overseeing
the work of the independent auditor. In recognition of this responsibility, the
Audit Committee has established a policy to pre-approve all audit and
permissible non-audit services provided by the independent auditor.
Prior to engagement of the independent auditor for the next year's audit,
management will submit an aggregate of services expected to be rendered during
that year for each of four categories of services to the Audit Committee for
approval.
1. Audit services include audit work performed in the preparation of
financial statements, as well as work that generally only the independent
auditor can reasonably be expected to provide, including comfort letters,
statutory audits, and attest services and consultation regarding financial
accounting and/or reporting standards.
2. Audit-Related services are for assurance and related services that are
traditionally performed by the independent auditor, including due diligence
related to mergers and acquisitions, employee benefit plan audits, and special
procedures required to meet certain regulatory requirements.
3. Tax services include all services performed by the independent
auditor's tax personnel except those services specifically related to the audit
of the financial statements, and includes fees in the areas of tax compliance,
tax planning, and tax advice.
4. Other Fees are those associated with services not captured in the other
categories. The Company generally does not request such services from the
independent auditor.
Prior to engagement, the Audit Committee pre-approves these services by
category of service. The fees are budgeted and the Audit Committee requires the
independent auditor and management to report actual fees versus the budget
periodically throughout the year by category of service. During the year,
circumstances may arise when it may become necessary to engage the independent
auditor for additional services not contemplated in the original pre-approval.
In those instances, the Audit Committee requires specific pre-approval before
engaging the independent auditor.
The Audit Committee may delegate pre-approval authority to one or more
of its members. The member to whom such authority is delegated must report, for
informational purposes only, any pre-approval decisions to the Audit Committee
at its next scheduled meeting.
52
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements.
The Consolidated Financial Statements filed as part of this Annual Report
on Form 10-K are identified in the Index to Consolidated Financial Statements on
page F-1 hereto.
(a)(2) Financial Statement Schedules.
Financial Statement Schedules have been omitted because the information
required to be set forth therein is not applicable or is shown on the financial
statements or notes thereto.
(a)(3) Exhibits.
The following exhibits are filed herewith or are incorporated by reference
to exhibits previously filed with the Securities and Exchange Commission.
Exhibit Description
Number -----------
- ------
3.1.1* Form of Restated Certificate of Incorporation of deltathree, Inc.
3.1.2*** Form of Amendment to Restated Certificate of Incorporation of
deltathree, Inc.
3.2* Form of Amended and Restated By-laws of deltathree, Inc.
4.1* Specimen Certificate of Common Stock.
4.2* Specimen Certificate of Class B Common Stock.
10.1* Form of deltathree, Inc. 1999 Stock Incentive Plan.
10.2* Form of deltathree, Inc. 1999 Employee Stock Purchase Plan.
10.3* Form of deltathree, Inc. 1999 Performance Incentive Plan.
10.4* Form of deltathree, Inc. 1999 Directors' Plan.
10.5### Employment Agreement, effective as of April 26, 2004, between Shimmy
Zimels and deltathree, Inc.
10.6### Employment Agreement, effective as of April 26, 2004, between Paul
White and deltathree, Inc.
10.7# 2004 Stock Incentive Plan
10.8# 2004 Non-Employee Director Stock Option Plan
10.9 Form of Option Agreement Pursuant to 2004 Stock Incentive Plan
10.10 Form of Option Agreement Pursuant to 2004 Non-Employee Director Stock
Option Plan
10.11 Executive and Director Compensation Arrangements
14.1## deltathree, Inc. Corporate Code of Conduct and Ethics
21.1 Subsidiaries of deltathree, Inc.
23.1 Consent of Brightman Almagor & Co.
31.1 Certification of the Chief Executive Officer, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32 Certifications of the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
- ----------
* Incorporated by reference to the Company's registration statement on Form
S-1 (Registration No. 333-122242).
** Incorporated by reference to the Company's quarterly report on Form 10-Q
filed on November 14, 2000.
*** Incorporated by reference to the Company's annual report on Form 10-K/A
filed on April 30, 2001.
# Incorporated by reference to the Company's registration statement on Form
S-8 (Registration No. 333-86503).
## Incorporated by reference to the Company's annual report on Form 10-K
filed on March 30, 2004.
### Incorporated by reference to the Company's annual report on Form 10-K/A
filed on April 29, 2004.
(b) Reports on Form 8-K.
53
DELTATHREE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Accounting Firm......................... F-2
Consolidated Balance Sheets as of December 31, 2004 and 2003............ F-3
Consolidated Statements of Operations for the years ended
December 31, 2004, 2003, and 2002...................................... F-4
Statements of Stockholders' Equity for the years ended
December 31, 2004, 2003, and 2002...................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003, and 2002...................................... F-6
Notes to Consolidated Financial Statements............................... F-7
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders of
Deltathree, Inc.
We have audited the accompanying consolidated balance sheets of
Deltathree, Inc. ("the Company") and its subsidiary as of December 31, 2004 and
2003 and the related consolidated statements of operations, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
2004. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company's
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company and its subsidiary as of December 31, 2004 and 2003, and the
consolidated results of its operations and its consolidated cash flows for each
of the three years in the period ended December 31, 2004 in conformity with U.S.
generally accepted accounting principles.
Brightman Almagor & Co.
Certified Public Accountants
A member firm of Deloitte Touche Tohmatsu
Tel Aviv, Israel
February 21, 2005
F-2
DELTATHREE, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
2004 2003
---- ----
($ in thousands)
ASSETS
Current assets:
Cash and cash equivalents ............................................. $ 13,755 $ 1,682
Short-term investments ................................................ 2,723 16,442
Accounts receivable, net (Note 3) ..................................... 325 363
Prepaid expenses and other current assets (Note 4) .................... 528 684
Inventory ............................................................. 193 60
--------- ---------
Total current assets ............................................... 17,524 19,231
--------- ---------
Property and equipment:
Telecommunications equipment .......................................... 17,349 14,548
--------- ---------
Furniture, fixtures and other ......................................... 535 534
Leasehold improvements ................................................ 4,615 4,615
Computers hardware & software ......................................... 7,370 7,091
--------- ---------
29,869 26,788
Less accumulated depreciation ......................................... (25,227) (22,481)
--------- ---------
Property and equipment, net ...................................... 4,642 4,307
--------- ---------
Deposits ............................................................... 107 105
--------- ---------
Total assets ...................................................... $ 22,273 $ 23,643
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ...................................................... $ 3,657 $ 2,139
Deferred revenues ..................................................... 453 172
Other current liabilities (Note 5) .................................... 2,034 2,100
--------- ---------
Total current liabilities .......................................... 6,144 4,411
--------- ---------
Long-term liabilities:
Severance pay obligations (Note 6) .................................... 104 91
--------- ---------
Total liabilities .................................................. 6,248 4,502
--------- ---------
Commitments and contingencies (Note 7)
Stockholders' equity (Note 8):
Share capital:
Class A Common stock, - par value $0.001; authorized 75,000,000 shares;
issued and outstanding: 29,638,913 at December 31, 2004;
29,490,796 at December 31, 2003...................................... 29 29
Class B Common stock - par value $0.001; authorized 1,000;
issued and outstanding: no shares at December 31, 2004 and 2003 .... -- --
Preferred stock, par value $0.001; authorized 25,000,000 shares;
issued and outstanding: no shares at December 31, 2004 and 2003 ..... -- --
Additional paid-in capital ............................................ 167,301 167,168
Accumulated deficit ................................................... (151,095) (147,846)
--------- ---------
16,235 19,351
--------- ---------
Treasury stock at cost: 257,600 shares of Class A Common Stock as of
December 31, 2004 and 2003 ........................................... (210) (210)
--------- ---------
Total stockholder's equity ............................................. 16,025 19,141
--------- ---------
Total liabilities and stockholder's equity ............................. $ 22,273 $ 23,643
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
DELTATHREE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
-----------------------
2004 2003 2002
---- ---- ----
($ in thousands, except share data)
Revenues (Note 11): ................................ $ 21,069 $ 13,162 $ 12,929
Costs and operating expenses:
Cost of revenues (exclusive of $1,218, $1,539 and
$1,703 depreciation included in a separate line 13,791 8,393 8,934
below, respectively)............................
Research and development expenses (Note 9) ....... 2,531 2,326 3,435
Selling and marketing expenses ................... 3,274 3,325 3,910
General and administrative expenses (exclusive of
non-cash compensation expense shown below) .... 2,186 2,062 2,158
Non-cash compensation expense .................... -- -- 270
Depreciation and amortization .................... 2,739 5,584 6,606
------------ ------------ ------------
Total costs and operating expenses ................. 24,521 21,690 25,313
------------ ------------ ------------
Loss from operations ............................... (3,452) (8,528) (12,384)
Interest income, net ............................... 269 245 448
------------ ------------ ------------
Loss before income taxes ........................... (3,183) (8,283) (11,936)
Income taxes (Note 10) ............................. 66 57 141
------------ ------------ ------------
Net loss ........................................... $ (3,249) $ (8,340) $ (12,077)
============ ============ ============
Net loss per share - basic and diluted ............. $ (0.11) $ (0.29) $ (0.42)
============ ============ ============
Weighted average number of shares outstanding -
basic and diluted (number of shares) .............. 29,346,971 28,988,589 28,888,367
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
DELTATHREE, INC.
STATEMENTS OF STOCKHOLDER'S EQUITY
($ in thousands, except share data)
Class A
Common stock
------------
Number of Number of
Outstanding Treasury Additional
Shares Shares Amount Paid-in Capital
----------- ------------ ------ ---------------
Balance at January 1, 2002 . 28,885,606 257,600 $ 29 166,801
Exercise of employee options 16,566 -* --
Amortization of deferred
compensation expense .....
Loss for the year ..........
----------- ------------ ------ ---------------
Balance at December 31, 2002 28,902,172 257,600 29 166,801
Exercise of employee options 331,024 -* 367
Loss for the year ..........
----------- ------------ ------ ---------------
Balance at December 31, 2003 29,233,196 257,600 29 167,168
Exercise of employee options 148,117 -* 133
Loss for the year ..........
----------- ------------ ------ ---------------
Balance at December 31, 2004 29,381,313 257,600 $ 29 $ 167,301
=========== ============ ====== ===============
Total
Deferred Treasury Stock Accumulated Stockholders'
Compensation (at Cost) Deficit Equity
------------ -------------- ----------- -------------
Balance at January 1, 2002 . $ (270) $ (210) $ (127,429) $ 38,921
Exercise of employee options --
Amortization of deferred
compensation expense ..... 270 270
Loss for the year .......... (12,077) (12,077)
------------ -------------- ----------- -------------
Balance at December 31, 2002 -- (210) (139,506) 27,114
Exercise of employee options 367
Loss for the year .......... (8,340) (8,340)
------------ -------------- ----------- -------------
Balance at December 31, 2003 -- (210) (147,846) 19,141
Exercise of employee options 133
Loss for the year .......... (3,249) (3,249)
------------ -------------- ----------- -------------
Balance at December 31, 2004 $ -- $ (210) $ (151,095) $ 16,025
============ ============== =========== =============
* - Less than $ 1 thousand.
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
DELTATHREE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
-----------------------
2004 2003 2002
---- ---- ----
($ in thousands)
Cash flows from operating activities:
Net loss ............................................................ $ (3,249) $ (8,340) $(12,077)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities
Depreciation and amortization ................................ 2,739 5,584 6,606
Amortization of deferred compensation ........................ -- -- 270
Capital gain, net ............................................ (2) (17) (56)
Increase (decrease) in liability for severance pay, net ...... 13 (22) (78)
Provision for losses on accounts receivable .................. -- 65 81
Decrease in accounts receivable .............................. 38 224 359
Decrease in other current assets ............................. 156 76 504
Increase in inventory ........................................ (133) (60) --
Increase (decrease) in accounts payable ...................... 765 (269) (975)
Increase (decrease) in deferred revenues ..................... 281 (162) (171)
Increase in current liabilities .............................. (66) (230) (667)
-------- -------- --------
3,791 5,189 5,873
-------- -------- --------
Net cash provided by (used in) operating activities ............... 542 (3,151) (6,204)
-------- -------- --------
Cash flows from investing activities:
Purchase of property and equipment ........................... (2,323) (368) (403)
Proceeds from sale of property and equipment ................. 4 48 62
Increase (decrease) in deposits .............................. (2) (5) 3
-------- -------- --------
Net cash used in investing activities ............................. (2,321) (325) (338)
-------- -------- --------
Cash flows from financing activities:
Decrease (increase) in short-term investments ................ 13,719 (890) (1,360)
Proceeds from exercise of employee options ................... 133 367 --
-------- -------- --------
Net cash provided by (used in) financing activities ............... 13,852 (523) (1,360)
-------- -------- --------
Increase (decrease) in cash and cash equivalents .................... 12,073 (3,999) (7,902)
Cash and cash equivalents at beginning of year ...................... 1,682 5,681 13,583
-------- -------- --------
Cash and cash equivalents at end of year ............................ $ 13,755 $ 1,682 $ 5,681
======== ======== ========
Supplemental disclosures of cash flow information:
Cash paid for:
Taxes ........................................................... $ 23 $ 57 $ 236
Supplemental schedule of non cash investing and financing activities:
Acquisition of fixed assets on credit ............................. $ 753 $ 102 $ 194
Cancellation of fixed assets in exchange of a payable ............. $ -- $ -- $ 136
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - The Company
Deltathree, Inc. (the "Company"), a Delaware corporation, is a global
provider of integrated Voice over Internet Protocol (VoIP) telephony
services. The Company was founded in 1996 to capitalize on the growth of
the Internet as a communication tool by commercially offering Internet
Protocol (IP) telephony services. IP telephony is the real time
transmission of voice communications in the form of digitized "packets" of
information over the public Internet or a private network, similar to the
way in which e-mail and other data is transmitted. The Company's business
currently includes the transmission of voice and data traffic for
communications carriers, the provision of enhanced Web-based and other
communications services to individual consumers and the provision of a
total "Hosted Communication Solution" that enables corporate customers and
service providers to offer private label telecommunications to their
customer bases.
Note 2 - Summary of significant accounting policies
a. Basis of presentation
The financial statements have been prepared in conformity with U.S.
generally accepted accounting principles.
b. Principles of consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiary. All significant intercompany accounts and transactions
have been eliminated.
c. Financial statements in U.S. dollars
The reporting currency of the Company is the U.S. dollar ("dollar"). The
dollar is the functional currency of the Company and its subsidiary.
Transactions and balances originally denominated in dollars are presented
at their original amounts. Non-dollar transactions and balances are
remeasured into dollars in accordance with the principles set forth in
Statement of Financial Accounting Standards ("SFAS") No. 52. All exchange
gains and losses from translation of monetary balance sheet items
resulting from transactions in non-dollar currencies are recorded in the
statement of operations as they arise.
d. Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions, primarily for allowances for doubtful accounts receivable and
the useful lives of fixed assets and intangible assets, that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
e. Cash and cash equivalents
Cash equivalents consist of short-term, highly liquid investments that are
readily convertible into cash with original maturities of three months or
less.
f. Short-term investments
Short-term investments consist primarily of high liquid debt instruments
purchased with an original maturity at the date of purchase of greater
than 90 days and investments in mutual funds. Short-term investments are
stated at market value.
g. Inventory
Inventory is stated at the lower of cost (principally on a standard cost
basis which approximates FIFO) or market.
h. Property and equipment
Property and equipment are stated at cost. Depreciation is calculated
using the straight-line method over the estimated useful lives of the
depreciable assets, which range from two to five years. Leasehold
improvements are amortized based on the straight-line method over the
shorter of the term of the lease, or the estimated useful life of the
improvements.
F-7
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies (Cont.)
i. Long lived assets
The Company applies provisions of SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. This statement requires that
long-lived assets and certain identifiable intangible assets be reviewed
for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying
amount of an asset to undiscounted future net cash flows expected to be
generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets.
j. Revenue recognition and deferred revenue
The Company recognizes revenues from Internet telephony services based on
minutes (or fractions thereof) of customer usage. The Company records
payments received in advance for prepaid services and services to be
supplied under contractual agreements as deferred revenue until such
related services are provided.
k. Cost of revenues
Cost of revenues is comprised primarily of access, transmission and
termination costs based on actual minutes in addition to monthly circuit
lease costs.
l. Research and development expenses
Research and development expenses are expensed as incurred.
m. Income taxes
The Company provides for income taxes using the liability approach defined
by SFAS No. 109, Accounting for Income Taxes. Deferred tax assets and
liabilities are recognized for the expected tax consequences between the
tax bases of the assets and liabilities and their reported amounts.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized and are reversed at such time
that realization is believed to be more likely than not.
n. Stock-based compensation
The Company accounts for employee stock-based compensation in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and in accordance with FASB Interpretation No. 44.
Pursuant to these accounting pronouncements, the Company records
compensation for stock options granted to employees over the vesting
period of the options based on the difference, if any, between the
exercise price of the options and the market price of the underlying
shares at that date. Deferred compensation is amortized to compensation
expense over the vesting period of the options.
Had compensation cost for the Company's option plans been determined on
the basis of the fair value at the grant dates in accordance with the
provisions of SFAS No. 123 "Accounting for Stock-Based Compensation," as
amended by SFAS No. 148, the Company's pro forma net loss and pro forma
basic and diluted net loss per share would have been as follows:
F-8
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies (Cont.)
n. Stock-based compensation (Cont.)
Year ended December 31,
-----------------------
2 0 0 4 2 0 0 3 2 0 0 2
------- ------- -------
($ in thousands)
Pro forma net loss:
Net loss for the year, as reported ..................... $ (3,249) $ (8,340) $(12,077)
Deduct: stock-based compensation determined under APB 25 -- -- 270
Add: stock-based compensation determined under SFAS 123 (202) (374) (2,102)
Pro forma net loss ..................................... $ (3,451) $ (8,714) $(13,909)
Net loss per share - basic and diluted:
As reported ............................................ $ (0.11) $ (0.29) $ (0.42)
Pro forma .............................................. $ (0.12) $ (0.30) $ (0.48)
The following assumptions were used for the years 2004, 2003 and 2002:
dividend yield of 0.00% for all periods; risk-free interest rate of 3.2%,
2.2% and 4.8% respectively; an expected life of 3-years for all periods; a
volatility rate of 87%, 140% and 150% respectively.
Because the determination of the fair value of all options granted
includes an expected volatility factor and since additional option grants
are expected to be made each year, the above pro forma disclosures are not
representative of the pro forma effects of reported net income for future
years.
o. Net loss per share
Basic and diluted net loss per share have been computed in accordance with
SFAS No. 128, "Earnings Per Share", using the weighted average number of
common stock outstanding. Diluted earnings per share give effect to all
potential dilutive issuances of ordinary shares that were outstanding
during the period. A total of 957,369, 222,553, and 32,746 incremental
shares were excluded from the calculation of diluted net loss per ordinary
share for 2004, 2003 and 2002 respectively.
p. Concentration of credit risk
The Company is subject to concentrations of credit risk, which consist
principally of cash and cash equivalents, short-term investments and trade
accounts receivable.
The Company maintains its cash balances at various financial institutions.
The Company performs periodic evaluations of the relative credit standing
of these institutions.
The majority of the Company's non-carrier customers prepay for their
services. The Company establishes an allowance for doubtful accounts based
upon factors surrounding the credit risk of customers, historical trends
and other information.
q. Fair value of financial instruments
The financial instruments of the Company consist mainly of cash and cash
equivalents, short-term investments, current accounts receivable, accounts
payable and long-term liabilities. In view of their nature, the fair value
of the financial instruments included in working capital of the Company is
usually identical or close to their carrying amounts.
F-9
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies (Cont.)
r. Derivatives
The Company adopted Statement of Financial Accounting Standard (SFAS) No.
133, "Accounting for Derivative Instruments and Hedging Activities," as
amended, at the beginning of fiscal year 2001. The standard requires the
Company to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through the
statement of operations. If the derivative is a hedge, depending on the
nature of the hedge, changes in the fair value of derivatives will either
be offset against the change in fair value of the hedged assets,
liabilities or firm commitments through earnings, or recognized in other
comprehensive income (loss) until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value
will be immediately recognized in earnings. The Company use of derivatives
is immaterial.
s. Recently issued accounting standards
SFAS NO. 123 (REVISED 2004) "SHARE BASED PAYMENTS" - In December 2004, the
FASB issued SFAS No. 123 (revised 2004) "Share Based Payments" ("SFAS
123(R)"). This Statement is a revision of FASB Statement No. 123,
"Accounting for Stock-Based Compensation", which supersedes APB Opinion
No. 25, "Accounting for Stock Issued Employees" and its authoritative
interpretations.
SFAS 123(R) establishes standards for the accounting for transactions in
which an entity exchanges its equity instruments for goods or services;
focuses primarily on accounting for transactions in which an entity
obtains employee and directors services in share-based payment
transactions; and does not change the accounting guidance for share-based
payment transactions with parties other than employees.
SFAS 123(R) eliminates the alternative to use APB 25's intrinsic value
method of accounting that was provided in SFAS 123 as originally issued
and requires measuring the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair value of
the award. The fair-value-based method in this Statement is similar to the
fair-value-based method in SFAS 123 in most respects. The costs associated
with the awards will be recognized over the period during which an
employee is required to provide service in exchange for the award- the
requisite service period (usually the vesting period).
The grant-date fair value of employee share options and similar
instruments will be estimated using option-pricing models adjusted for the
unique characteristics of those instruments (unless observable market
prices for the same or similar instruments are available). If an equity
award is modified after the grant date, incremental compensation cost will
be recognized in an amount equal to the excess of the fair value of the
modified award over the fair value of the original award immediately
before the modification.
The provisions of SFAS 123(R) apply to all awards to be granted by the
Company after June 30, 2005 and to awards modified, repurchased, or
cancelled after that date. When initially applying the provisions of SFAS
123(R), in the third quarter of 2005, the Company will be required to
elect between using either the "modified prospective method" or the
"modified retrospective method". Under the modified prospective method,
the Company is required to recognize compensation cost for all awards
granted after the adoption of SFAS 123(R) and for the unvested portion of
previously granted awards that are outstanding on that date. Under the
modified retrospective method, the Company is required to restate its
previously issued financial statements to recognize the amounts previously
calculated and reported on a pro forma basis, as if the original
provisions of SFAS 123 had been adopted. Under both methods, it is
permitted to use either a straight line or an accelerated method to
amortize the cost as an expense for awards with graded vesting.
Management has recently commenced identifying the potential future impact
of applying the provisions of SFAS 123(R), including each of its proposed
transition methods, yet is currently unable to fully quantify the effect
of this Standard on the Company's future financial position and results of
operations. Nonetheless, it is expected that the adoption of SFAS 123(R)
will increase the stock-based-award expenses the Company is to record in
the future in comparison to the expenses recorded under the guidance
currently applied by the Company.
SFAS 153, EXCHANGE OF NON-MONETARY ASSETS - In December 2004, the FASB
issued SFAS No. 153, "Exchanges of Nonmonetary Assets an amendment of APB
No. 29". This Statement amends Opinion 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have
commercial substance. The Statement specifies that a nonmonetary exchange
has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. This
Statement is effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. Earlier application is permitted.
F-10
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Accounts receivable, net
Accounts receivable are stated net of an allowance for doubtful accounts
of $ 40,000 and $ 40,000 at December 31, 2004 and 2003, respectively.
Note 4 - Prepaid expenses and other current assets
Prepaid expenses and other current assets consist of the following:
December 31,
2004 2003
---- ----
($ in thousands)
Government of Israel (VAT refund and other) ................ $ 29 $ 24
Deposits with suppliers .................................... 149 364
Prepaid expenses ........................................... 207 228
Other ...................................................... 143 68
Total prepaid expenses and other current assets ......... $528 $684
Note 5 - Other current liabilities
Other current liabilities consist of the following:
December 31,
2004 2003
---- ----
($ in thousands)
Accrued expenses ................................. $1,123 $1,017
Employees and related expenses ................... 668 806
Other ............................................ 243 277
Total other current liabilities ................ $2,034 $2,100
Note 6 - Severance pay obligations
Deltathree Ltd., the Company's Israeli subsidiary, is subject to certain
Israeli law and labor agreements that determine the obligations of
Deltathree Ltd. to make severance payments to dismissed employees and to
employees leaving the Company under certain other circumstances. The
obligation for severance pay benefits, as determined by Israeli law, is
based upon length of service and the employee's most recent salary. This
obligation is partially funded through regular deposits made by Deltathree
Ltd. into unaffiliated companies for managers' insurance policies. Amounts
funded are controlled by the fund trustees and insurance companies and are
not under the control and management of Deltathree Ltd.
Expenses )income) relating to employee termination benefits were $ 12,338,
$ (8,375) and $ 5,000 for the years ended December 31, 2004, 2003 and
2002, respectively.
The aggregate value of the insurance policies as of December 31, 2004 and
2003 was $513,000 and $409,000 respectively.
Note 7 - Commitments and contingencies
a. Lease commitments
The Company leases offices in New York City for the headquarters of its
United States operation with an initial cost of approximately $650,000,
increasing annually to $815,000 during the final year of the lease. The
lease extends until July 2010 with an option to extend the lease for an
additional five years.
F-11
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On October 2003 the company entered into a sub-lease agreement with a
third party to sub-lease approximately 30% of the overall the New York
office space. The annual sub-lease income in 2004 was approximately
$150,000, increasing annually to $168,000 during the final year of the
lease. The sub-lease extends until July 2010.
Rent expense, net was $ 611,000, $ 695,067 and $ 681,545 for the years
ended December 31, 2004, 2003 and 2002, respectively.
In addition, the Company leases offices in Israel at an annual cost of $
209,000. The lease term that expired on February 2003 contained an option
to extend the lease for up to an additional five years. In June 2002 the
Company signed an extension agreement for an additional three years,
commencing February 2003, at an annual cost of $202,000.
b. Legal proceedings
Final settlement documentation for litigation relating to a number of
initial public offerings, including the Company, is in the process of
being approved. The Company does not presently expect to make any payments
under the pending settlement. The history of this litigation is as
follows:
The Company, as well as certain of its former officers and directors, has
been named as defendants in a number of purported securities class actions
in Federal District Court for the Southern District of New York, arising
out of the Company's initial public offering in November 1999 (the "IPO").
Various underwriters of the IPO also are named as defendants in the
actions. The complaints allege, among other things, that the registration
statement and prospectus filed with the Securities and Exchange Commission
for purposes of the IPO were false and misleading because they failed to
disclose that the underwriters allegedly (i) solicited and received
commissions from certain investors in exchange for allocating to them
shares of our stock in connection with the IPO and (ii) entered into
agreements with their customers to allocate such stock to those customers
in exchange for the customers agreeing to purchase additional shares in
the aftermarket at predetermined prices. On August 8, 2001, the court
ordered that these actions, along with hundreds of IPO allocation cases
against other issuers, be transferred to Judge Scheindlin for coordinated
pre-trial proceedings. In July 2002, omnibus motions to dismiss the
complaints based on common legal issues were filed on behalf of all
issuers and underwriters. On February 19, 2003, the Court issued an
opinion granting in part and denying in part those motions to dismiss. The
complaint against the Company was not dismissed as a matter of law. The
Company believes that the claims asserted against the Company in these
cases are without merit and intends to defend itself vigorously against
them. Final settlement documentation is in the process of being approved.
Under the terms of the proposed settlement agreement, the Company is not
conceding any liability and will not bear any expenses associated with the
settlement, other than legal fees that may be incurred.
c. Other marketing and cooperation agreements
The Company has entered into marketing and cooperation agreements with
various other companies that maintain sites on the Web. Pursuant to
certain of these agreements, the Company is obligated to pay commissions
based on revenues derived from such Web links.
F-12
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8 - Stockholders' equity
a. Share capital
Following the Company's initial public offering, effective December 1999,
the Company's stock was listed on the NASDAQ National Market System. On
September 17, 2002 the listing of the Company's common stock was
transferred from the Nasdaq National Market to the Nasdaq SmallCap Market.
b. Stock Options
In November 1999, the Company's Board established the 1999 Stock Incentive
Plan. Under this plan, 4,000,000 shares of Class A were reserved for
issuance upon exercise of awards to be granted. On September 23, 2004 the
Board of Directors adopted the 2004 Stock Incentive Plan and it was
subsequently approved by the stockholders at the annual meeting on
November 8, 2004. This plan replaced the 1999 Stock Incentive Plan. Under
the 2004 Stock Incentive Plan, the Compensation Committee is authorized to
grant options for 759,732 shares of Common Stock (which represents
4,000,000 shares of Common Stock reserved under the 1999 Stock Incentive
Plan less the amount of shares represented by awards previously granted
under the 1999 Stock Incentive Plan and exercised or outstanding as of
September 28, 2004), plus (b) such additional shares of Common Stock as
are represented by awards previously granted under the 1999 Stock
Incentive Plan which are cancelled or without delivery of shares of stock
by the Company. In addition, the Company's compensation committee may
grant both incentive and non-incentive stock options for shares of Class A
common stock of the Company. The options generally have a term of seven
years and become exercisable in three equal installments commencing on the
first anniversary of the date of the grant. The purchase price per share
payable upon exercise of an option is no less than the fair market value
of the share at the date of grant.
In November 1999, the Company adopted the 1999 Directors' Compensation
Plan. Under this plan, 600,000 shares of Class A were reserved for
issuance upon exercise of awards to be granted to non-employee directors.
On September 23, 2004 the Board of Directors adopted the 2004 Non-employee
Director Stock Option Plan and it was subsequently approved by the
stockholders at the annual meeting on November 8, 2004. This plan replaced
the 1999 Director' Plan. Under the 2004 Non-employee Director Stock Option
Plan , the Compensation Committee is authorized to grant options for
351,216 shares of Common Stock (which represents 600,000 shares of Common
Stock reserved under the 1999 Directors' Compensation Plan less the amount
of shares represented by awards previously granted under the 1999
Directors' Compensation Plan and exercised or outstanding as of September
28, 2004), plus (b) such additional shares of Common Stock as are
represented by awards previously granted under the 1999 Directors'
Compensation Plan which are cancelled or without delivery of shares of
stock by the Company. The options generally have a term of seven years and
become exercisable commencing on the first anniversary of the date of the
grant. The purchase price per share payable upon exercise of an option is
no less than the fair market value of the share at the date of grant.
As of December 31, 2004, options to purchase 3,066,939 shares of Class A
were outstanding with exercise prices ranging between $ 0.004 and $15.00
per share.
F-13
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8 - Stockholders' equity (Cont.)
b. Stock Options (Cont.)
A summary of the status of the Company's stock option plans as of December
31, 2004, 2003 and 2002 and changes during the years then ended, is
presented below:
December 31, 2004 December 31, 2003 December 31, 2002
------------------------- ------------------------ -------------------------
Weighted Weighted Weighted
average average average
Shares Exercise price Shares Exercise price Shares Exercise price
--------- -------------- --------- -------------- ------- --------------
Options outstanding at beginning
of year ........................... 2,753,530 $ 2.55 3,449,520 $ 2.87 2,591,2 $ 4.24
Granted during the year ........... 606,862 2.82 344,500 $ 1.75 1,335,348 $ 0.98
Exercised during the year ......... 148,117 0.90 331,024 $ 1.08 16,566 $ 0.004
Forfeited during the year ......... 144,936 6.80 709,866 $ 4.39 460,467 $ 5.20
--------- -------------- --------- -------------- ------- --------------
Outstanding at end of year ........ 3,066,939 $ 2.50 2,753,130 $ 2.55 3,449,520 $ 2.87
========= ============== ========= ============== ========= ==============
Weighted average fair value of
options granted during the year.... $ 2.82 $ 1.75 $ 0.95
========= ========= =========
Additional information regarding options outstanding as of December 31, 2004 is
as follows:
Options Outstanding Options Exercisable
------------------- ---------------------------
Weighted average
Remaining Weighted Number of Weighted
Range of Number of Contractual Average Exercisable Average
Exercise Prices Outstanding Life (Years) Exercise Price Options Exercise Price
- ---------------- ----------- ------------------- -------------- ----------- --------------
$0.00 - $0.01 3,313 3.3 $ 0.00 3,313 $ 0.00
$0.44 - $0.44 27,668 6.6 0.44 18,332 0.44
$0.74 - $1.02 778,072 6.6 1.00 540,270 0.99
$1.13 - $1.38 825,442 6.0 1.33 825,442 1.33
$1.75 - $2.15 353,944 8.7 1.79 142,266 1.85
$2.85 - $2.95 586,348 9.3 2.87 74,848 2.95
$5.11 - $5.11 357,152 4.2 5.11 357,152 5.11
$10.25 - $15.00 135,000 4.1 12.08 135,000 12.08
----------- -----------
3,066,939 6.9 $ 2.50 2,097,073 $ 2.66
=========== ===========
F-14
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 9 - Research and development expenses
Research and development expenses consist of the following:
Year ended December 31,
2004 2003 2002
---- ---- ----
($ in thousands)
Salaries and related expenses .................... $1,775 $1,689 $2,462
Consulting and advisory fees ..................... 88 96 78
Travel ........................................... 65 22 41
Other ............................................ 603 519 854
------ ------ ------
Total research and development expenses ...... $2,531 $2,326 $3,435
====== ====== ======
Note 10 - Income taxes
a. Provision for income taxes
No provision for income taxes was required for the years ended December
31, 2004, 2003 and 2002 due to net losses in these periods
b. Tax loss carryforwards
As of December 31, 2004, the Company had net operating loss carryforwards
generated in the U.S. and Israel of approximately $131,042,000 and $
6,555,000, respectively. The Company's U.S. net operating loss
carryforwards will expire at various dates between 2012 and 2024 if not
utilized. In addition, a portion of those net operating loss carryforwards
could be subject to limitation due to changes in ownership of the Company.
The Company's net operating losses generated in Israel may be carried
forward indefinitely. The Israeli subsidiary received final tax
assessments through the tax year ended December 31, 1999.
c. In accordance with SFAS No. 109, the components of deferred income
taxes are as follows:
December 31,
2004 2003
---- ----
($ in thousands)
Net operating losses carryforwards ............. $ 49,535 $ 48,297
Less valuation allowance ...................... (49,535) (48,297)
-------- --------
Net deferred tax assets ..................... $ -- $ --
======== ========
As of December 31, 2004, and 2003, a valuation allowance of $ 49,535,000
and $48,297,000 respectively, is provided as the realization of the
deferred tax assets are not assured.
d. Loss before income taxes:
Year ended December 31,
-----------------------
2 0 0 4 2 0 0 3 2 0 0 2
------- ------- -------
(US$ in thousands)
Domestic .................... $ 3,145 $ 8,240 $ 9,820
Foreign ..................... 38 43 2,116
------- ------- -------
Total ..................... $ 3,183 $ 8,283 $11,936
======= ======= =======
F-15
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 11 - Segment reporting, geographical information and major customers
The Company operates in one business segment, IP Telephony services, and
makes business decisions and allocates resources accordingly.
The following table summarizes the Company's revenues and long-lived
assets by country. Revenue is attributed to geographic region based on the
location of the customers. Long-lived assets are attributed to geographic
region based on the country in which the assets are located.
Year ended December 31,
-----------------------
2004 2003 2002
---- ---- ----
($ in thousands)
Revenues:
United States ........................................ $ 4,224 $ 4,602 $ 5,077
Europe ............................................... 1,127 966 984
South America ........................................ 2,432 817 903
Far East ............................................. 4,234 540 1,109
Middle East .......................................... 7,239 4,040 3,041
Other ................................................ 1,813 2,197 1,815
------- ------- -------
Total revenues ..................................... $21,069 $13,162 $12,929
======= ======= =======
Revenues from major customers exceeding 10% of revenues:
Master Reseller - A .................................. 16% 19% --
December 31,
2004 2003
---- ----
($ in thousands)
Long-lived assets:
United States ............................... $4,331 $3,229
Israel ...................................... 240 653
Europe ...................................... 95 360
Other ....................................... -- 65
------ ------
Total long-lived assets .................... $4,642 $4,307
====== ======
F-16
DELTATHREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Selected Quarterly Financial Information (Unaudited)
Three Months Ended,
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
($ in thousands, except per share data)
2004
Total revenues ................................ $ 4,606 $ 4,701 $ 5,530 $ 6,232
Costs and operating expenses:
Cost of revenues ............................ 3,009 3,047 3,665 4,070
Research and development expenses ........... 581 558 703 689
Selling and marketing expenses .............. 803 822 737 912
General and administrative expenses ......... 597 484 546 549
Depreciation and amortization ............... 747 719 619 656
------------ ------------ ------------ ------------
Total costs and operating expenses ............ 5,737 5,630 6,270 6,876
------------ ------------ ------------ ------------
Loss from operations .......................... (1,131) (929) (740) (644)
Interest income, net .......................... 86 49 81 53
------------ ------------ ------------ ------------
Loss before income taxes ...................... (1,045) (880) (659) (591)
Income taxes .................................. 38 6 12 10
------------ ------------ ------------ ------------
Net loss ...................................... $ (1,083) $ (886) $ (671) $ (601)
============ ============ ============ ============
Net loss per share - basic and diluted ........ $ (0.04) $ (0.03) (0.02) $ (0.02)
============ ============ ============ ============
Weighted average number of shares outstanding -
basic and diluted ........................ 29,278,433 29,312,835 29,319,307 29,346,971
============ ============ ============ ============
2003
Total revenues ................................ $ 2,972 $ 2,985 $ 3,320 $ 3,885
Costs and operating expenses:
Cost of revenues ............................ 1,862 1,955 2,010 2,566
Research and development expenses ........... 663 555 562 546
Selling and marketing expenses .............. 783 871 888 783
General and administrative expenses ......... 661 478 463 460
Depreciation and amortization ............... 1,604 1,527 1,313 1,140
------------ ------------ ------------ ------------
Total costs and operating expenses ............ 5,573 5,386 5,236 5,495
------------ ------------ ------------ ------------
Loss from operations .......................... (2,601) (2,401) (1,916) (1,610)
Interest income, net .......................... 104 42 73 26
------------ ------------ ------------ ------------
Loss before income taxes ...................... (2,497) (2,359) (1,843) (1,584)
Income taxes .................................. 18 4 24 11
------------ ------------ ------------ ------------
Net loss ...................................... $ (2,515) $ (2,363) $ (1,867) $ (1,595)
============ ============ ============ ============
Net loss per share - basic and diluted ........ $ (0.09) $ (0.08) (0.06) $ (0.06)
============ ============ ============ ============
Weighted average number of shares outstanding -
basic and diluted ........................ 28,923,296 28,923,296 28,976,345 29,138,244
============ ============ ============ ============
F-17
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized,
in New York, New York on March 30, 2005.
DELTATHREE, INC.
By: /s/ Paul C. White
----------------------------------
Paul C. White, Chief Financial Officer
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Shimmy Zimels and Paul C. White his true and
lawful attorney-in-fact, each acting alone, with full power of substitution and
resubstitution for him and in his name, place and stead, in any and all
capacities to sign this Annual Report, and to file the same, with all exhibits
thereto, and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that said
attorney-in-fact or his substitutes, each acting alone, may lawfully do or cause
to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Annual Report has been signed by the following persons in the capacities
and on the dates indicated:
Signature Title Date
/s/ Shimmy Zimels Chief Executive Officer, President March 30, 2005
- ------------------------ and Director
Shimmy Zimels (Principal Executive Officer)
/s/ Paul C. White Chief Financial Officer (Principal March 30, 2005
- ------------------------ Accounting and Financial Officer)
Paul C. White
/s/ Noam Bardin Chairman of the Board of Directors March 30, 2005
- ------------------------
Noam Bardin
/s/ Noam Ben-Ozer Director March 30, 2005
- ------------------------
Noam Ben-Ozer
/s/ Ilan Biran Director March 30, 2005
- ------------------------
Ilan Biran
/s/ Amir Gera Director March 30, 2005
- ------------------------
Amir Gera
/s/ Joshua Maor Director March 30, 2005
- ------------------------
Joshua Maor
/s/ Lior Samuelson Director March 30, 2005
- ------------------------
Lior Samuelson
54