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EX-32.2 - EXHIBIT 32.2 - XpresSpa Group, Inc.v231250_ex32-2.htm
  

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
 

FORM 10-Q
 

 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2011
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             
 
Commission file number: 001-34785
 

 
VRINGO, INC.
(Exact Name of Registrant as Specified in its Charter)
 

 
Delaware
 
20-4988129
(State or other jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
     
44 W. 28th Street New York, New York
 
10001
(Address of Principal Executive Offices)
 
(Zip Code)
 
(646) 525-4319
(Registrant's Telephone Number, Including Area Code)
 
18 East 16th Street, 7th Floor, New York, New York 10003
(Former name or former address, if changed since last report)
 

 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ¨     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer
¨
Accelerated filer
¨
       
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨    No x
 
As of August 15, 2011, 6,136,613 shares of the registrant's common stock were outstanding.
 

 
 
 

 

VRINGO, INC.
 
Table of Contents
 
   
Page
   
PART I. FINANCIAL INFORMATION
3
     
Item 1.
Financial Statements
3
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
19
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
34
Item 4T.
Controls and Procedures
34
   
PART II. OTHER INFORMATION
35
     
Item 1.
Legal Proceedings
35
Item 1A.
Risk Factors
35
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
35
Item 3.
Defaults Upon Senior Securities
35
Item 5.
Other Information
35
Item 6.
Exhibits
35
 
2

 
 
Part I — FINANCIAL INFORMATION
 
Item 1.         Financial Statements.
 
Vringo, Inc. and Subsidiary
(a Development Stage Company)
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands except share and per share data)
  
         
June 30,
2011
   
December 31,
2010
 
   
Note
   
U.S.$
   
U.S.$
 
Current assets
                 
Cash and cash equivalents
          407       5,407  
Restricted cash equivalents
  4       1,051        
Short-term deposit (restricted)
                  20  
Accounts receivable
            243       80  
Prepaid expenses and other current assets
            151       168  
                         
Total current assets
            1,852       5,675  
                         
Long-term deposit
            9       9  
Property and equipment, at cost, net of $431 and $393 accumulated depreciation and amortization, as of June 30, 2011 and December 31, 2010, respectively
            169       178  
Deferred tax assets—long-term
            28       27  
Total assets
            2,058       5,889  
 
 
The accompanying notes form an integral part of these consolidated financial statements.
 
 
3

 
 
Vringo, Inc. and Subsidiary
(a Development Stage Company)
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands except share and per share data)
 
         
June 30,
2011
   
December 31,
2010
 
   
Note
   
U.S.$
   
U.S.$
 
Current liabilities
                 
Deferred short-term tax liabilities, net
          68       50  
Accounts payable and accrued expenses*
          437       421  
Accrued employee compensation
          345       358  
Accrued short-term severance pay
                178  
Current maturities of venture loan
    4       1,051       1,262  
Total current liabilities
            1,901       2,269  
Long-term liabilities
                       
Accrued severance pay
            185       178  
Venture loan
    4             1,911  
Derivative liabilities on account of warrants
    3       1,725       1,770  
Total long-term liabilities
            1,910       3,859  
Commitments and contingencies
    6                  
Deficit in stockholders' equity
    5                  
Preferred stock, $0.01 par value per share; 5,000,000 authorized; none issued and outstanding as of June 30, 2011 and December 31, 2010
                   
Common stock, $0.01 par value per share 28,000,000 authorized; 5,963,614 and 5,405,080 issued and outstanding as of June 30, 2011 and December 31, 2010 respectively
            60       54  
Additional paid-in capital
            30,867       29,774  
Deficit accumulated during the development stage
           
(32,680
)     (30,067
Total deficit in stockholders' equity
           
(1,753
)     (239
Total liabilities and deficit in stockholders' equity
           
2,058
      5,889  
 
*
Amounts recorded as of June 30, 2011 and December 31, 2010 include $21 and $20 to a related party, respectively.
 
The accompanying notes form an integral part of these consolidated financial statements.
 
 
4

 

 Vringo, Inc. and Subsidiary
(a Development Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands except share and per share data)
   
   
Three months ended June 30,
   
Six months ended June 30,
   
Cumulative
from inception
to June 30,
 
   
2011
   
2010
   
2011
   
2010
   
2011
 
   
U.S.$
   
U.S.$
   
U.S.$
   
U.S.$
   
U.S.$
 
Revenue
    227       44       374       74       605  
                                         
Costs and Expenses*
                                       
Cost of revenue
    45       34       70       67       281  
Research and development
    460       603       979       1,180       12,305  
Marketing
    685       632       1,306       1,107       10,605  
General and administrative
    690       504       1,355       714       6,594  
Total operating expenses
    1,880       1,773       3,710       3,068       29,785  
Operating loss
    (1,653 )     (1,729 )     (3,336 )     (2,994 )     (29,180 )
                                         
Non-operating income
          10       4             470  
Non-operating expenses
    (7 )           (18 )     (16 )     (177 )
Interest and amortization of debt discount expense
    (118 )     (3,355 )     (227 )     (4,009 )     (5,359 )
Decrease (increase) in the fair value of warrants
    (663 )     480       45       448       997  
Gain on restructuring of venture loan
    963             963             963  
Loss on extinguishment of debt
                            (321 )
                                         
Loss before taxes on income
    (1,478 )     (4,594 )     (2,569 )     (6,571 )     (32,607 )
Income tax expense
    (26 )     (18 )     (44 )     (38 )     (73 )
                                         
Net loss
    (1,504 )     (4,612 )     (2,613 )     (6,609 )     (32,680 )
Basic and diluted net loss per common share
    (0.26 )     (5.20 )     (0.45 )     (10.54 )     (23.90 )
                                         
Weighted average number of shares used in computing basic and dilutive net loss per common share
    5,845,738       887,567       5,784,337       627,174       1,367,246  
                                         

*
The amount recorded for the three and six months ending June 30, 2011 and 2010 and the cumulative period from inception include $31, $162, $31, $89 and $1,213, respectively, to related parties.
 
The accompanying notes form an integral part of these consolidated financial statements.
 
 
5

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(Unaudited)
(in thousands)
 
 
  
Common stock
 
  
Series A
convertible
preferred
stock
 
  
Additional
paid-in capital
   
Deficit
accumulated
during the
development
stage
   
Total
 
 
  
U.S.$
 
  
U.S.$
 
  
U.S.$
   
U.S.$
   
U.S.$
 
Balance as of January 9, 2006 (inception)
  
 
  
  
 
  
  
 
  
   
  
   
  
Issuance of common stock
  
 
*—
  
  
 
  
  
 
  
   
  
   
*—
  
Issuance of series A convertible preferred stock, net of issuance costs of $33
  
 
  
  
 
*—
  
  
 
2,321
  
   
  
   
2,321
  
Stock dividend
  
 
20
  
  
 
24
  
  
 
(44
)
   
  
   
  
Grants of stock options, net of forfeitures—employees
  
 
  
  
 
  
  
 
7
  
   
  
   
7
  
Grants of stock options, net of forfeitures—non employees
  
 
  
  
 
  
  
 
4
  
   
  
   
4
  
                                         
Net loss for the period
  
 
  
  
 
  
  
 
  
   
(1,481
)
   
(1,481
)
Balance as of December 31, 2006
  
 
20
  
  
 
24
  
  
 
2,288
  
   
(1,481
)
   
851
  
Issuance of common stock as part of conversion of convertible loan
  
 
2
  
  
 
  
  
 
138
  
   
  
   
140
  
Discounts to temporary equity
  
 
  
  
 
  
  
 
43
  
   
  
   
43
  
Amortization of discounts to temporary equity
  
 
  
  
 
  
  
 
(4
)
   
  
   
(4
)
Grants of stock options, net of forfeitures—employees
  
 
  
  
 
  
  
 
98
  
   
  
   
98
  
Grants of stock options, net of forfeitures—non employees
  
 
  
  
 
  
  
 
15
  
   
  
   
15
  
                                         
Net loss for the year
  
 
  
  
 
  
  
 
  
   
(5,163
)
   
(5,163
)
Balance as of December 31, 2007
  
 
22
  
  
 
24
  
  
 
2,578
  
   
(6,644
)
   
(4,020
)
Issuance of warrants
  
 
  
  
 
  
  
 
360
  
   
  
   
360
  
Amortization of discounts to temporary equity
  
 
  
  
 
  
  
 
(7
)
   
  
   
(7
)
Grants of stock options, net of forfeitures—employees
  
 
  
  
 
  
  
 
18
  
   
  
   
18
  
Grants of stock options, net of forfeitures—non employees
  
 
  
  
 
  
  
 
11
  
   
  
   
11
  
                                         
Net loss for the year
  
 
  
  
 
  
  
 
  
   
(7,332
)
   
(7,332
)
 
The accompanying notes form an integral part of these consolidated financial statements.
 
 
6

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(Unaudited)
(in thousands)
 
 
  
Common stock
   
Series A
convertible
preferred
stock
   
Additional
paid-in capital
   
Deficit
accumulated
during the
development
stage
   
Total
 
 
  
U.S.$
   
U.S.$
   
U.S.$
   
U.S.$
   
U.S.$
 
Balance as of December 31, 2008
  
 
22
  
   
24
  
   
2,960
  
   
(13,976
)
   
(10,970
)
Issuance of warrants
  
 
  
   
  
   
60
  
   
  
   
60
  
Loan modification
  
 
  
   
  
   
500
  
   
  
   
500
  
Amortization of discounts to temporary equity
  
 
  
   
  
   
(7
)
   
  
   
(7
)
Grants of stock options, net of forfeitures—employees
  
 
  
   
  
   
178
  
   
  
   
178
  
Grants of stock options, net of forfeiture—non employees
  
 
  
   
  
   
10
  
   
  
   
10
  
Net loss for the year
  
 
  
   
  
   
  
   
(6,149
)
   
(6,149
)
Balance as of December 31, 2009
  
 
22
  
   
24
  
   
3,701
  
   
(20,125
)
   
(16,378
)
Issuance of common stock, net of issuance costs of $1,768
  
 
24
  
   
  
   
9,239
  
   
  
   
9,263
  
Exchange of series A convertible preferred stock for common stock
  
 
24
  
   
(24
)
   
  
   
  
   
  
Conversion of Bridge notes
  
 
9
  
   
  
   
2,536
  
   
  
   
2,545
  
Amortization of discounts to temporary equity
  
 
  
   
  
   
(3
)
   
  
   
(3
)
Grants of stock options, net of forfeitures—employees
  
 
  
   
  
   
883
  
   
  
   
883
  
Grants of stock options, net of forfeitures—non employees
  
 
  
   
  
   
29
  
   
  
   
29
  
Exercise of warrants to charity
  
 
*—
  
   
  
   
11
  
   
  
   
11
  
Grants of warrants to lead investors
  
 
  
   
  
   
1,342
  
   
  
   
1,342
  
Grants of warrants to charity
  
 
  
   
  
   
37
  
   
  
   
37
  
Exercise of stock options
  
 
1
  
   
  
   
  
   
  
   
1
 
Exercise of warrants
  
 
2
  
   
  
   
  
   
  
   
2
  
Stock dividend
  
 
19
  
   
  
   
(19
)
   
  
   
  
Reverse stock split
  
 
(93
)
   
  
   
93
  
   
  
   
  
Exchange of series B convertible preferred stock for common stock
  
 
46
  
   
  
   
11,925
  
   
  
   
11,971
  
Cashless exercise of warrants to charity
  
 
*—
  
   
  
   
*—
  
           
*—
  
Net loss for the year
  
 
  
   
  
   
  
   
(9,942
)
   
(9,942
Balance as of December 31, 2010
  
 
54
  
   
  
   
29,774
  
   
(30,067
)
   
(239
Grants of stock options, net of forfeitures—employees
  
 
  
   
  
   
764
  
   
  
   
764
  
Grants of stock options, net of forfeitures—non employees
  
 
  
   
  
   
30
  
   
  
   
30
  
Exercise of warrants
  
 
3
  
   
  
   
  
   
  
   
3
  
Issuance of shares to a consultant
  
 
*—
  
   
  
   
46
  
   
  
   
46
  
Issuance of shares in connection with restructuring of venture loan
   
3
     
     
210
     
     
213
 
Grants of warrants to charity
  
 
  
   
  
   
43
  
   
  
   
43
  
Net loss for the period
  
 
  
   
  
   
  
   
(2,613
   
(2,613
)
Balance as of June 30, 2011
  
 
60
  
   
  
   
30,867
  
   
(32,680
)
   
(1,753
 
*    Consideration for less than $1.
 
The accompanying notes form an integral part of these consolidated financial statements.
 
 
7

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
 
               
Cumulative
 
               
from inception
 
   
Six months ended June 30,
   
to June 30,
 
   
2011
   
2010
   
2011
 
   
U.S.$
   
U.S.$
   
U.S.$
 
Cash flows from operating activities
                 
Net loss
    (2,613 )     (6,609 )     (32,680 )
Adjustments to reconcile net cash flows used in operating activities:
                       
Items not affecting cash flows
                       
Depreciation and amortization
    38       45       431  
Change in deferred tax assets and liabilities
    16       (8 )     44  
Increase (decrease) in accrued severance pay
    (179 )           148  
Share-based payment expenses
    883       1,817       3,576  
Accrued interest expense
    98       2,398       2,855  
Decrease (increase) in fair value of warrants
    (45 )     (448 )     (997 )
Gain on restructuring of venture loan
    (963 )           (963 )
Loss on extinguishment of debt
                321  
Exchange rate (gains) losses
    (24 )     (18 )    
28
 
Changes in current assets and liabilities
                       
Decrease (increase) in receivables, prepaid expenses and other current assets
   
(145
)     45       (394 )
Increase (decrease) in payables and accruals
    18       (9 )     792  
Net cash used in operating activities
    (2,916 )     (2,787 )     (26,839 )
Cash flows from investing activities
                       
Acquisition of property and equipment
    (28 )     (34 )     (599 )
Decrease in lease deposits
                (9 )
Investment in restricted short-term deposits and cash equivalents
    (1,031 )     2,582       (1,051 )
Net cash provided by (used in) investing activities
    (1,059 )     2,548       (1,659 )
 
The accompanying notes form an integral part of these consolidated financial statements.
 
 
8

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
 
               
Cumulative
 
         
from inception
 
   
Six months ended June 30,
   
to June 30,
 
   
2011
   
2010
   
2011
 
   
U.S.$
   
U.S.$
   
U.S.$
 
Cash flows from financing activities
                 
Receipt of a venture loan
                5,000  
Repayment on account of venture loan
    (1,034 )     (88 )     (2,590 )
Issuance of common stock and warrants, net
          9,263      
9,263
 
Issuance of warrants
                1,070  
Receipt of convertible loans
                3,976  
Issuance of convertible preferred stock
                12,195  
Exercise of common stock options and warrants
   
3
      11      
17
 
Net cash provided by (used in) financing activities
    (1,031 )     9,186       28,931  
Effect of exchange rate changes on cash and cash equivalents
    6       1       (26 )
Increase (decrease) in cash and cash equivalents
    (5,000 )     8,948       407  
Cash and cash equivalents at beginning of period
    5,407       744        
Cash and cash equivalents at end of period
    407       9,692       407  
Supplemental disclosure of cash flows information
                       
Interest paid
    151       199       1,137  
Non-cash investing and financing transactions
                       
Conversion of convertible loan into convertible preferred stock
                1,964  
Extinguishment of debt
                  321  
Discount to the series B convertible preferred stock
                43  
Allocation of fair value of loan warrants
                334  
Allocation of fair value of conversion warrants
          1,564       1,564  
Exchange of series B convertible preferred stock for common stock
          11,971       11,971  
Exchange of series A convertible preferred stock for common stock
          24       24  
Conversion of bridge notes into common stock
          2,545       2,545  
Amortization of discounts to temporary equity
          3       21  
Issuance of shares in consideration of restructuring of venture loan
    213            
213
 
 
The accompanying notes form an integral part of these consolidated financial statements.
 
 
9

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1—General
 
Vringo, Inc. (a Development Stage Company) (the "Parent") was incorporated in Delaware on January 9, 2006 and commenced operations during the first quarter of 2006. The Parent formed a wholly-owned subsidiary, Vringo (Israel) Ltd. (the "Subsidiary") in March 2006, primarily for the purpose of providing research and development services, as detailed in the intercompany service agreement. The Parent and the Subsidiary are collectively referred to herein as the "Company".
 
The Company is engaged in developing software platforms and applications for mobile phones. The Company provides a variety of mobile video services including a comprehensive platform that allows users to create, download and share video ringtones. The Company's proprietary ringtone platform includes social networking capability and integration with web systems.
 
The Company is still in the development stage. There is no certainty regarding the Company's ability to complete the development of its products and ensure the success of its marketing. The continuation of the stages of development and the realization of assets related to the planned activities depend on future events, including future financings and achieving operational profitability.
 
In June 2010, the Company completed an initial public offering (the "IPO") of 2,392,000 units, each containing one share of common stock and two warrants, at an issue price of $4.60 per unit. Each warrant in the IPO unit is exercisable for five years after the IPO at an exercise price of $5.06. Gross proceeds of the IPO totaled approximately $11 million, of which the Company received approximately $9.3 million in net proceeds after deducting underwriting discounts and other offering costs. Immediately prior to the closing of the offering, the Company's outstanding shares of preferred stock were exchanged for shares of common stock and the Company effected a 1 for 6 reverse stock split of its common stock. The Company issued a stock dividend to holders of the preferred stock prior to the split and exchange. All share and per-share information in these consolidated financial statements have been adjusted to give effect to the reverse stock split. On July 27, 2010, the units were separated into their components and the shares and warrants began to trade separately. Upon separation of the units into shares and warrants, the units ceased trading.
 
There is still significant doubt as to the ability of the Company to continue operating as a "going concern". The Company has incurred significant losses since its inception and expects that it will continue to operate at a net loss in the foreseeable future. For the three and six month periods ended June 30, 2011 and for the cumulative period from inception until June 30, 2011, the Company incurred net losses of $1.5 million, $2.6 million and $32.7 million, respectively. The Company's deficit in stockholders' equity as of June 30, 2011 was $1.8 million.
 
In July 2011, after the balance sheet date, the Company signed a non-binding Letter of Intent to acquire substantially all the assets, and assume substantially all of the liabilities, of Zlango Ltd. (see Note 8 b). The consummation of the transaction is subject to the signing of a definitive agreement, completion of due diligence investigation and receipt of regulatory and stockholder approval. In addition, during July 2011, the Company raised an aggregate amount of $2.5 million through the issuance of convertible notes in a private placement and intends to seek additional financing. There is no assurance that the subsequent financing will be consummated. Should it not be consummated by January 1, 2012, the convertible notes will be repayable in full, unless earlier converted (see Note 8 c). Based on the above, the Company has sufficient cash to meet planned operating needs into the first quarter of 2012.
 
These financial statements were prepared using principles applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business for the foreseeable future, and do not include any adjustments to reflect the possible effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result should the Company not be able to continue as a going concern.
 
The high-tech industry in which the Company operates is highly competitive and is characterized by the risks of rapidly changing technologies. Penetration into global markets requires investment of considerable resources and continuous development efforts. The Company's future success depends upon several factors including the technological quality, price and performance of its product relative to those of its competitors.
 
As of June 30, 2011, approximately $180 thousand of the Company's net liabilities were located outside of the United States.
 
 
10

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
Note 2—Significant Accounting and Reporting Policies
 
(a) Basis of presentation
 
The accompanying consolidated financial statements include the accounts of the Parent and the Subsidiary and are presented in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP"). All significant intercompany balances and transactions have been eliminated in consolidation.
 
The accompanying unaudited consolidated financial statements were prepared in accordance with U.S. GAAP and instructions to Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles. These financial statements should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2010. The results of operations for the three and six month period ended June 30, 2011 are not necessarily indicative of the results that may be expected for the entire fiscal year or for any other interim period.
 
(b) Development stage enterprise
 
The Company's principal activities to date have been the research and development of its products and the Company has not generated significant revenues from its planned, principal operations. Accordingly, the Company's financial statements are presented as those of a development stage enterprise.
 
(c) Translation into U.S. dollars
 
The currency of the primary economic environment in which the operations of the Company are conducted is the U.S. dollar ("dollar"). Therefore, the dollar has been determined to be the Company's functional currency.
 
Transactions in foreign currency (primarily in New Israeli Shekels or "NIS") are recorded at the exchange rate as of the transaction date. All exchange gains and losses from re-measurement of monetary balance sheet items denominated in non-dollar currencies are reflected as finance expense in the statement of operations, as they arise.
 
At June 30, 2011, the exchange rate was U.S. $1 = NIS 3.415 (December 31, 2010—U.S. $1 = NIS 3.549). The average exchange rate for the three and six months ended June 30, 2011 was U.S. $1 = 3.441 NIS and U.S. $1 = 3.521 NIS, respectively (three and six months ended June 30, 2010— U.S. $1 = NIS 3.783 and US $1 = NIS 3.759, respectively).
 
 
11

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
Note 2—Significant Accounting and Reporting Policies—(cont'd)
 
(d) Use of estimates
 
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results may differ from such estimates. Significant items subject to such estimates and assumptions include the useful lives of property and equipment, deferred tax assets and liabilities, valuation of warrants, valuation of common stock share-based compensation, income tax uncertainties and other contingencies. The current economic environment has increased the degree of uncertainty inherent in those estimates and assumptions.
 
(e) Accounting for share-based compensation
 
Share-based compensation is recognized as an expense in the financial statements and such cost is measured at the grant-date fair value of the equity-settled award. The expense is recognized using the straight-line method, over the requisite service period, and is reduced for estimated forfeitures.
 
The fair value of stock options granted to management, employees and directors (except for the $5.50 options granted in 2010 and in 2011) is estimated at the date of grant using the Black-Scholes-Merton option-pricing model, which takes into consideration the share price at the date of grant, the exercise price of the option, the expected life of the option, risk-free interest rate, expected dividend and the expected volatility. The fair value of the stock options granted to management, employees and directors at an exercise price of $5.50 was valued using the Lattice model, which takes into consideration the share price at the date of grant, the exercise price of the option, the expected life of the option, risk free interest rate, expected dividend, and the expected volatility. The Company uses the Lattice option pricing model for the valuation of options that are not plain vanilla that are issued to management, employees and directors.
 
The fair value of stock options granted to consultants is estimated at the date of grant using the Black-Scholes-Merton option-pricing model. In cases where no measurement date has been reached nor there is a counter-party performance commitment, the options are revalued at the reporting date. The options are valued using the share price, the exercise price of the option, the expected life of the option, risk-free interest rates and the expected volatility, at the reporting period date.
 
(f) Impact of new accounting standards not yet adopted
 
In May 2011, the FASB issued guidance to amend the accounting and disclosure requirements on fair value measurements (ASU 2011-04). The new guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, the new guidance expands the disclosures on Level 3 inputs by requiring quantitative disclosure of the unobservable inputs and assumptions, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. The new guidance will be effective beginning January 1, 2012. The Company does not anticipate a material impact on its financial statements upon adoption of the new requirements.
 
 
12

 
 
Vringo, Inc. and Subsidiary
(a Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
(g) Net loss per share data
 
Basic net loss per share is computed by dividing the net loss for the period by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted-average number of shares of common stock plus dilutive potential common stock considered outstanding during the period. However, as the Company generated net losses in all periods presented, potentially dilutive securities, comprised mainly of warrants and stock options, are not reflected in diluted net loss per share because such shares are anti-dilutive.
 
The table below presents the computation of basic and diluted net losses per common share:
  
               
Cumulative
 
               
from inception
 
   
Three months ended June 30,
   
Six months ended June 30,
   
to June 30,
 
   
2011
   
2010
   
2011
   
2010
   
2011
 
Numerator:
 
(in thousands, except share and per share data)
 
                               
Net loss attributable to common stock shares (basic and diluted)
    (1,504 )     (4,612 )     (2,613 )     (6,609 )     (32,680 )
Denominator:
                                       
Weighted average number of common stock shares outstanding during the period (basic and diluted)
    5,756,345       839,332       5,654,929       603,057       1,319,021  
Weighted average number of penny stock options and warrants (basic and diluted)
    89,393       48,235       129,408       24,117       48,225  
Basic and diluted common stock share outstanding
    5,845,738       887,567       5,784,337       627,174       1,367,246  
Basic and diluted net losses per common stock share
    (0.26 )     (5.20 )     (0.45 )     (10.54 )     (23.90 )
 
(h) Reclassification
Certain balances have been reclassified to conform to current year presentation.
 
 
13

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
Note 3—Fair Value Measurements
 
The Company measures fair value in accordance with ASC 820-10, "Fair Value Measurements and Disclosures" (formerly SFAS 157, Fair Value Measurements). ASC 820-10 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, ASC 820-10 establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
 
Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.
 
Level 2 Inputs: Other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
 
Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date. The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
 
The Company measures its cash equivalents, Special Bridge Warrants and Conversion Warrants at fair value. Cash equivalents are classified within Level 1 because they are valued using quoted active market prices. The Special Bridge Warrants and Conversion Warrants are classified within Level 3 because they are valued using the Black-Scholes-Merton and the Monte-Carlo (as these warrants include a down-round protection clause) models which utilize significant inputs that are unobservable in the market such as the expected stock price volatility and the dividend yield, and the remaining period of time the warrants will be outstanding before they expire.
 
The following table presents the Company's assets and liabilities measured at fair value on a recurring basis as of June 30, 2011 and December 31, 2010, aggregated by the level in the fair-value hierarchy within which those measurements fall:
 
 
  
   
  
Fair value measurement at reporting date using
 
 
  
June 30,
2011
 
  
Quoted prices in
active markets
for identical
assets (Level 1)
 
  
Significant other
observable
inputs (Level 2)
 
  
Significant
unobservable
inputs (Level 3)
 
Description
  
U.S.$ thousands
 
Assets
  
     
  
     
  
     
  
     
Cash equivalents
  
 
51
  
  
 
51
  
  
 
  
  
 
  
Cash equivalents (restricted)
   
1,051
     
1,051
     
     
 
Total assets
  
 
1,102
  
  
 
1,102
  
  
 
  
  
 
  
Liabilities
  
     
  
     
  
     
  
     
Derivative liabilities on account of warrants
  
 
1,725
  
  
 
  
  
 
  
  
 
1,725
  
Total liabilities
  
 
1,725
  
  
 
  
  
 
  
  
 
1,725
  

 
14

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
Note 3—Fair Value Measurements—(cont'd)

 
  
   
  
Fair value measurement at reporting date using
 
 
  
December 31,
2010
 
  
Quoted prices in
active markets
for identical
assets (Level 1)
 
  
Significant other
observable
inputs (Level 2)
 
  
Significant
unobservable
inputs (Level 3)
 
Description
  
U.S.$ thousands
 
Assets
  
     
  
     
  
     
  
     
Cash equivalents
  
 
4,542
  
  
 
4,542
  
  
 
  
  
 
  
Total assets
  
 
4,542
  
  
 
4,542
  
  
 
  
  
 
  
Liabilities
  
     
  
     
  
     
  
     
Derivative liability on account of warrants
  
 
1,770
  
  
 
  
  
 
  
  
 
1,770
  
Total liabilities
  
 
1,770
  
  
 
  
  
 
  
  
 
1,770
  
 
In addition to the above, the Company's financial instruments at June 30, 2011 and December 31, 2010, consisted of cash, accounts receivable, long-term deposits, accrued expenses and the venture loan. The carrying amounts of all the aforementioned financial instruments, approximate fair value, except the venture loan (see below).
 
The following table summarizes the changes in the Company's liabilities measured at fair value using significant unobservable inputs (Level 3) during the six months ended June 30, 2011:
 
 
  
Level 3
 
 
  
Special Bridge
Warrants
   
Conversion
Warrants
   
Total
 
 
  
U.S.$ thousands
 
Original allocated amount
  
 
1,070
  
   
  
   
1,070
  
Additional allocated amount (upon IPO)
  
 
88
  
   
1,564
  
   
1,652
  
Fair value adjustment included in statement of operations
  
 
(382
   
(570
   
(952
Balance at December 31, 2010
  
 
776
  
   
994
  
   
1,770
  
Fair value adjustment included in statement of operations
  
 
172
     
(217
   
(45
Balance at June 30, 2011
  
 
948
  
   
777
  
   
1,725
  
 
 
15

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
Note 3—Fair Value Measurements—(cont'd)
 
Carrying amounts and the related estimated fair value of the venture loan are as follows: (see also Note 4):
 
 
June 30, 2011
 
December 31, 2010
 
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
 
 
U.S.$ thousands
 
U.S.$ thousands
 
Venture loan
  1,051     1,051     3,173     3,317  
 
Note 4—Venture Loan
 
On June 8, 2011, the Company entered into a Settlement Agreement (the “Agreement”) with the lenders of the venture loan (the "Lenders"), pursuant to which the Lenders agreed to accept less than the full amount owed to them by the Company. As part of the Agreement, the Company immediately repaid $331 thousand, and placed additional $1,051 thousand as collateral into a restricted account. In addition, the Company issued the Lenders 250,000 shares of its common stock, in exchange for 250,000 Senior Lender Warrants, which were cancelled. Subsequent to the balance sheet date, the Company repaid the outstanding balance of its venture loan, using the funds set aside in the restricted account (see Note 8 a).
 
On the date of the Agreement, subsequent to the repayment of the $331 thousand, the loan balance was recorded down to $1,051 thousand.  The difference between the fair market value of the shares of common stock issued and the fair market value of the cancelled Senior Lender Warrants, amounting to $231 thousand, was recorded in the statement of stockholders’ equity. In addition, the difference between the carrying value of the loan and the total sum of future payments on the loan, including the above mentioned $231 thousand, net of legal fees, resulted in a gain on restructuring of debt, in the total amount of $963 thousand, recorded in the statements of operations. Basic and diluted per share gain on restructuring of venture loan is $0.16.

Note 5—Stockholders' Equity
 
Stock Options
 
On January 31, 2011, the Company granted 480 thousand options to purchase shares of common stock to its employees, management and consultants (see below). During the three and six month period ended June 30, 2011, 120 thousand and 234 thousand stock options were forfeited and 20 thousand and 20 thousand stock options were exercised, respectively.
 
In addition, during the three and six month period ended June 30, 2011, the Company issued 0 and 27 thousand shares of common stock to one of its consultants, respectively. As a result, compensation expense in the total amount of approximately $45 thousand was recorded.
 
In January 2011, the Company granted warrants to purchase 40 thousand shares of common stock as a charitable donation. 20 thousand of these warrants were granted at an exercise price of $5.50 per share and the remaining 20 thousand at an exercise price of $0.01 per share. The total fair value of approximately $43 thousand was calculated using the Black-Scholes-Merton model, using the following assumptions: stock price of $1.68, expected life of 6 years, risk-free interest rate of 2.38%, expected volatility of 56.41% and no dividend yield. The total fair value of the grant was recorded as an additional share-based payment expense in the six month period ended June 30, 2011. In April 2011, the Company issued 19,862 shares of common stock upon exercise of 20 thousand charitable warrants with an exercise price of $0.01 per share.
 
As of June 30, 2011, there was approximately $2.5 million of total unrecognized share-based payment costs related to non-vested share-based compensation arrangements granted under the Company’s incentive plans. That cost is expected to be recognized over an estimated 3.25 years period.
 
 
16

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
Note 5—Stockholders' Equity—(cont'd)
 
On January 31, 2011, the Company's Board of Directors (the "Board") approved the granting of 216 thousand options to management, employees and consultants at an exercise price of $0.01 per share. These options will vest yearly over three and four year periods (according to the applicable schedule of each optionee). The Board also approved the granting of 264 thousand options at an exercise price of $5.50 to its management, employees and consultants. These options will vest over three and four years (according to the applicable schedule of each optionee).
 
As of June 30, 2011, there were approximately 11.1 million shares of common stock available for future grants.
The following table summarizes the option activity for the year 2011 to balance sheet date, by grant date:
 
 
  
No. of options to
Employees
 
  
No. of options to
Non-Employees
 
  
Exercise
price
 
  
Average
fair value of
granted option
 
 
  
   
  
   
  
U.S.$
 
  
U.S.$
 
January 31, 2011
  
 
194,000
  
  
 
22,000
  
  
 
0.01
  
  
 
1.67
  
January 31, 2011
  
 
252,500
  
  
 
12,000
  
  
 
5.50
  
  
 
0.42
  
 
The fair value of the $0.01 options granted January 31, 2011, to management employees and directors was calculated using the Black-Scholes-Merton model with an expected life of 4-4.25 years, a risk-free interest rate of 1.44%-1.55% and an expected volatility of 47.9%-52.2% and no dividend yield. The fair value of the common stock used for this calculation was $1.68.
 
The fair value of the $5.50 options granted January 31, 2011, to employees and directors was calculated using the Lattice model with an expected life of 6 years, a risk-free interest rate of 2.38% and an expected volatility of 56.41% and no dividend yield. The fair value of the common stock used for this calculation was $1.68.
 
The total fair value of all options granted to non-employees, is calculated using the Black-Scholes-Merton model with an expected life of 2.5-5.75 years, stock price of $1.22, a risk free interest rate of 0.57%-2.01% and an expected volatility of 45.71%-54.41% and no dividend yield.
 
 
17

 

Vringo, Inc. and Subsidiary
(a Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
Note 6—Commitments and Contingencies
 
Future minimum lease payments under non-cancelable operating leases for office space and cars, as of June 30, 2011, are as follows:
 
   
U.S.$
 
   
thousands
 
Year ending December 31,
     
2011 (six months ending December 31, 2011)
    48  
2012
    55  
2013
    8  
      111  
 
Rental expense for operating leases for both office space and cars for the six months ended June 30, 2011 and 2010 was $55 thousand, and $65 thousand, respectively. Rental expense for operating leases for both office space and cars for the three months ended June 30, 2011 and 2010 was $22 thousand, and $39 thousand, respectively.
 
Note 7—Risks and Uncertainties
 
 
(a)
The Company's primary business is to provide video ringtones globally by partnering with international telecommunication carriers. Principal markets targeted are the U.S., Europe and the Far East. The Company's business depends on the technological infrastructures, wireless networks and information systems of its international carrier partners.

 
(b)
The wireless industry in which the Company conducts its business is characterized by rapid technological changes, frequent new product innovations, changes in customer requirements and expectations and evolving industry standards.

 
(c)
The Company's data is hosted at a remote location. Although the Company has full alternative site data backed up, they do not have data hosting redundancy and are thus exposed to the business risk of significant service interruptions.

 
(d)
A significant portion of the Company's expenses are denominated in NIS. The Company expects this level of NIS expenses to continue for the foreseeable future. If the value of the U.S. dollar weakens against the value of NIS, there will be a negative impact on the Company's operating costs. In addition, to the extent the Company holds monetary assets and liabilities that are denominated in currencies other than the U.S. dollar, the Company will be subject to the risk of exchange rate fluctuations.

 
(e)
In order to continue operating as a going concern the Company needs to raise capital through further debt or equity transactions. The Company is thus exposed to a market risk that it will not be able to raise this capital, as disclosed in Note 1.
 
Note 8—Subsequent Events
 
(a)  
In July 2011, the Company repaid the outstanding $1,051 thousand balance of its venture loan, using the funds set aside in the restricted account (see Note 4).
 
(b)  
In July 2011, the Company announced that it executed a Letter of Intent ("LOI") to acquire substantially all of the assets, and assume substantially all of the liabilities, including a long-term loan of up to $3 million, of Zlango Ltd., a mobile messaging company ("Zlango"). Under the terms of the LOI, the Company will issue 3 million shares of its common stock and provide Zlango's management with a retention package comprised of options to purchase 250 thousand shares of common stock. Further, as a condition of closing, Zlango’s long-term loan is to be renegotiated to provide a minimum eighteen month principal holiday and a reduced interest rate during the initial eighteen month period, with repayments to begin over the subsequent 48 month period.
 
(c)  
In July 2011, the Company issued convertible notes in a private placement, in the aggregate amount of $2.5 million, primarily to two venture capital firms: Benchmark Capital and DAG Ventures. These venture capital firms may participate in a subsequent financing, following the intended acquisition of Zlango (see Note 8 b). Should the subsequent financing occur, the convertible notes will automatically convert into the same securities as the subsequent financing, except that the conversion price for the convertible notes will be equal to the lower of: (i) the closing price of the Company's common stock on the day the private placement was announced; or (ii) the closing price of the Company's common stock on the closing date; or (iii) a 10% discount to the securities issued in the subsequent financing. Should the subsequent financing not occur by January 1, 2012, then the principal and all accrued but unpaid interest thereon shall be repayable in full to convertible note holders.
 
 
18

 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
 
This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained herein that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "will," "plan," "project," "seek," "should," "target," "will," "would," and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included in our Annual Report on Form 10-K filed on March 31, 2011. The forward-looking statements set forth herein speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
 
General
 
We provide comprehensive software platforms and applications that allows users to create, download and share mobile video entertainment content in the form of video ringtones for mobile phones, “ReMixed” video clips from artists and branded content, Fan Loyalty mobile applications for contestant based reality TV shows, as well as social picture ringtone and ringback content. We believe that our service represents the next stage in the evolution of the mobile content and mobile social applications market. We anticipate that the mobile content and service market will begin to migrate from standard audio ringtones and content to high-quality video services, with social networking capability and integration with web systems. We also believe that social network information and updates will begin to be shared regularly when friends regularly communicate by voice and by text. Our video ringtone solutions and other mobile social and video applications, which encompasses a suite of mobile and PC-based tools, enables users to create, download and share video and other social content with ease as part of the normal communication process, and provides our business partners with a consumer-friendly and easy-to-integrate monetization platform.
 
In addition to our core video ringtone platform we have also developed three new platforms: our Video ReMix Platform that allows users to create their own “mix” combining their own clips together with artist and branded content, our Facetones™ platform that automatically generates a slideshow from social network pictures which provides relevant and social visual enhancement to the Ringtone and the Ringback tone, and our Fan Loyalty platform that allows users to obtain video and video ringtones, view information on reality television stars and vote for contestants. To develop these new platforms, we have leveraged our existing technology, intellectual property and our extensive experience with mobile video. We believe that these new platforms will represent a major component of our business on a going forward basis.
 
We believe that the mobile content and mobile social services market is fragmented and that there are opportunities to acquire additional assets. We have been focusing on commercializing our core video ringtone service primarily through agreements with mobile carriers and other distribution partners in related areas such as handset manufactures and retailers such as the CarPhone Warehouse. We have launched our Video Ringtone service commercially with five mobile carriers operating in Turkey, Malaysia, United Arab Emirates, Singapore, and the United Kingdom. In addition, we launched a Video ringtone service with RTL, a major television network in Belgium, and with Hungama Digital Media Entertainment ("Hungama"), a content and mobile services aggregator in India. The service with Hungama is being offered to customers of 15 different mobile carriers in India. As of the end of the second quarter, we no longer offer our service commercially in Armenia. As of August 15, 2011, our partners have an aggregate of approximately 700 million subscribers, of which 294,000 are paid subscribers to our service, and another 25,000 subscribers have enrolled on a free-trial basis.
 
In the first half of 2011, we launched our products and services with Everything Everywhere Limited, a United Kingdom communication company which operates the T–Mobile UK and Orange UK mobile services. With this launch, our video ringtone service is available to over 16 million Orange subscribers in the United Kingdom. We anticipate further integration with T-Mobile for a future release which would make our service directly available to another 14-plus million mobile subscribers in the UK.
 
We also launched our Video ringtone products and services with StarHub, a mobile carrier in Singapore. Through this new carrier, our video ringtone service will be co-branded by StarHub and made available to its over 2 million customers. Following the termination of our agreement with Avea in Turkey, we signed a deal with Retromedya, a third party service provider there, to offer our service to the customers of all carriers in Turkey. In April 2011, we launched our ringtone service in India with Hungama, which is available to a potential 500 million plus subscribers. We are negotiating with additional mobile carriers in a number of different countries and we expect to continue to scale our video ringtone business with carriers during the remainder of 2011.
 
Our new platforms – Video ReMix, Facetones™, and Fan Loyalty, have generated a significant portion of second quarter revenues.
 
Following our first quarter launch of our Video ReMix platform, we continued in the second quarter to partner with Corso Communications and its client Heineken, to deliver a sponsored version of this platform.

 
19

 

In the second quarter, we launched our Facetones™ platform, with a product for Android users together with BlueVia, the new global software developer platform of Telefonica, the largest mobile operator in the Spanish speaking world, and fourth largest globally. Facetones™ will be initially available on Telefonica's Application Store (Mstore) in several global markets. Subsequent to quarter end, Facetones™ was launched in Japan for Android users through the docomo market, a mobile internet portal operated by NTT DOCOMO, INC., the largest mobile phone operator in Japan, with 50+ million customers. Revenue from the Facetones TM platform was earned for development services from Nokia (NYSE: NOK).
 
In the second quarter, we launched our Fan Loyalty platform by co-branding our fan-loyalty application with Star Academy 8 the largest music competition in the Middle East and Nokia, the world’s largest handset maker. This platform enables users to obtain video content from the show as well as from behind the scenes, retrieve information regarding the show and vote for their favorite contestants. The free app was launched in partnership with Rotana, a diversified media company and the world's largest producer of music and music television in the Middle East, and sponsored by Nokia. The application features exclusive content and fully integrated live voting capabilities for the blockbuster "Star Academy" reality music show, which reaches over 300 million viewers and is available in over 10 countries in the region.
 
Our applications are monetized not only via carrier relationships, but also through various application stores (“App stores”). We commenced distribution of our apps through Nokia’s Ovi store, Verizon V Cast App Store, Vodafone Shop, Telefonica owned portals as well as the NTT Docomo Market. Our content partnerships include major artists, celebrities and content providers, including EMI, Warner Music, T–Pain, Muhammad Ali Enterprises, Tiesto, Turner, Marvel, Hungama Mobile, RTL and Ingrooves. 
 
In July 2011, we executed a Letter of Intent ("LOI") to acquire substantially all assets and assume practically all liabilities of Zlango Ltd., a mobile messaging company ("Zlango"). We intend to leverage Zlango's rich media messaging services together with our strong portfolio of mobile social and video applications to create a new leader in the mobile social arena. Zlango's technology can effortlessly add icons, themes and images to standard text messages. Zlango provides a set of technology platforms through a managed services environment for enabling rich media messages over the existing mobile text infrastructure. It also offers a platform for premium and syndicated content, as well as user-generated content.
 
On July 21, 2011, the NYSE Amex (the "Exchange") accepted our plan for regaining compliance with the Exchange's listing standards (the "Plan"). The Plan was submitted on June 23, 2011, in response to a notice received on May 24, 2011 from the Exchange regarding our non-compliance with certain continued listing standards. While we are not yet in compliance with the Exchange's listing standards, with the Exchange's acceptance of the Plan, our listing is now continued under an extension with a target completion date of September 30, 2011. We will continue to provide the Exchange staff with updates relative to the initiatives detailed in the Plan, which calls for us to regain compliance with the Exchange's continued listing standards by September 30, 2011.

 
20

 

Our Business Model
 
Our business model for our video ringtone platform entails revenue sharing and/or charging fees from our mobile carriers or app store distribution partners primarily using a subscription-based model where users pay a monthly fee for access to the service, as well as, additional fees for access to certain premium content. Some of our products are available for one time purchase fees in app stores. In addition, as in the case of our Video ReMix for Corso/Heineken and our Fan Loyalty platform for the Star Academy service, we have engaged primarily in developing free experiences for consumers in exchange for one-time fees from sponsors. Our Facetones™ product is or will be offered in a variety of business models including monthly subscription services together with operators, as a premium app available for purchase in app stores, and in a free direct to consumer version where we are monetizing by displaying ads at the end of the phone call.
 
We have launched our various services together with mobile carriers and other partners in Latin America, parts of Europe including the United Kingdom and Spain, Japan, India, Singapore, Turkey, Malaysia, Armenia and the United Arab Emirates. Our mobile carrier partners co-brand our service and help market it to their subscribers. The pricing for subscriptions and content in various countries will vary substantially based on local economic conditions. In general, we aim to sell the monthly subscriptions ranging from $1 to $5 and we expect to generally receive at least 40% of the monthly subscription revenue. We currently monetize our video ringtone service across our existing launches on a blended rate basis of $0.13 per subscriber per month and we intend to increase this rate going forward as we move to more lucrative markets in Europe and North America. We expect that premium content will generally be sold for $1 to $5 per item although this price and the monthly subscription rate may vary substantially by country. Operators usually do not charge us or our users for any data charges associated with using our service or for using the operator's text messaging infrastructure to communicate with our subscribers.
 
Our Video ReMix Platform allows users to create their own “mix” combining their own clips together with artist and branded content.  Our Facetones™ product creates an automated video slideshow using friends' photos from social networks which is played each time a user makes or receives a call. Facetones™ initially connects with Facebook(R), the world's leading social media site, providing for a significantly enhanced mobile experience for users of social media. Our Fan Loyalty platform allows users to obtain video and video ringtones, view information on reality television stars and vote for contestants.
 
Our model consists of growing our user base through carrier partnerships, continuing to ensure we have broad handset reach, enhancing our viral and social tools, maintaining and growing our product and technology portfolio, building a strong revenue base of recurring monthly subscription revenue, finding new forms of distribution, exploring monetization through advertising, and revenue through content sales.
 
Overview
 
We are a development stage company. From inception through June 30, 2011, we have raised approximately $28.5 million. These amounts have been used to finance our operations, as until now, we have not yet generated any significant revenues. From inception and until June 30, 2011, we recorded losses of $32.7 million and net cash outflow from operations of $26.8 million.
 
Our financial statements were prepared using principles applicable to a going concern, which contemplate the realizations of assets and liquidation of liabilities in the normal course of business for the foreseeable future, and do not include any adjustments to reflect the possible effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result if we are not able to continue as a going concern. As of June 30, 2011, we had approximately $0.4 million in cash and cash equivalents. Our average monthly burn rate from operations for the six month period ended June 30, 2011, was approximately $0.5 million. In addition, in order to conserve funds, we underwent resource reductions in the first half of 2011.
 
In July 2011, we issued convertible notes in a private placement, in the aggregate amount of $2.5 million, primarily to two venture capital firms: Benchmark Capital and DAG Ventures. These venture capital firms may participate in a subsequent financing, following the intended acquisition of Zlango. Should the subsequent financing round occur, the convertible notes will automatically convert into the same securities as the ones issued in the subsequent financing. Should the subsequent financing not occur by January 1, 2012, the principal and all accrued but unpaid interest thereon shall be repayable in full to the holders of the convertible note, unless the notes are converted prior to such time.
 
A substantial portion of our revenues and anticipated revenues are in dollars and euros, while a significant portion of our expenses, principally salaries and related personnel expenses, are paid in Israeli currency by our subsidiary. As a result, we are exposed to an exchange rate risk if the value of the dollar or euro significantly depreciates vis-à-vis the value of the New Israeli Shekel.
 
Revenue
 
We recognize revenue from monthly subscription from carriers, development projects and content sales when all the conditions for revenue recognition are met: (i) persuasive evidence of an arrangement exists, (ii) collection of the fee is probable, (iii) the sales price is fixed and determinable and (iv) delivery has occurred or services have been rendered. Our subscription service arrangements are evidenced by a written document signed by both parties. Our revenues from monthly subscription fees and content purchases are recognized when we have received confirmation from the carrier that the amount is due to us, which provides proof that the services have been rendered, and making collection probable.

 
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We recognize revenue from non-refundable up-front fees relating to set-up and billing integration across the period of the contract for the subscription service as these fees are part of hosting solution that we provide to the carrier. The hosting is provided on our servers for the entire period of the arrangement with this carrier, and the revenues relating to the monthly subscription, set-up fees and billing integration have been recognized over the period in the agreement.
 
Cost of revenue
 
Cost of revenue consists primarily of expenses directly related to providing our service in launched markets. These expenses include the costs associated with production servers serving the end-users, royalty fees for content sales, amortization of prepaid content licenses, the direct costs of billing services and text messaging providers. In addition, cost of revenue includes certain set-up and other direct costs incurred in connection with adjustments made to our products for each individual client.
 
Research and development expenses
 
Research and development expenses consist primarily of salary expenses of our development and quality assurance engineers in our research and development facility in Israel, outsourcing of certain development activities, preparation of patent filings, and server and support functions for our development environment.
 
Marketing expenses
 
Marketing expenses include the salary of all business development and marketing personnel, travel expenses relating to business development activity and tradeshows, as well as public relations, advertising and customer acquisition expenses. As we increase our sales, certain commissions to agents will also be included in sales and marketing expenses.
 
General and administrative expenses
 
General and administrative expenses include the salary of our finance and administrative personnel, rental costs, legal and accounting fees, insurance, telephone and other office expenses including depreciation and amortization. Following the consummation of our IPO, general and administrative expenses increased significantly as we incurred additional costs of being a public company. These costs include increased legal and accounting costs, additional insurance costs, director compensation and increased share based compensation expenses.
 
Non-operating expenses (income)
 
Non-operating expense (income) includes transaction gains (losses) from foreign exchange rate differences, interest on deposits, bank charges and interest and discount amortization expenses on venture loan. In addition, non-operating expense (income) includes gain on restructuring of venture loan in light of the settlement agreement signed June 8, 2011. Fair value adjustments of derivative liabilities on account of the Special Bridge Warrants and the Conversion Warrants, which are highly influenced by our stock price at the period end (measurement date), are recorded in non-operating expense (income).
 
Income taxes
 
Our effective tax rate differs from the statutory federal rate primarily due to differences between income and expense recognition prescribed by income tax regulations and generally accepted accounting principles. We utilize different methods and useful lives for depreciating and amortizing property and equipment and different methods and timing for certain expenses. Furthermore, permanent differences arise from certain income and expense items recorded for financial reporting purposes but not recognizable for income tax purposes. In addition, our income tax expense has been adjusted for the effect of foreign income from our wholly owned subsidiary. At June 30, 2011, our deferred tax assets generated from our U.S. activities were entirely offset by a valuation allowance because realization depends on generating future taxable income, which, in our estimation, is not more likely than not to be realized. The deferred tax assets and liabilities generated from our subsidiary's operations are not offset by an allowance, as in our estimation, it is more likely than not to be realized.
 
Our subsidiary generates net taxable income from services it provides to us. The subsidiary charges us for research and development and certain management services provided to us, plus a profit margin on such costs, which is currently 8%. However, the subsidiary is a "Beneficiary Enterprise" as defined in amendment No. 60 to the Israeli Law for the Encouragement of Capital Investment, 1959, which means that income arising from its approved research and development activities is subject to zero percent tax for a period of two years and a reduced tax rate for the subsequent five years. The subsidiary elected to receive the zero percent tax benefits for the fiscal years of 2007 and 2008. In January 2011, new legislation amending the Investment Law was enacted. According to the amendment, the uniform tax rate applicable to the zone where the production facilities of the subsidiary are located would be 15% in 2011 and 2012, 12.5% in 2013 and 2014, and 12% in 2015 and thereafter. Under the transitory provisions of the new legislation, the subsidiary irrevocably implemented the new law while waiving benefits provided under the current law.
 
During February 2011, the Israeli tax authorities commenced an audit of the subsidiary's Israeli tax returns for the 2007 through 2009 tax years. To date, the subsidiary has not yet received any findings from the audit by the Israeli tax authorities.

 
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Results of Operations
 
Three and Six Months ended June 30, 2011 and 2010 and the development stage period (cumulative from inception through June 30, 2011)
 
Revenue
 
   
Three months Ended June 30,
   
Six months Ended June 30,
   
Cumulative
from inception to
June 30,
 
    
2011
   
2010
   
Change
   
2011
   
2010
   
Change
   
2011
 
          
($ - in thousands)
               
($ - in thousands)
         
($ - in thousands)
 
                                           
Revenue
    227       44       183       374       74       300       605  
 
Three Months Ended June 30, 2011, Compared to Three Months Ended June 30, 2010
 
During the three month period ended June 30, 2011, we recorded revenues of $227 thousand, which represents an increase of $183 thousand (or 416%) from revenues recorded for the three month period ended June 30, 2010. The increase was mainly due to revenue in Malaysia ($78 thousand in the second quarter of 2011, compared to the $15 thousand recorded in the second quarter of 2010), completion of Facetones™ ($50 thousand recognized in the second quarter of 2011) and completion of development of Fan Loyalty application ($45 thousand recognized in the second quarter of 2011).
 
Six Months Ended June 30, 2011, Compared to Six Months Ended June 30, 2010
 
During the six month period ended June 30, 2011, we recorded revenues of $374 thousand, which represents an increase of $300 thousand (or 405%) from revenues recorded for the six month period ended June 30, 2010. The increase was mainly due to revenue in Malaysia ($155 thousand in the first half of 2011, compared to the $25 thousand in the first half of 2010), completion of Facetones™ ($50 thousand recognized in the first half of 2011), completion of development of Fan Loyalty application ($45 thousand recognized in the first half of 2011), delivery of Video ReMix platform ($30 thousand recognized in the first half of 2011), revenue recorded in connection with set-up fees for the new agreement in Singapore ($18 thousand recognized in the first half of 2011).
 
From Inception Through June 30, 2011
 
From inception through June 30, 2011, we recorded revenues of $605 thousand, which includes $375 thousand from revenue share subscription services, $100 thousand from one-time setup fees, $50 thousand from Facetones™, 45 thousand from Fan Loyalty application formats, $30 thousand from Video ReMix platform and $5 thousand from applications sold.
 
We expect to continue to generate a substantial portion of our revenues for the remainder of the year from: (i) Video Remix, Facetones™ and Fan Loyalty application platforms, (ii) revenue-sharing agreements in Malaysia, (iii) services provided in the United Arab Emirates, (iv) agreements with Everything Everywhere Limited and Bango in the UK, (v) recently launched services in India, and (vi) partnership with StarHub in Singapore. Our agreement with Vivacell in Armenia expired on June 30, 2011 and was not renewed.

 
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Cost of Revenue

   
Three months Ended June 30,
   
Six months Ended June 30,
   
Cumulative
from inception to
June 30,
 
    
2011
   
2010
   
Change
   
2011
   
2010
   
Change
   
2011
 
          
($ - in thousands)
               
($ - in thousands)
         
($ - in thousands)
 
                                           
Cost of revenue
    45       34       11       70       67       (15 )     281  
 
Our cost of revenue is mainly comprised of cost of services related to the provision of content to end-users and cost of hosted servers needed to support our service in markets where we have launched our product. The increase in cost of revenue recorded during three and six month period ended June 30, 2011, compared with three and six month period ended June 30, 2010, is mainly related to costs incurred in connection with the Fan Loyalty platform integration with Rotana and Video ReMix Platform modifications for Corso. This increase was offset by a decrease in content purchases and related expenses.
 
We expect that cost of revenue will increase, as we provide more services and content to our users. As some of these costs are fixed irrespective of our revenues, we expect our gross margin to increase, as our revenues increase. We believe that we currently have enough server capacity to service up to two million global users before we need to expand our server capacity. From inception through June 30, 2011, our total cost of revenue was $281 thousand.

 
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Research and Development

   
Three months Ended June 30,
   
Six months Ended June 30,
   
Cumulative
from inception to
June 30,
 
    
2011
   
2010
   
Change
   
2011
   
2010
   
Change
   
2011
 
          
($ - in thousands)
               
($ - in thousands)
         
($ - in thousands)
 
                                           
Research and development
    460       603       (143 )     979       1,180       (201 )     12,305  
 
Three Months Ended June 30, 2011, Compared to Three Months Ended June 30, 2010
 
Research and development expenses decreased from $603 thousand to $460 thousand (-22%) during the three month period ended June 30, 2011, compared to the three month period ended June 30, 2010. The decrease was mainly due to lower salary and compensation expenses (a decrease of $50 thousand compared to the second quarter of 2010), and a decrease in development services provided by subcontractors (a decrease of $32 thousand compared to the second quarter of 2010), as part of the cost saving plan implemented by us.
 
Six Months Ended June 30, 2011, Compared to Six Months Ended June 30, 2010
 
 Research and development expenses decreased from $1,180 thousand to $979 thousand (-17%) during the six month period ended June 30, 2011, compared to the six month period ended June 30, 2010. The decrease is due to lower salary and compensation expenses (a decrease of $170 thousand compared to the first half of 2010) mainly in connection with a separation agreement signed with one of our officers, as part of the cost saving plan implemented by us.
 
From Inception Through June 30, 2011
 
From inception through June 30, 2011, research and development expenses amounted to approximately $12.3 million. Of this amount, approximately $8.3 million was attributed to salaries and related expenses, $1.8 million was attributed to sub-contracting and consulting services, $0.8 million was attributed to operating expenses, $0.6 was attributed to overhead and $0.8 million was attributed to patent expenses.

 
25

 

Marketing
 
   
Three months Ended June 30,
   
Six months Ended June 30,
   
Cumulative
from inception to
June 30,
 
    
2011
   
2010
   
Change
   
2011
   
2010
   
Change
   
2011
 
          
($ - in thousands)
               
($ - in thousands)
         
($ - in thousands)
 
                                           
Marketing
    685       632       53       1,306       1,107       199       10,605  
 
Three Months Ended June 30, 2011, Compared to Three Months Ended June 30, 2010
 
Marketing expenses increased from $632 thousand to $685 thousand (8%) during the three month period ended June 30, 2011, compared to the three month period ended June 30, 2010. The increase was mainly due to higher salary and compensation expenses partially because of higher share-based compensation expenses in 2011 and partially because of hiring of our President in the US, whose efforts are focused on marketing and business development.
 
Six Months Ended June 30, 2011, Compared to Six Months Ended June 30, 2010
 
Marketing expenses increased from $1,107 thousand to $1,306 thousand (18%) during the six month period ended June 30, 2011, compared to the six month period ended June 30, 2010. The increase is mainly due to share-based compensation expense (an increase of $139 thousand compared to the first half of 2010), an increase in salary paid in the US which included hiring, of our President in the US (an increase of $18 thousand compared to the first half of 2010) and increase in labor cost due to exchange rate differences (an increase of $48 thousand compared to the first half of 2010).
 
From Inception Through June 30, 2011
 
From inception through June 30, 2011, marketing expenses amounted to approximately $10.6 million. Of this amount, approximately $5.5 million was attributed to salaries and related expenses, $2.0 million was attributed to travel and tradeshows, $1.5 million was attributed to sub-contracting and consulting services, $0.9 million was attributed to public relations services and customer acquisition expenses and $0.7 was attributed to overhead expenses.
 
A significant portion of our marketing activity relates to the launching of services with our global partners and building a pipeline for further agreements. In addition, we conduct direct-to-consumer marketing activities in countries where we have launched our services to build on the efforts of our partners. While we do not expect to invest heavily in direct-to-consumer marketing activities in the future, we do expect an increase in marketing expenses as we continue launching our service in different global markets. In certain markets, our marketing efforts may include hiring local personnel to introduce us to the market and purchasing rights to certain local content. As our market reach grows, we expect our marketing expenses to continue to increase our visibility to potential partners.

 
26

 

General and Administrative
 
   
Three months Ended June 30,
   
Six months Ended June 30,
   
Cumulative
from inception to
June 30,
 
    
2011