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U.S. SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-K
 

 
(Mark One)
 
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2011
 
Commission file number 000-51384
 

InterMetro Communications, Inc.
(Exact Name of Registrant as Specified in its Charter)

       
Nevada
   
88-0476779
            
(State of
Incorporation)
 
(IRS Employer
Identification No.)
 
 
2685 Park Center Drive, Building A
Simi Valley, California 93065
(Address of principal executive offices) (Zip Code)
 
(805) 433-8000
(Registrant’s telephone number, including area code)
 

 
Securities registered pursuant to Section 12(b) of the Act: None
 
Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, $0.001 par value
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o  No ý
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  ¨ No  ý
 
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  ý 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý 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 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.
 
Indicate by check mark whether the registrant is a large accelerated file, an accelerated file, a non-accelerated filer, or a smaller reporting company.  See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 Large accelerated filer               Accelerated Filer              Non-accelerated filer         Smaller reporting company    x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨  No  ý
 
The aggregate market value of voting stock held by non-affiliates of the registrant, based upon the average of the bid and ask prices reported by the OTC Pink Sheets on June 30, 2011, was approximately $685,000.
 
There were 70,262,798 shares outstanding of the registrant’s Common Stock as of  March 15, 2012.
 
Documents Incorporated by Reference:  None
 
TABLE OF CONTENTS

         
 
     
 
     
Page
   
PART I
   
Item 1.
   
1
Item 1A.
   
6
Item 1B.
   
18
Item 2.
   
18
Item 3.
   
19
Item 4.
   
19
         
   
PART II
   
Item 5.
   
20
Item 6.
   
22
Item 7.
   
22
Item 7A.
   
30
Item 8.
   
31
Item 9.
   
31
Item 9A.
   
31
Item 9B.
   
32
         
   
PART III
   
Item 10.
   
33
Item 11.
   
36
Item 12.
   
38
Item 13.
   
40
Item 14.
   
41
         
   
PART IV
   
Item 15.
   
 42
     
 
44

 

Cautionary Note Regarding Forward-Looking Statements
 
This Annual Report contains financial projections and other “forward-looking statements,” as that term is used in federal securities laws, about our financial condition, results of operations and business. These statements include, among others: statements concerning the potential for revenues and expenses and other matters that are not historical facts. These statements may be made expressly in this Annual Report. You can find many of these statements by looking for words such as “believes,” “expects,” “anticipates,” “estimates,” or similar expressions used in this Annual Report. These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. The most important facts that could prevent us from achieving our stated goals include, but are not limited to, the risks discussed in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Report and the following:
 
 
(a)
volatility or decline of our stock price;
 
 
(b)
potential fluctuation in quarterly results;
 
 
(c)
our failure to earn revenues or profits;
 
 
(d)
inadequate capital and barriers to raising capital or to obtaining the financing needed to implement its business plans;
 
 
(e)
changes in demand for our products and services;
 
 
(f)
rapid and significant changes in markets;
 
 
(g)
litigation with or legal claims and allegations by outside parties;
 
 
(h)
insufficient revenues to cover operating costs;
 
 
(i)
the possibility we may be unable to manage our growth;
 
 
(j)
extensive competition;
 
 
(k)
loss of members of our senior management;
 
 
(l)
our dependence on local exchange carriers;
 
 
(m)
our need to effectively integrate businesses we acquire;
 
 
(n)
risks related to acceptance, changes in, and failure and security of, technology; and
 
 
(o)
regulatory interpretations and changes.
 
We caution you not to place undue reliance on the statements, which speak only as of the date of this Annual Report. The cautionary statements contained or referred to in this section should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on behalf of us may issue. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this Annual Report or to reflect the occurrence of unanticipated events.
 
 
 
PART I
 
Item 1. Description of Business
 
General
 
We have built a national, private, proprietary voice-over Internet Protocol, or VoIP, network infrastructure offering an alternative to traditional long distance network providers. We use our network infrastructure to deliver voice calling services to traditional long distance carriers, broadband phone companies, VoIP service providers, wireless providers, other communications companies and end users. Our VoIP network utilizes proprietary software, configurations and processes, advanced Internet Protocol, or IP, switching equipment and fiber-optic lines to deliver carrier-quality VoIP services that can be substituted transparently for traditional long distance services. Based on the ability to compress data transported across VoIP infrastructures and lower capital cost per equivalent equipment capacity, we believe that VoIP technology is generally more cost efficient than the circuit-based technologies predominately used in existing long distance networks. In addition, traditional circuit based switches typically use proprietary embedded call control systems. In contrast, we believe VoIP technology, which uses software specifically developed to facilitate the sharing of data across different systems, makes it easier to integrate with enhanced IP communications services such as web-enabled phone call dialing, unified messaging and video conferencing services.
 
We focus on providing the national transport component of voice services over our private VoIP infrastructure. This entails connecting phone calls of carriers or end users, such as wireless subscribers, residential customers and broadband phone users, in one metropolitan market to carriers or end users in a second metropolitan market by carrying them over our VoIP infrastructure. We compress the phone calls on our network allowing us to carry up to approximately eight times the number of calls carried by a traditional long distance company over an equivalent amount of bandwidth. In addition, we believe our VoIP equipment costs significantly less than traditional long distance equipment based on the cost per equivalent voice port capacity and is less expensive to operate and maintain based on lower electricity needs, smaller space requirements and fewer engineers to operate. Our proprietary software and hardware configuration enables us to quickly, without modifying the existing network, add equipment that increases our geographic coverage and calling capacity.
 
During 2006, we enhanced our network’s functionality by implementing Signaling System 7, or SS-7, technology. SS-7 allows access to customers of the local telephone companies, as well as customers of wireless carriers. SS-7 is the established industry standard for reliable call completion, and it also provides interoperability between our VoIP infrastructure and traditional telephone company networks.
 
Historically, VoIP services have been hampered by poor sound quality and by lack of interoperability with traditional circuit-based phone devices. Our private, managed network design, as opposed to use of the unmanaged public Internet, gives us a high level of control of sound quality and we have designed internal software that provides access to our infrastructure from traditional phone devices. Our network services allow our customers to reduce costs while taking advantage of access to useful information about their voice traffic and can be easily accessed with both traditional phone devices and new IP-based devices, such as broadband IP phones, IP videophones and wireless IP phones.
 
Our VoIP infrastructure delivers significant benefits to our customers, including:
 
 
·
increasing the margins earned from existing retail voice services or reducing the costs of using voice services;
 
 
·
improving customer service through access to real-time information about network performance and billing;
 
 
·
reducing the administrative burden of managing end users for our carrier customers;
 
 
·
increasing the investment return on customer owned traditional circuit-based equipment; and
 
 
·
enabling the creation of value-added enhanced voice services.
 
Our goal is to displace the current long distance carriers as the presumed choice for voice transport services. We also intend to become a significant provider of VoIP infrastructure services for traditional phone companies and wireless carriers, as well as new high growth entrants in the consumer voice services market such as broadband phone companies and cable operators. We also package our VoIP services into calling cards and prepaid services. We have developed plug-and-play technology designed to enable IP devices, such as broadband phones and videophones, to be plugged directly into end users’ broadband internet routers, allowing for instant use of our services without having to configure the device or install any software to interoperate with our network. These technologies are expected to be sold under private label third-party arrangements.  We sell our services through our direct sales force and independent sales agents. Our calling cards and prepaid services are primarily sold by our retail distribution partners. We believe that our proprietary technology and management experience in the communications industry, and in particular with VoIP, will enable us to benefit from the adoption of VoIP technologies by traditional phone companies. The wide-spread adoption of VoIP in the telecommunications industry may not materialize, however, and our business may not benefit from any adoption that does occur.
 
 
Company Background
 
InterMetro Communications, Inc. (hereinafter, “we,” “us,”  “InterMetro” or the “Company”) is a Nevada corporation which, through its wholly owned subsidiary, InterMetro Communications, Inc. (Delaware) (hereinafter, “InterMetro Delaware”), is engaged in the business of providing voice over Internet Protocol (“VoIP”) communications services. On December 29, 2006, InterMetro, a public “shell” company, completed a Business Combination with InterMetro Delaware whereby InterMetro Delaware became our wholly-owned subsidiary.  On the closing of the Business Combination, we authorized the issuance of 27,490,194 shares of common stock and 3,652,842 common stock purchase warrants to the InterMetro Delaware security holders. On May 31, 2007, the Company filed Amended and Restated Articles of Incorporation increasing the Company’s authorized shares of common stock to 150,000,000, par value $0.001 per share, at which time the second phase of 14,049,580 shares of common stock and 2,983,335 common stock purchase warrants were effectively issued in exchange for all of the remaining InterMetro Delaware common stock and warrants held by InterMetro Delaware security holders. All InterMetro Delaware securities were effectively cancelled except 100 shares of InterMetro Delaware common stock which represent 100% of the outstanding stock of the wholly-owned subsidiary.
 
InterMetro Delaware was originally incorporated in the State of California on July 22, 2003 to build a communications business based on VoIP technology and was reincorporated in Delaware on May 10, 2006.

In March 2006, we acquired all of the outstanding stock of Advanced Tel, Inc. (“ATI”), a switchless reseller of wholesale long-distance services, for a combination of stock and cash. ATI was acquired to increase our customer base, to add minutes to our network and to access new sales channels.
 
Our Service Offerings
 
We use our network backbone to deliver voice calling services to traditional long distance carriers, broadband phone companies, VoIP service providers, wireless providers, other communications companies and end users.
 
Carrier Services . Carrier services consist of origination and termination services. Such services are provided over our VoIP network constructed as a nationwide system of regional IP nodes known as points-of-presence, or PoPs, connected by a fiber-optic backbone and other bandwidth segments utilizing a secure packet technology called asynchronous transfer mode, or ATM. Our PoPs are typically located in major metropolitan cities and allow us to connect to a majority of the personal and business telephones within a metropolitan geographic region.
 
Because the network is based on IP technology, the network enables a significant amount of information to be passed to our customers. This allows us to differentiate our service from traditional wholesale voice providers by providing unique real-time information along with enhanced voice services. Important uses for this functionality include the ability to quickly identify misuse or fraud that is occurring with a customer’s user base or to react more quickly to marketing opportunities based on identifiable trends in traffic patterns.
 
We believe our services offer our carrier customers a competitive advantage by:
 
 
·
providing an alternative to the large traditional network service providers that have influenced price and service levels;
 
 
·
increasing margins transparently by reducing direct network costs while maintaining or improving the quality of service received by their end users;
 
 
·
providing access to our VoIP infrastructure without altering the physical connection process to a voice network and without any required investment in new equipment or software; and
 
 
·
providing new functionality to reduce the cost of customer care and improve fraud detection.
 
Retail Services . Our retail VoIP services are sold to consumers and distributed in the form of calling cards or through the distribution of personal identification numbers, or PINs. Our retail services integrate the installation of voice services with billing and customer care functionality and voice and data applications such as on-demand conferencing and find-me/follow-me service. We primarily distribute our services through retail distribution partners who keep a portion of the retail revenue. We have created an automated system for activating and recharging our retail products. We believe our automation significantly lowers costs for retail distribution partners. For example, our automated PIN generating system replaces the need for point of sale terminals which charge per sale transaction fees and require initial integration and software setup.
 
Our VoIP network is highly flexible and allows our retail distribution partners to design voice products that fit the needs of their underlying end users. Our VoIP network allows our retail distribution partners to take advantage of their brand name recognition and customer loyalty.
 
 
We believe our services offer end users and retail distribution partners attractive solutions by:
 
 
·
allowing for delivery of “ready-to-shelf” customized voice service products tailored specifically to our retail distribution partners’ end user demographics; and
 
 
·
providing access to our VoIP network allowing retail customers to use their existing telephones with no requirement to purchase new equipment or software and without the need for broadband access.
 
IP Devices . We expect to enter into arrangements with one or more distribution partners under which they would sell plug-and-play product devices which do not require additional software. These devices would be purchased from manufacturers and would be configured to work exclusively with our network. We have developed three IP devices the Broadband MetroFone, the VideoLine MetroFone, and the DialLine MetroFone. We do not currently generate any revenue from these products.
 
 
·
Broadband MetroFone . The Broadband MetroFone looks and operates like a traditional phone but will use a customer’s broadband internet connection and our network to complete calls as compared to traditional phone calls which travel over low bandwidth copper line networks.
 
 
·
VideoLine MetroFone . The VideoLine MetroFone operates in the same manner as the Broadband MetroFone but has the additional capability of sending and receiving real-time television quality video between any of our videophones.
 
 
·
DialLine MetroFone . The DialLine MetroFone is an IP device, which connects between a retail customer’s phone and wall jack and automatically connects a retail customer with our network.
 
Web-Services . We are in the process of developing a web-service offering. Web-services allow voice to be embedded in applications so that end users can move seamlessly between voice and data communications streams.
 
Technology and Network Infrastructure
 
Our state-of-the-art proprietary VoIP network is comprised of three basic components: switching equipment, software and network facilities. Our VoIP switching equipment is manufactured by leading telecommunications industry equipment manufacturers, and enables us to manage voice and data traffic and the associated billing information. Our software applications, including both third party software and internally developed proprietary software, allow for web-based control of our VoIP switching platform and access to data gathered by our VoIP switches. We and our customers utilize this advanced functionality to monitor network performance, capacity utilization and traffic patterns, among other metrics, in real-time. Our IP-based core network facilities provide an efficient physical transport layer for voice and data traffic, and are supplemented by other carriers’ networks to provide extensive domestic and international coverage.
 
The geographic markets serviced by our VoIP infrastructure are connected by leased fiber lines and private IP circuits. In many geographic markets we have leased collocation facilities where we have installed our ATM/MPLS switching equipment which is used to interconnect these fiber lines and IP circuits. This equipment interconnects to the fiber lines running between markets in the network and our VoIP gateway equipment. The VoIP gateway equipment performs analog-to-digital conversion and compression of IP voice. The network is designed to be redundant and self-healing, so that isolated events do not disrupt overall service. Our proprietary software and hardware configuration enables us to quickly, without modifying the existing network, add equipment that increases our geographic coverage and calling capacity.
 
Our network switching system is configured to connect to carrier customers by connecting their switches with ours via traditional circuit-switched connections, or increasingly, through private and public IP connections. We also connect to local exchange carriers through traditional circuit-switched connections so that retail customers can gain access to our services through their existing telephones and telecommunications devices.
 
We believe that our competitive advantage includes the ability to incorporate software applications into our VoIP network. This allows us to provide enhanced functionality and customer service tools. Our VoIP switching system has an application programming interface to allow for the creation of software application tools to create the enhanced control and functionality features. Our engineering team has extensive experience in implementing value-added applications that allow for greater flexibility in creating services and greater control over network efficiencies and costs. We have developed technology to provide control of the network and access to network utilization data to us and to our customers. Customers can access their own customer service web interfaces that can be used for operations, such as rate modification, customer activation and deactivation, fraud/abuse detection and capacity utilization, among other services. Customers can also utilize the interfaces to control costs by managing traffic flow to their various network vendors, allowing them to least cost route in the same way as large telecommunications companies.
 
Service Developments
 
We implemented technology to connect our network directly to local telephone companies and wireless networks in the major metropolitan markets that we serve through the addition of SS-7 capabilities to our VoIP infrastructure. SS-7 technology allows direct access to customers of local telephone companies. Prior to the SS-7 implementation, we primarily connected to competitive local exchange carriers, or CLECs, in each metropolitan market which in turn connected to the local telephone company in that market.
 
The combination of SS-7 technology and direct local telephone company interconnections allows us to offer additional services to our customers and we believe makes it easier for potential customers that use long distance companies to transition their voice traffic to our VoIP network. The SS-7 technology also allows us to offer an increased number of services and enhances our ability to develop new services. We began connecting to the local telephone company networks through the purchase of a significant amount of recurring fixed-cost network interconnection capacity in late 2005 in anticipation of future growth. In March 2006, we began utilizing the SS-7 connections to provide services.
 
 
 
Sales, Marketing and Distribution
 
Carrier Services Sales Strategy . We employ a direct sales approach for carrier sales, which is led by experienced sales professionals with detailed knowledge of the carrier industry. We provide product knowledge, product application consulting, pricing, delivery, and performance information to potential customers so that they are able to help us design services that meet their needs. As we expect to expand the resources of our sales department, sales professionals will be increasingly focused on customer, channel, and geographic levels that are intended to allow us to manage the sales cycle more efficiently. We currently target traditional purchasers of wholesale voice transport services including: inter-exchange carriers, international-based carriers sending voice calls to the U.S., wireless carriers, prepaid service providers, internet-based voice service providers, such as broadband phone companies and cable companies.
 
We complement our direct sales force with an agent-based sales channel. Through the use of sales agents we reach a larger universe of potential customers. The agent community in the telecommunication industry is large and well-established. A typical agent promotes solutions from a variety of service providers into the carrier buying community. Agents act as telecommunications consultants to the customer, create long-term relationships and develop contacts within organizations. A key role of the agent is to advise the customer of various providers’ offerings.
 
Retail Services Sales Strategy . We package our VoIP services into calling card and other prepaid services and PIN products sold to retail customers of voice services. These VoIP services are sold through retail distribution partners, including general merchandise and discount retail chains, and do not require distributors to invest in any new technology or to understand the underlying technologies required to service and bill voice products. We enter into agreements with our retail distribution partners that define the terms under which they sell our services.
 
We design specific products for each retail distribution partner to improve adoption of our services and to improve their profitability. Retail distributors of our VoIP services collect the revenue from the sale of our products and pass on a majority of the cash collected, holding back a portion of the revenue as their compensation for providing distribution services. We seek innovative ways to expand the scope of our distribution channels and enhance our ability to identify and retain distribution partners. In addition, we also intend to cross-sell services through existing retail distribution partners.
 
Marketing Overview . We create brand awareness and lead generation through our presence at key trade shows, targeted mailings to specific industry carrier lists and buyers and trade magazine advertising. Additionally, we maintain a web site presence and make available collateral describing our services and business.
 
Competition
 
Carrier Services. When selling to carrier customers, we primarily compete with other carriers, including Verizon, Qwest and Global Crossing. We also compete with a number of smaller IP-based providers that focus either on a specific product or set of products or within a geographic region. We compete primarily on the basis of transmission quality, network reliability, price and customer service and support.
 
Retail Services. We compete for retail distribution partners against long distance providers including AT&T, MCI, Sprint and IDT who provide calling cards and prepaid services. Retail distributors purchase these products based on price and private label customization.
 
Our Competitive Strengths
 
We believe our highly flexible, scalable and secure VoIP infrastructure delivers the cost and functionality benefits of VoIP technology to our customers. Since inception, we have built our network on VoIP technology and do not have to make investments to upgrade from less efficient circuit-based technology used by many traditional carriers. We believe our VoIP network is robust and efficient, based on redundancies in equipment and network transmission paths, and utilizes some of the most advanced VoIP technology available.
 
We help our carrier customers increase their margins by lowering the cost of their wholesale voice transport usage, which enhances the economic value to them of their existing end users. We help our retail customers access lower cost VoIP-based solutions for their communications service needs by making our services accessible through their existing residential and wireless phones. We intend to continue investing in our VoIP infrastructure to improve and expand our existing service offerings and to address the constantly evolving needs of voice transport customers.
 
 
 
Our competitive strengths include:
 
 
·
State-of-the-art private VoIP infrastructure . We built our VoIP infrastructure from advanced IP technology. We are not burdened by some of the constraints commonly faced by traditional telecommunications companies that use circuit-based equipment. Legacy equipment is more difficult to combine with the latest add-on voice services and network transport technology because it typically uses proprietary embedded call control systems. We operate and maintain our VoIP technology with significantly less personnel and lower operating costs than switch-based technology achieving comparable capacity.
 
 
·
Cost-efficient IP-based voice services . We believe our VoIP technology provides significant cost savings due to compression and routing efficiencies. In addition, we save money by using equipment that requires little space and significantly reduced electricity costs versus older circuit-switched equipment. Our management team has extensive experience in negotiating pricing and contract terms for these types of products and services. We pass a significant portion of our cost savings on to our customers to help drive sales growth.
 
 
·
Experience marketing VoIP services . Our seasoned management team has significant experience with wireline and wireless telecommunications and experience with IP-based communications. Our knowledge of the VoIP industry, including familiarity with the hardware, software and vendors, allows us to advise potential customers on how to incorporate the technology to increase profitability and increase customer reach. Members of our management team have marketed VoIP services to a wide range of customers and have been instrumental in developing new products to meet individual customer demands.
 
 
·
Product flexibility and speed of deployment . We believe our private network equipment provides a high level of integration between the installation of voice services and billing and customer care functions. We believe our VoIP technology software, specifically developed to facilitate the sharing of data across different systems, allows us to create and deploy new products more quickly than traditional communications companies. We also utilize our VoIP infrastructure to tailor retail products to the individual needs of our retail distribution partners.
 
 
·
Strong engineering team with experience in both voice and data networking . Our engineering team is comprised of individuals with backgrounds in networking, software development, database administration and telecommunications installations. We believe that our engineering team is among the most experienced in understanding VoIP services and the related software applications. Members of our engineering team have successfully deployed leading-edge technology in prior businesses, including the build-outs of both a national web hosting service and a large IP-based voice service network.
 
Intellectual Property
 
Our intellectual property is an important element of our business, but we believe that our competitive advantage depends primarily on the experience of our management team and the knowledge and skill of our engineering and technology staff. Our management team and technical staff periodically review our technological developments to identify core technology that provides us with a competitive advantage. We rely on a combination of patent, copyright, trademark and trade secret laws both domestically and internationally and confidentiality procedures to protect our intellectual property rights. Further, our employees and independent contractors are required to sign agreements acknowledging that all inventions, trade secrets, copyrights, works of authorship, developments and other processes generated by them on our behalf are our property, and assigning to us any ownership that they may claim in those matters. Our standard form agreements for carrier customers and retail distribution partners also contain provisions designed to protect our intellectual property rights.
 
We are the owners of one patent and two patent applications filed with the U.S. Patent and Trademark Office. Our patent relates to a system for routing toll free telephone calls. Both of our patent applications have been published. One patent application relates to the technology which combines instant messenger services with voice services. The other application relates to a method for transporting voice calls utilizing a combination of Internet Protocol and Asynchronous Transfer Mode. We are working with legal counsel to make all necessary filings to advance the examination of both patent applications.  In January 2011 we filed a provisional patent with the U.S. Patent and Trademark Office relating to a proprietary system for lowest cost routing of voice calls over our network.
 
We are the owner of numerous trademarks and service marks for telecommunication services, phone cards, computer software, computer hardware, and telephone sets and have applied for registration of our trademarks and service marks to establish and protect our brand names as part of our intellectual property strategy.
 
In addition, we have non-exclusive license agreements with respect to technology and related databases from third parties related to the operations of our VoIP platform and the provision of certain service features. We believe our licenses will be renewable or replaceable on commercially reasonable terms.
 
Governmental Regulation
 
We are subject to federal, state, local and foreign laws, regulations, and orders affecting the rates, terms, and conditions of certain service and product offerings, costs, and other aspects of operations, including relations with other service providers. Regulation varies in each jurisdiction and may change in response to judicial proceedings, legislative and administrative proposals, government policies, competition, and technological developments.
 
 
 
The Federal Communications Commission, or FCC, has jurisdiction over our facilities and services to the extent they are used in the provision of interstate or international communications services. State regulatory commissions, commonly referred to as public service commissions or public utilities commissions, or PSCs or PUCs, generally have jurisdiction over facilities and services to the extent they are used in the provision of intrastate services. Local governments may assert authority to regulate aspects of our business through zoning requirements, permit or right-of-way procedures, taxation and franchise requirements. Foreign laws and regulations apply to communications that originate or terminate in a foreign country. Generally, the FCC and PSCs have not regulated Internet, video conferencing, or certain data services, although the underlying communications components of such offerings may be regulated. Our operations also are subject to various environmental, building, safety, health, and other governmental laws and regulations.
 
Federal law generally preempts any inconsistent state or local statutes and regulations that restrict the provision of competitive local, long distance and information services. Consequently, we are generally free to provide a broad range of communications services in every state. While this federal preemption greatly increases our potential for growth, it also increases the amount of competition to which we may be subject. It is also possible, despite the general federal preemption, that state or local regulatory agencies will assert jurisdiction over our services.
 
IP-based enhanced voice services are currently exempt from the reporting and pricing restrictions placed on common carriers by the FCC.  Due to the growing acceptance and deployment of VoIP services, the FCC and a number of state PSCs are conducting regulatory proceedings that could affect the regulatory duties and rights of entities that provide IP-based voice applications. There is regulatory uncertainty as to the imposition of traditional retail, common carrier regulation on VoIP products and services but VoIP providers do have to comply with some traditional common carrier regulatory requirements including compliance with 911/E911 requirements, contributions to the federal Universal Service Fund, compliance with Local Number Portability and customer privacy/marketing restrictions and Communications Assistance for Law Enforcement obligations.
 
The use of the public Internet and private Internet protocol networks to provide voice communications services, including VoIP, is a relatively recent market development. The provision of such services is largely unregulated within the U.S. There are, however, several pending FCC proceedings that will likely affect the regulatory status of Internet telephony and other IP-enabled services. Despite the fact that the FCC also has conducted several pending declaratory rulings regarding the regulatory classification of certain IP-enabled services or arrangements it has not reached a conclusion as to their regulatory classification. We cannot predict when the FCC may take action in other proceedings, or what action the FCC will take. Any of these proceedings could have an adverse impact on our business.
 
We cannot predict the outcome of any current regulatory proceedings or any similar petitions and regulatory proceedings pending before the FCC or state public utility commissions. Moreover, we cannot predict how their outcomes may affect our operations or whether the FCC or state public utility commissions will impose additional requirements, regulations or charges upon our provision of IP communications services.
 
The Communications Act of 1934 requires that every telecommunications carrier contribute, on an equitable and non-discriminatory basis, to federal universal service mechanisms established by the FCC, and the FCC also requires providers of non-common carrier telecommunications to contribute to universal service, subject to some exclusions and limitations. At present, these contributions are calculated based on contributors’ interstate and international revenue derived from U.S. end users for telecommunications or telecommunications services, as those terms are defined under FCC regulations. Changes or uncertainties in the regulations applicable to our business and the communications industry may negatively affect our business. If regulatory approvals become a requirement, delays in receiving required regulatory approvals may result in higher costs and lower revenues. Further, changes in communications, trade, monetary, fiscal and tax policies in the U.S. may negatively impact our results of operations.
 
Employees
 
As of December 31, 2011, we had 23 employees, all of whom were full time and located in the United States. We have never had a work stoppage and none of our employees is represented by a labor organization or under any collective bargaining arrangements. We consider our employee relations to be good.
 
Item 1A. Risk Factors
 
Our business is subject to a variety of risks and uncertainties including the material risks described below. If any of these risks materialize, our business, financial condition or operating results could be adversely affected. The risks described below are not the only ones we face. Additional risks not currently known to us or that we currently do not deem material also may become important factors that may materially and adversely affect our business.
 
Risks Related To Our Business
 
We have a working capital deficit and had losses in the past, which raise doubt about our ability to continue as a going concern.
 
We have a working capital deficit of $12.7 million as of December 31, 2011.  Though we were profitable in the year ended December 2011, we had net losses in previous years and we will have to generate and sustain significant gross margin to maintain profitability. Our increasing gross margin growth trends in prior periods may not be sustainable, and we may not achieve sufficient revenue to maintain profitability. We may incur significant losses in the future for a number of reasons, including those discussed in other risk factors and due to factors that we cannot foresee.  We have past due balances with certain vendors that may result in collection actions unless we settle them.  We may not generate sufficient funds to bring these accounts current.
 
 

The Independent Auditor’s Report covering the Company’s audited financial statements for the year ended December 31, 2011 contains an explanatory paragraph expressing substantial doubt about the Company’s ability to continue as a going concern.  As indicated in Note 1 to such financial statements, our ability to continue as a going concern will require additional financings if our ability to generate cash from operations does not fund required payments on our debt obligations.  Additionally, the Company has other significant matters such as vendor disputes and lawsuits that could have material adverse consequences to the Company, including possible cessation of operations.  While the Company is actively taking steps to address these issues (see Note 1), there can be no assurance that the Company will be successful in this regard.
 
   If the Company were to require additional financings in order to fund ongoing operations until such time as the Company continues to consistently achieve positive cash flow from operations, there can be no assurance that we will be successful in completing the required financings or that we will continue operations.

We did not make scheduled interest payments on certain secured notes in 2011.
 
The Company has entered into two bridge loan agreements with individual investors, including related parties.  The first (the “2008 Bridge Loan”) involved the sale of secured notes in the aggregate amount of $1,920,000.  The second (the “2009 Bridge Loan”) involved the advance by existing note holders of an additional $462,500. See Note 7 for a description of the terms of 2008 and 2009 Bridge Loans.  The 2008 and 2009 Bridge Loans are collateralized by substantially all of the assets of the Company.  Both the 2008 Bridge Loan and the 2009 Bridge Loan provide for payments of principal and interest to be made during 2011 and subsequent years.  The Company did not make certain scheduled payments during 2011, as described in Note 7.  The Company has not received a notice of cure or default from any of the note holders in response to the non-payments.  There can be no assurance, however, that one or more note holders will not notify the Company asserting a default under these loan agreements and pursue repayment in accordance with the governing loan documents.  Any such action could be expected to have a material adverse effect on the Company and its financial condition and results of operations.
 
We have a relatively limited operating history, which could make it difficult to accurately evaluate our business and prospects.
 
We began offering VoIP services in March 2004. Accordingly, we have a relatively limited operating history and, as a result, we have limited historical financial data that you can use to evaluate our business and prospects. In addition, we derive nearly all of our revenue from VoIP services, which utilize a relatively new technology that has undergone rapid changes in its short history. Our business model is also evolving and it may not be successful. As a result of these factors, the future revenue and income potential of our business is uncertain. Although we have experienced revenue growth in the past, we have not been able to sustain this growth. Any evaluation of our business and our prospects must be considered in light of these factors and the risks and uncertainties often encountered by companies in our stage of development. Some of these risks and uncertainties relate to our ability to do the following:
 
 
·
maintain and expand our current relationships, and develop new relationships, with carrier customers, retail distribution partners, network vendors and equipment providers;
 
 
·
continue to grow our revenue and meet anticipated growth targets;
 
 
·
manage our expanding operations and implement and improve our operational, financial and management controls;
 
 
·
adapt to industry consolidation;
 
 
·
continue to grow our sales force and marketing efforts;
 
 
·
successfully introduce new, and upgrade our existing, VoIP technologies and services;
 
 
·
respond to government regulations and legislation relating to VoIP, traditional telecommunications services, the Internet, IP-based services and other aspects of our business;
 
 
·
respond effectively to competition; and
 
 
·
attract and retain qualified management and employees.
 
If we are unable to address these risks, our business, results of operations and prospects could suffer.
 
 
 
Our operating results may fluctuate in the future, which could make our results of operations difficult to predict or cause them to fall short of expectations.
 
Our future operating results may vary significantly from quarter to quarter due to a variety of factors, many of which are beyond our control and could cause our results to be below investors’ expectations, causing the value of our securities to fall. Because our business is evolving, our historical operating results may not be useful in predicting our future operating results. Factors that may increase the volatility of our operating results include the following:
 
 
·
the addition of new carrier customers and retail distribution partners or the loss of existing customers and retail distribution partners;
 
 
·
changes in demand and pricing for our VoIP services;
 
 
·
the timing of our introduction of new VoIP products and services and the costs we incur to develop these technologies;
 
 
·
the timing and amount of sales and marketing expenses incurred to attract new carrier customers and retail distribution partners;
 
 
·
changes in the economic prospects of carrier customers or the economy generally, which could alter current or prospective need for voice services, or could increase the time it takes us to close sales with customers;
 
 
·
changes in our pricing policies, the pricing policies of our competitors or the pricing of VoIP services or traditional voice services generally;
 
 
·
costs related to acquisitions of businesses or technologies; and
 
 
·
the use of VoIP as a replacement for traditional voice services is a relatively new occurrence and carrier customers have not settled into consistent spending patterns.
 
A substantial portion of our revenue is generated from a limited number of carrier customers, and if we lose a major customer our revenue and profits could decrease.
 
A substantial portion of our revenue is generated from a limited number of our carrier customers. Our top 10 customers have accounted for approximately 72.2% and 77.0% of our revenues for the years ended December 31, 2011 and 2010, respectively. Further, three such customers accounted for 48.2% of revenue for the year ended December 31, 2011. We expect that a limited number of carrier customers may continue to account for a significant percentage of our revenue and the loss of, or material reduction of, their purchases could materially decrease our revenue and profits and harm our business.
 
We have entered into a number of settlement and payment plans with vendors and our obligations under these plans may adversely affect our liquidity.
 
As a function of the losses the Company experienced in years prior to 2010, the Company delayed payments due to certain of its vendors.  During 2011, we entered into a number of payment plan agreements with vendors, and we will continue to approach vendors to enter into similar agreements.   Although these agreements allowed the Company to record a gain on forgiveness of debt for 2011 and 2010 (see Note 6 to the Consolidated Financial Statements), our repayment obligations under the agreements entered into to date totals an aggregate of approximately $81,000 per month as of December 31, 2011. These obligations can be expected to have an adverse effect on our liquidity in the short to mid-term.
 
 
 
Our industry is highly competitive and competitive pressures could prevent us from competing successfully in the voice transport services industry.
 
The carrier and retail markets for voice transport services are intensely competitive. We expect this competition to continue to increase because there are currently no significant barriers to entry into our market. We compete both for wholesale carrier business and for retail consumption of voice transport services. We compete for wholesale carrier business on the basis of a number of factors, including price, quality, geographic reach and customer service. Our competitors often are large, well-established in the communications industry and enjoy several competitive advantages over us, including:
 
 
·
greater financial and personnel resources;
 
 
·
greater name recognition;
 
 
·
established relationships with greater numbers of wholesale carriers;
 
 
·
established distribution networks;
 
 
·
greater experience in obtaining and maintaining FCC and other regulatory approvals for products and product enhancements and greater experience in developing compliance programs under U.S. federal, state and local laws and regulations;
 
 
·
greater experience in lobbying the U.S. Congress and state legislatures for the enactment of legislation favorable to their interests;
 
 
·
greater experience in product research and development;
 
 
·
greater experience in launching, marketing, distributing and selling products; and
 
 
·
broader-based and deeper product lines.
 
Our primary current and potential competitors consist of carriers including AT&T, Sprint, Verizon, Qwest, Level (3) and Global Crossing, other start-up VoIP providers that have been formed in the recent past and IP networking companies that are attempting to add voice as a supplement to their current data services offerings.
 
We also compete with companies focused on the distribution of retail voice services and expect to compete with companies providing VoIP services and broadband IP phones and videophones.
 
If we lose any member of our senior management team and are unable to find a suitable replacement, we may not have the depth of senior management resources required to efficiently manage our business and execute our growth strategy.
 
We depend on the continued contributions of our senior management and skilled employees. We do not maintain key person life insurance policies on any of our officers. There is a risk that the loss of a significant number of key personnel could have negative effects on our results of operations. We may not be able to attract and hire highly skilled personnel to replace lost employees necessary to carry out our business plan. There is also a risk that management may not be able to adopt or maintain an organizational structure that meets its objectives, including managing costs and attracting and retaining key employees.
 
We also need to hire additional members of senior management to adequately manage our growing business. We may not be able to identify and attract additional qualified senior management. Competition for senior management in our industry is intense. Qualified individuals are in high demand, and we may incur significant costs to attract them. If we are unable to attract and retain qualified senior management we may not be able to implement our business strategy effectively and our revenue may decline. Our success is substantially dependent on the performance of our executive officers and key employees. Given our early stage of development, we are dependent on our ability to retain and motivate high quality personnel. An inability to engage qualified personnel could materially adversely affect our ability to market our VoIP services. The loss of one or more of our key employees or our inability to hire and retain other qualified employees could have a material adverse effect on our business. See “Management”.
 
 
 
We are dependent on a limited number of suppliers and on other capacity providers.
 
We currently depend on critical services and equipment from a small number of suppliers. There is no guarantee that these suppliers will continue to offer us the services and equipment we require. If we cannot obtain adequate replacement equipment or services from our suppliers or acceptable alternate vendors, we could experience a material impact on our financial condition and operating results. In addition, we rely on other providers for network capacity beyond what we provide over our own network and there is a risk that current capacity providers may cease to provide capacity at economically justifiable rates.
 
We are dependent on providers of local telecommunications services to reach the end users for our services.
 
We currently depend on providers of local telecommunications services to provide end users with access to substantially all of our VoIP services. In the future, we may utilize other local telecommunications services suppliers to reach end users such as wireless carriers, cable companies, power companies and other providers of local broadband services. There is no guarantee that these suppliers will continue to offer the services we require, that these services will be available on economic terms sufficient to execute on our business model or that these suppliers will continue to do business with us. If we cannot obtain adequate replacement services from our suppliers or acceptable alternate vendors, we could experience a material impact on our financial condition and operating results.
 
We are from time to time subject to disputes with customers, vendors and other third parties relating to amounts claimed due for services which we may not be able to resolve in our favor.
 
It is not unusual in our industry to occasionally have disagreements with vendors and other third parties relating to amounts claimed due in connection with the services provided by us or companies like us.  To the extent we are unable to favorably resolve these disputes, our revenues, profitability or cash may be adversely affected.  We currently have a dispute reserve of approximately $61,000 which is management’s estimate of the Company’s potential exposure.  The majority of this dispute reserve relates to the difference in pricing that we expect to pay when calls originate and terminate in different U.S. states or international jurisdictions versus the characterizations of these calls as being originated and terminated within the same U.S. state.
 
We are negotiating with certain federal agencies regarding payment of amounts owing, and failure to finalize, or meet the terms of, the related payment plans could have a material adverse effect on the Company.
 
In 2009 and 2010 the Company did not make all of the payments claimed by the Universal Service Administrative Company (“USAC”) which administers the Universal Service Fund.  See Item 3 (Legal Proceedings) below for a description of this matter.  These unpaid amounts were transferred to the Federal Communications Commission (“FCC”) for collection, and the FCC has transferred some of these amounts to the Department of the Treasury, which has worked with the Company to establish long term payment plans.  The Company is continuing to work with the FCC and the Department of the Treasury to resolve these amounts in long term payment programs.  The failure for any reason to finalize a payment plan, or the failure to satisfy the terms of any such plan once established, could be expected to have a material adverse effect on the Company and its financial condition and results of operations
 
We may pursue the acquisition of other businesses in order to grow our customer base and access technology and talent, and any such acquisition may not achieve the desired results or could result in operating difficulties, dilution and other harmful consequences.
 
We expect to pursue acquisitions in the future as a key component of our business strategy. We do not know if we will be able to successfully complete any future acquisitions. Furthermore, we do not know that we will be able to successfully integrate any other acquired business, product or technology or retain any key employees of any acquired business. Integrating any business, product or technology we acquire could be expensive and time-consuming, disrupt our ongoing business and distract our management. If we are unable to integrate any acquired businesses, products or technologies effectively, our results of operations and financial condition will suffer. There may not be attractive acquisition opportunities available to us in the future. In addition, acquisitions involve numerous risks, any of which could harm our business, including:
 
 
·
diversion of management’s attention and resources from other business concerns;
 
 
·
difficulties and expenditures associated with integrating the operations and employees from the acquired company into our organization, and integrating each company’s accounting, management information, human resources and other administrative systems to permit effective management;
 
 
·
inability to maintain the key business relationships and the reputations of the acquired businesses;
 
 
·
ineffectiveness or incompatibility of acquired technologies or services with our existing technologies and systems;
 
 
·
potential loss of key employees of acquired businesses;
 
 
·
responsibility for liabilities of acquired businesses;
 
 
·
unavailability of favorable financing for future acquisitions;
 
 
·
inability to maintain our standards, controls, procedures and policies, which could affect our ability to receive an unqualified attestation from our independent accountants regarding management’s required assessment of the effectiveness of our internal control structure and procedures for financial reporting; and
 
 
·
increased fixed costs.
 
 
 
The acquisition of another business, particularly in another country, can subject us to liabilities and claims arising out of such business, including tax liabilities and liabilities arising under foreign regulations. Future acquisitions would also likely require additional financing, resulting in an increase in our indebtedness or the issuance of additional capital stock which could be dilutive to holders of shares issued in this offering. Finally, any amortization or charges resulting from the costs of acquisitions could harm our operating results.
 
If we fail to manage our growth effectively, our business could be adversely affected.
 
We have experienced rapid growth in our operations and to a lesser extent, our headcount, and we may experience continued growth in our business, both through acquisitions and internal growth. This growth will continue to place significant demands on our management and our operational and financial resources. In particular, continued growth will make it more difficult for us to accomplish the following:
 
 
·
recruit, train and retain a sufficient number of highly skilled personnel;
 
 
·
maintain our customer service standards;
 
 
·
maintain the quality of our VoIP platform;
 
 
·
develop and improve our operational, financial and management controls and maintain adequate reporting systems and procedures;
 
 
·
successfully scale our VoIP platform, including network, software and other technology, to accommodate a larger business; and
 
 
·
maintain carrier and end user satisfaction.
 
The improvements required to manage our growth will require us to make significant expenditures and allocate valuable management resources.
 
Sales of our IP devices may be severely limited due to their failure to gain broad market acceptance.
 
In the future, we intend to sell IP devices and related services. Market acceptance requires, among other things, that we
 
 
·
educate consumers on the benefits of our products;
 
 
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commit a substantial amount of human and financial resources to secure strategic partnerships and otherwise support the retail and/or carrier distribution of our products;
 
 
·
develop our own sales, marketing and support activities to consumers, broadband providers and retailers; and
 
 
·
establish a sufficient number of retail locations carrying our products.
 
In the event we are unable to achieve any or all of these objectives, consumers may perceive little or no benefit from our products and may be unwilling to pay for them.
 
 
 
Rapid technological changes in the industry in which we operate our business or the market in which we intend to sell our IP devices may render such devices obsolete or otherwise harm us competitively.
 
We operate in a highly technological industry segment that is subject to rapid and frequent changes in technology and market demand. Frequently such changes can immediately and unexpectedly render existing technologies obsolete. Management expects that technology developed in the future will be superior to the technology that we (and others) now have. Our success depends on our ability to assimilate new technologies into our VoIP infrastructure and our IP devices and to properly train engineers, sales staff, distributors and resellers in the use of our technology. The success of our future service offerings or devices depends on several factors, including but not limited to proper new product definition, product cost, timely completion and market introduction of such services, differentiation of our future products from those of our competitors and market acceptance of these products. Competing technologies developed by others may render our current or future developed products or technologies obsolete or noncompetitive. The failure of our new product development efforts could have a detrimental effect on our business and results of operations.
 
If we discover IP device defects, we may have product-related liabilities that may cause us to lose revenues or delay market acceptance of our IP devices.
 
Devices as complex as those we intend to offer frequently contain errors, defects, and functional limitations when first introduced or as new versions are released. We have in the past experienced such errors, defects or functional limitations.
 
We intend to sell devices into markets that are demanding of robust, reliable and fully functional products. Therefore, delivery of devices with production defects or reliability, quality, or compatibility problems could significantly delay or hinder market acceptance, which could damage our credibility with our customers and adversely affect our ability to attract new customers. Moreover, such errors, defects, or functional limitations could cause problems, interruptions, delays, or a cessation of sales to our customers. Alleviating such problems may require significant expenditures of capital and resources by us. Despite our testing, our suppliers or our customers may find errors, defects or functional limitations in new products after commencement of commercial production, which could result in additional development costs, loss of, or delays in, market acceptance, diversion of technical and other resources from our other development efforts, product repair or replacement costs, claims by our customers or others against us, or the loss of credibility with prospective customers.
 
Uncertainty or negative publicity may negatively affect the VoIP industry generally and our business.
 
There is a possibility that uncertainty regarding broad market acceptance of VoIP technology or adverse publicity or negative perceptions about the VoIP industry as a whole could hinder our ability to obtain new customers or undermine our commercial relationship with existing customers. Further, the adoption of VoIP in the telecommunications industry may not materialize and, even if there is such adoption, our business may not benefit from it.
 
Our ability to protect our intellectual property is uncertain.
 
We rely on patent protection, trade secrets, know-how and contractual means to protect our proprietary technology.  Patents may afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. For example, our pending U.S. patent applications may not issue as patents in a form that will be advantageous to us, or may issue and be subsequently successfully challenged by others and invalidated. In addition, our pending patent applications include claims to material aspects of our products and methods that are not currently protected by issued patents. Furthermore, competitors may be able to design around the claims of our patents, or develop products or methods outside the scope of our issued claims which provide outcomes which are comparable to ours. We also rely on know-how and trade secrets to maintain our competitive position. Confidentiality agreements or other agreements with our employees, consultants and advisors may not be enforceable or may not provide meaningful protection for our proprietary technology, know-how, trade secrets, or other proprietary information in the event of misappropriation, unauthorized use or disclosure or other breaches of the agreements, or, even if such agreements are legally enforceable, we may not have adequate remedies for breaches of such agreements. The failure of our patents or agreements to protect our proprietary technology could result in significantly lower revenues, reduced profit margins or loss of market share.
 
The market for our products depends to a significant extent upon the goodwill associated with our trademarks and service marks. We own, or have licenses to use, the material trademarks, service marks and trade names used in connection with the packaging, marketing and distribution of our products in the markets where those products are sold. Therefore, trademark protection is important to our business. Although most of our trademarks and service marks are registered in the U.S., we may not be successful in asserting trademark protection. In addition, the laws of certain foreign countries may not protect our trademarks or service marks to the same extent as the laws of the U.S. The loss or infringement of our trademarks or service marks could impair the goodwill associated with our brands, harm our reputation and have a material adverse effect on our financial results.
 
Network failures or delays may result in the loss of our customers or expose us to potential liability.
 
Our VoIP network infrastructure uses a collection of communications equipment, software, operating protocols and applications for the transport of voice among multiple locations. Given the complexity of the network, it is possible that there could be severe disruptions in our ability to timely turn up service requests, minimize service interruptions and meet requirements of customer service level agreements. We have critical systems in our Los Angeles, California and New York, New York collocation facilities. Our California facilities are located in areas with a high risk of major earthquakes. Our facilities and network are also subject to break-ins, sabotage, intentional acts of vandalism and terrorism and to potential disruptions if the operators of these facilities encounter financial difficulties. Some of our systems may not be fully redundant, and our disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, an operator’s decision to close a facility we are using without adequate notice for financial reasons or other unanticipated problems at our facilities could result in lengthy interruptions in our service. Network failures or delays in the turn up of services could cause business interruptions resulting in possible losses to our customers. Such failures or delays may expose us to claims by our customers and may result in the loss of customers.
 
 
 
VoIP networks are vulnerable to unauthorized access or use by outside parties.
 
While we built a private secure fiber optic infrastructure to minimize security risks from third party unauthorized sources, no network is invulnerable to hackers. A small percentage of voice traffic transported across our network may at times utilize the public internet. However, providing entry or exit points to our customers via the internet could enable computer hackers to access our network, and could lead to the impairment, failure or theft of our services. Further, it could also lead to the unauthorized interception and monitoring of end user voice calls. Unauthorized access or use may have an adverse impact on our services and reputation.
 
Our products or activities may infringe, or may be alleged to infringe, upon intellectual property rights of others.
 
We may encounter future litigation by third parties based on claims that our products or activities infringe the intellectual property rights of others, or that we have misappropriated the trade secrets of others. If any litigation or claims are resolved against us, we may be required to do one or more of the following:
 
 
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cease selling, incorporating or using any of our products that incorporates the infringed intellectual property, which would adversely affect our revenue or costs or both;
 
 
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obtain a license from the holder of the infringed intellectual property right, which might be costly or might not be available on reasonable terms, if at all; or
 
 
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redesign our products to make them non-infringing, which could be costly and time-consuming and may not be possible at all.
 
Because patent applications can take many months to be published, there may be pending applications, unknown to us, that may later result in issued patents that our products or product candidates or processes may infringe. These patent applications may have priority over patent applications filed by us. Disputes may arise regarding the ownership or inventorship of our intellectual property. There also could be existing patents of which we are unaware that our products may be infringing. As the number of participants in the market grows, the possibility of patent infringement claims against us increases. It is difficult, if not impossible, to determine how such disputes would be resolved.
 
Furthermore, because of the substantial amount of discovery required in connection with patent litigation, there is a risk that some of our confidential information could be required to be publicly disclosed. In addition, during the course of patent litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments in the litigation. Any litigation claims against us may cause us to incur substantial costs and could place a significant strain on our financial resources, divert the attention of management or restrict our core business.
 
We may be subject to damages resulting from claims that we, or our employees, have wrongfully used or disclosed alleged trade secrets of former employers.
 
Some of our employees were previously employed at other communications companies, including our competitors or potential competitors. Although no such claims against us are currently pending, we may be subject to claims that we or these employees have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to commercialize product candidates, which could severely harm our business.
 
We are exposed to various possible claims relating to our business and our insurance may not fully protect us.
 
We may incur uninsured liabilities and losses as a result of the conduct of our business. For example, network failures or security breaches could subject us to claims by our customers, and physical damage to the leased facilities in which we maintain our equipment could result in damage or loss to our equipment. We plan to maintain comprehensive liability and property insurance which may not replace the full value of our potential liabilities or losses or cover such claims. We will also evaluate the availability and cost of business interruption insurance. However, should uninsured losses occur, shareholders could lose their invested capital.
 
The costs incurred by us to develop, implement, and enhance our VoIP services may be higher than anticipated, which could hurt our ability to earn a profit.
 
We may incur substantial cost overruns in the development and establishment of our VoIP services. For example, delays in the SS-7 enhancement to our VoIP infrastructure will cause us to incur monthly costs related to equipment and network components we are not able to fully utilize. Unanticipated costs may force us to obtain additional capital or financing from other sources, or may cause the loss of your entire investment in our common stock if we are unable to obtain the additional funds necessary to implement our business plan.
 
 
We may need to raise additional funds in the future and such funds may not be available on acceptable terms or at all.
 
We may need to raise additional funds in the future for any number of reasons, including:
 
 
·
the loss of revenues generated by sales of our services and products;
 
 
·
the upfront and ongoing costs associated with expanding and enhancing our VoIP infrastructure;
 
 
·
the costs associated with expanding our sales and marketing efforts;
 
 
·
the expenses we incur in manufacturing and selling our services and products;
 
 
·
the costs of developing new products or technologies;
 
 
·
the cost of obtaining and maintaining regulatory approval or clearance of our products and products in development; and
 
 
·
the number and timing of acquisitions and other strategic transactions.
 
If we issue equity or debt securities to raise additional funds, our existing shareholders may experience dilution and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing shareholders. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms or at all, we may not be able to develop or enhance our products, execute our business plan, take advantage of future opportunities or respond to competitive pressures or unanticipated customer requirements. In these events, our ability to achieve our development and commercialization goals would be adversely affected.
 
Additional Risks Related to Regulation
 
Our industry is subject to regulation that could adversely impact our business.
 
Traditional telephone service has been subject to significant federal and state regulation. Internet services generally have been subject to far less regulation. Because aspects of VoIP are similar to the traditional telephone services provided by incumbent local exchange carriers and other aspects are similar to the services provided by Internet service providers, the VoIP industry has not fit easily within the existing regulatory framework of communications law, and until recently has developed in an environment largely free from regulation.
 
The Federal Communications Commission, or FCC, the U.S. Congress and various regulatory bodies in the states and in foreign countries have begun to assert regulatory authority over VoIP providers, and are evaluating how VoIP may be regulated in the future. In addition, while some of the existing regulation concerning VoIP is applicable to the entire industry, many regulatory proceedings are focused on specific companies or categories of VoIP services. As a result, both the application of existing rules to us and our competitors and the effects of future regulatory developments are uncertain.
 
Communications services are generally subject to regulation at the federal, state, local and international levels. These regulations affect us, our customers, and our existing and potential competitors. Delays in receiving required regulatory approvals, completing interconnection agreements or other agreements with local exchange carriers or the adoption of new and adverse regulations may have a material adverse effect on us. In addition, future legislative and judicial actions could have a material adverse effect on us.
 
Federal legislation generally provides for significant deregulation of the U.S. communications industry, including the information service, local exchange, long distance and cable television industries. This legislation remains subject to judicial review and additional FCC rulemaking. As a result, we cannot predict the legislation’s effect on our future operations. Regulatory proceedings are under way or are being contemplated by federal and state authorities regarding items relevant to our business. These actions could have a material adverse effect on our business.
 
 
 
Future legislation or regulation of the Internet and/or voice and video over IP services could restrict our business, prevent us from offering service or increase our cost of doing business.
 
At present there are few laws, regulations or rulings that specifically address access to commerce and communications services that utilize internet protocol, including VoIP. We are unable to predict the impact, if any, that future legislation, judicial decisions or regulations concerning internet protocol products and services may have on our business, financial condition, and results of operations. Regulation may be targeted towards, among other things, fees, charges, surcharges, and taxation of VoIP services, liability for information retrieved from or transmitted over the Internet, online content regulation, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, filing requirements, consumer protection, public safety issues like enhanced 911 emergency service, or E911, the Communications Assistance for Law Enforcement Act, or CALEA, the provision of online payment services, broadband residential Internet access, and the characteristics and quality of products and services, any of which could restrict our business or increase our cost of doing business. The increasing growth of the VoIP market and popularity of VoIP products and services heighten the risk that governmental agencies will seek to regulate VoIP and the Internet.
 
Many regulatory actions are underway or are being contemplated by governmental agencies. Several states of the U.S. and municipalities have recently shown an interest in regulating VoIP services, as they do for providers of traditional telephone service. If this trend continues, and if such regulation is not preempted by action of the U.S. federal government, we may become subject to a variety of inconsistent state and local regulations and taxes, which would increase our costs of doing business, and adversely affect our operating results and future prospects.
 
There is risk that a regulatory agency could require us to conform to rules that are unsuitable for IP communications technologies or rules that cannot be complied with due to the nature and efficiencies of IP routing, or are unnecessary or unreasonable in light of the manner in which we offer service to our customers. It is not possible to separate the Internet, or any service offered over it, into intrastate and interstate transmission components. While suitable alternatives may be developed in the future, the current IP network does not enable us to identify the geographic path of the traffic.
 
Our products must comply with industry standards, FCC regulations, state, local, country-specific and international regulations, and changes may require us to modify existing products and/or services.
 
In addition to reliability and quality standards, the market acceptance of VoIP is dependent upon the adoption of industry standards so that products from multiple manufacturers are able to communicate with each other. Our VoIP products and services rely heavily on communication standards such as SIP, H.323 and SS-7 and network standards such as TCP/IP to interoperate with other vendors’ equipment. There is currently a lack of agreement among industry leaders about which standard should be used for a particular application, and about the definition of the standards themselves. These standards, as well as audio and video compression standards, continue to evolve. We also must comply with certain rules and regulations of the FCC regarding electromagnetic radiation and safety standards established by Underwriters Laboratories, as well as similar regulations and standards applicable in other countries. Standards are continuously being modified and replaced. As standards evolve, we may be required to modify our existing products or develop and support new versions of our products. We must comply with certain federal, state and local requirements regarding how we interact with our customers, including consumer protection, privacy and billing issues, the provision of 911 emergency service and the quality of service we provide to our customers. The failure of our products and services to comply, or delays in compliance, with various existing and evolving standards could delay or interrupt volume production of our VoIP telephony products, subject us to fines or other imposed penalties, or harm the perception and adoption rates of our service, any of which would have a material adverse effect on our business, financial condition or operating results.
 
There may be risks associated with the lack of 911 emergency dialing or the limitations associated with E911 emergency dialing with our VoIP services.
 
In the future, we intend to sell and support IP devices. In May 2005, the FCC unanimously adopted an Order and Notice of Proposed Rulemaking, or NPRM, that requires some VoIP providers to provide emergency 911, or E911, service. On June 3, 2005, the FCC released the text of the First Report and Order and Notice of Proposed Rulemaking in the VoIP E911 proceeding, or the VoIP E911 Order. As a result of the VoIP E911 Order, VoIP service providers that interconnect to the public switched telephone network, or PSTN, or interconnected VoIP providers, will be required to offer the same 911 emergency calling capabilities offered by traditional landline phone companies. All interconnected VoIP providers must deliver 911 calls to the appropriate local public safety answering point, or PSAP, along with call back number and location, where the PSAP is able to receive that information. E911 must be included in the basic service offering; it cannot be an optional or extra feature. The PSAP delivery obligation, along with call back number and location information must be provided regardless of whether the service is “fixed” or “nomadic.” User registration of location is permissible initially, although the FCC is committed to an advanced form of E911 that will determine user location without user intervention. The VoIP E911 Order mandates that existing and prospective customers must be notified of the capabilities and limitations of VoIP service with respect to emergency calling, and interconnected VoIP providers must obtain and maintain affirmative acknowledgement from each customer that the customer has read and understood the notice of limitations and distribute warning labels or stickers alerting consumers and other potential users of the limitations of VoIP 911 service to each new subscriber prior to the initiation of service. In addition, an interconnected VoIP provider must make it possible for customers to update their address (i.e., change their registered location) via at least one option that requires no equipment other than that needed to access the VoIP service. The VoIP E911 Order will increase our cost of doing business and may adversely affect our ability to deliver service to new and existing end users in all geographic regions. We cannot guarantee that E911 service will be available to all of our subscribers. The VoIP E911 Order or follow-on orders or clarifications and potential legislation could have a material adverse effect on our business, financial condition and operating results.
 
The IP devices we intend to offer could be adversely impacted if network operators are permitted to restrict or degrade access to their broadband networks.
 
The concept of net neutrality asserts that network operators should not be allowed to charge content or application providers fees for faster delivery or other preferential treatment. This issue has been subject to ongoing regulatory proceedings. Further, federal legislation may also address net neutrality in a manner that requires, permits or disallows the FCC to implement its stated net neutrality policy. Such legislation could also require the FCC to modify its policy in whole or in part. Because some of our IP devices and services may utilize the networks of third parties, regulation and potential legislation concerning net neutrality could impact our business. Further, some of our carrier customers rely, in part, on the implementation of net neutrality principles in order to offer their VoIP services. If our carrier customers are adversely impacted by legislative or regulatory action concerning net neutrality, it could also adversely impact us.
 
 
 
Uncertainty regarding whether certain of our services are classified as “telecommunications” or “information” services makes it difficult to predict whether we will need to pay additional charges, surcharges, fees and/or taxes to provide our services and whether we are subject to state and local regulation.
 
There are many unresolved proceedings at the FCC intended to address whether various types of VoIP services are properly classified as telecommunications services and/or information services. Federal legislation may also impact this determination. If our services are determined to be telecommunications services, we may be subject to additional regulation, including but not limited to the application of additional charges, surcharges, taxes and fees that would adversely impact our business. If it is determined that we provide telecommunications services, we could also be required to comply with state regulation and the related filing requirements that could adversely impact our business.
 
We may from time to time be subject to disputes with customers and vendors relating to amounts invoiced for services provided which we may not be able to resolve in our favor.
 
It is not unusual in our industry to occasionally have disagreements with vendors relating to amounts billed for services provided between the recipient of the services and the vendor. To the extent we are unable to favorably resolve these disputes, our revenues, profitability or cash may be adversely affected.
 
Risks Related to our Common Stock
 
Our common stock may be considered a “penny stock” and may be difficult to sell.
 
The Securities and Exchange Commission has adopted regulations which generally define “penny stock” to be an equity security that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to specific exemptions. The market price of our common stock is less than $5.00 per share and therefore may be designated as a “penny stock” according to Securities and Exchange Commission rules. This designation requires any broker or dealer selling these securities to disclose certain information concerning the transaction, obtain a written agreement from the purchaser and determine that the purchaser is reasonably suitable to purchase the securities. These rules may restrict the ability of brokers or dealers to sell our common stock and may affect the ability of investors to sell their shares. In addition, since our common stock is currently listed on the NASD’s OTC Pink Sheets, investors may find it difficult to obtain accurate quotations of our common stock and may experience a lack of buyers to purchase such stock or a lack of market makers to support the stock price.
 
Security analysts of major brokerage firms may not provide coverage of us since there is no incentive for brokerage firms to recommend the purchase of our common stock. No assurance can be given that brokerage firms will want to conduct any secondary public offerings on our behalf in the future.
 
Our principal shareholders have significant voting power and may take actions that may not be in the best interest of other shareholders.
 
As of March 30, 2012, our executive officers, directors, and principal shareholders who hold 5% or more of our outstanding common stock beneficially owned, in the aggregate, approximately 64% of our outstanding common stock. These shareholders are able to exercise significant control over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of all our shareholders.
 
We incur increased costs and risks as a result of being a public company, particularly in the context of Section 404 of the Sarbanes-Oxley Act of 2002.
 
We incur increased costs as a result of becoming a public company and from compliance activities related to the Sarbanes-Oxley Act of 2002, or SOX, as well as new rules subsequently implemented by the Securities and Exchange Commission and the NASD, and these costs may continue to increase. These new rules and regulations have increased our legal and financial compliance costs and made some activities more time-consuming and costly. In addition, we incur costs associated with our public company reporting requirements. These rules and regulations to make it more expensive for us to obtain certain types of insurance, including directors’ and officers’ liability insurance and we may be forced to accept reduced policy limits and coverage in the future or incur substantially higher costs to obtain the same or similar coverage. The impact of these events also could make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We are presently evaluating and monitoring developments with respect to new rules and regulations and cannot predict the amount of the additional costs we may incur or the timing of such costs.
 
Section 404 of SOX requires us to include an internal controls report from management in our Annual Reports on Form 10-K, and we are required to expend significant resources in developing the necessary documentation and testing procedures. Given the risks inherent in the design and operation of internal controls over financial reporting, we evaluated our system of internal controls and concluded that our internal controls over financial reporting is not effective. If our internal controls are not designed or operating effectively, we are required to disclose that our internal control over financial reporting was not effective, as we have done in this Annual Report under Item 9A. Investors may lose confidence in the reliability of our financial statements, which could cause the market price of our common stock to decline and which could affect our ability to operate our business as we otherwise would like to.
 
 
 
Our management has identified a number of material weaknesses in our internal control over financial reporting as of December 31, 2011, which, if not remediated, could result in material misstatements in our annual or interim financial statements in future periods.
 
In connection with our management’s assessment of our internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002, our management identified a number of material weaknesses in our internal control over financial reporting as of December 31, 2011. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. As a result, our management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2011. The deficiencies noted at December 31, 2011 were also identified as existing as of December 31, 2010.
 
If any remediation efforts are insufficient to address these material weaknesses, or if additional material weaknesses in our internal control over financial reporting are discovered in the future, we may fail to meet our future reporting obligations, our financial statements may contain material misstatements and our financial conditions and results of operations may be adversely impacted. Any such failure could also adversely affect our results of periodic management assessment regarding the effectiveness of our internal control over financial reporting, as required by the SEC's rules under Section 404 of the Sarbanes-Oxley Act of 2002. The existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements or failure to meet reporting obligations, which in turn could cause investors to lose confidence in reported financial information leading to a decline in our stock price.
 
Although we believe that these remediation efforts will enable us to improve our internal control over financial reporting, we cannot assure you that these remediation efforts will remediate the material weaknesses identified or that any additional material weaknesses will not arise in the future due to a failure to implement and maintain adequate internal control over financial reporting. Furthermore, there are inherent limitations to the effectiveness of controls and procedures, including the possibility of human error and circumvention or overriding of controls and procedures

The market price of our common stock may be volatile.
 
The market price of our common stock has been and will likely continue to be highly volatile, as is the stock market in general. Some of the factors that may materially affect the market price of our common stock are beyond our control, such as changes in financial estimates by industry and securities analysts, conditions or trends in the communications industry, announcements made by our competitors or sales of our common stock. These factors may materially adversely affect the market price of our common stock, regardless of our performance.
 
In addition, the public stock markets have experienced extreme price and trading volume volatility. This volatility has significantly affected the market prices of securities of many companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.
 
Factors which may adversely affect market prices of our common stock.
 
Market prices for our common stock will be influenced by a number of factors, including:
 
 
·
the issuance of new equity securities pursuant to a future offering or acquisition;
 
 
·
changes in interest rates;
 
 
·
competitive developments, including announcements by competitors of new products or services or significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
 
 
·
variations in quarterly operating results;
 
 
·
changes in financial estimates by securities analysts;
 
 
·
the depth and liquidity of the market for our common stock;
 
 
·
investor perceptions of us and the communications industry generally; and
 
 
·
general economic and other national conditions.
 
 
 
There is no assurance of an established public trading market, and the failure to establish one would adversely affect the ability of our investors to sell their securities in the public market.
 
At present, there is minimal trading of our securities, and there can be no assurance that an active trading market will develop. Our common stock, however, is traded on the OTC Pink Sheets. The OTC Pink Sheets is an inter-dealer, over-the-counter market that provides significantly less liquidity than the NASD’s automated quotation system, or NASDAQ Stock Market. Quotes for stocks included on the OTC Pink Sheets are not listed in the financial sections of newspapers as are those for the NASDAQ Stock Market. Therefore, prices for securities traded solely on the OTC Pink Sheets may be difficult to obtain and holders of common stock may be unable to resell their securities at or near their original price or at any price.
 
A significant number of our shares are eligible for sale, and their sale could depress the market price of our common stock.
 
Sales of a significant number of shares of our common stock in the public market could harm the market price of our common stock. In May 2007 and January 2008 we registered an aggregate of 21,429,000 shares and shares underlying warrants, or 29% of our common stock currently outstanding, for resale in the public market pursuant to Form SB-2 registration statements. As such shares of our common stock are resold in the public market, the supply of our common stock will increase, which could decrease its price. Some or all of our shares of common stock as well as shares of common stock underlying warrants and options may also be offered from time to time in the open market pursuant to an effective registration statement or Rule 144, and these sales may have a depressive effect on the market for our shares of common stock. In general, a person who has held restricted shares for a period of six months may, upon filing with the Securities and Exchange Commission a notification on Form 144, sell into the market shares of our common stock.
 
Shares eligible for future sale may adversely affect the market price of our common stock.
 
The former non-affiliated securities holders of InterMetro Delaware who received shares of our common stock in the Business Combination, as well various vendors who were issued shares pursuant to settling vendor obligations, are eligible to sell all of these approximate 7.2 million shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144 promulgated under the Securities Act of 1933, as amended (the “Securities Act”), Rule 144. Any substantial resale, and the possibility of substantial resales, of the common stock under Rule 144 may have an adverse effect on the market price of our common stock by creating an excessive supply.
 
Provisions in our articles of incorporation and bylaws and under Nevada law may discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.
 
Our articles of incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change of control of our company or changes in our management that the shareholders of our company may deem advantageous. These provisions:
 
 
·
authorize the issuance of “blank check” preferred stock that our board of directors could issue to increase the number of outstanding shares to discourage a takeover attempt;
 
 
·
allow shareholders to request that we call a special meeting of our shareholders only if the requesting shareholders hold of record at least a majority of the outstanding shares of common stock;
 
 
·
provide that the board of directors is expressly authorized to make, alter, amend or repeal our bylaws; and
 
 
·
provide that business to be conducted at any special meeting of shareholders be limited to matters relating to the purposes stated in the applicable notice of meeting.
 
We do not foresee paying cash dividends in the foreseeable future.
 
We have not paid cash dividends on our stock and do not plan to pay cash dividends on our common stock in the foreseeable future.
 
Item 1B. Unresolved Staff Comments
 
 None.
 
Item 2. Properties
 
Our principal executive office is located in Simi Valley, California, where we lease a facility with 18,674 square feet of space for $14,000 per month under a lease that expires March 31, 2013. We believe that our space will be adequate for our needs and that suitable additional or substitute space in the future will be available to accommodate the foreseeable expansion of our operations. We also lease collocation space for our VoIP equipment in carrier class telecommunications facilities in major metropolitan markets throughout the U.S. and expect to add additional collocation facilities as we expand our VoIP network.
 
 
 
Item 3. Legal Proceedings

From time to time we may be involved in litigation of claims relating to disputes of the cost and quality of services provided by us, our network component vendors, providers of general and administrative services and employees. We may also be involved with litigation of claims of alleged infringement, misuse or misappropriation of intellectual property rights of third parties. In the normal course of business, we may also be subject to claims arising out of our operations, and may file collection claims against delinquent customers.   We cannot predict the outcome of any of these proceedings at this time.  In cases where a Court has stayed proceeding, we can not predict how long the Court’s stay (if any) will remain in place.  A ruling against us in any of the proceedings listed below could have a material adverse impact on our operating results, financial condition and business performance.

A Network Service Provider – On September 22, 2010, the Company was served a complaint filed in the Superior Court of California, Ventura County, by MPower Communications Corp (“MPower”), a network service provider, against the Company asserting various causes of action.  MPower claims that the Company owes various charges totaling $505,583. The Company denied that it owed this amount.  The Company and MPower settled the complaint on August 12, 2011 for $100,000, subject to timely payment through January 2013. The remaining amount due under the settlement was $65,000 at December 31, 2011.

On March 31, 2011, the Company was notified that the seller and the former president of Advanced Tel, Inc, (“ATI”) the Company’s wholly owned subsidiary, had filed suit against the Company asserting, among other things, that the Company owed said seller certain amounts related to the agreement entered into by the parties (“Purchase Agreement”) when the Company purchased ATI in 2006.  On November 30, 2011, the parties arbitrated a settlement with precedent conditions to be performed by the Company in the first quarter of 2012, conditions that were met on March 14, 2012 resulting in dismissal of the suit on March 14, 2012.  As part of the settlement the Company will void the disputed 4,089,930 shares originally issued to the seller in 2008 as part of the stock compensation in the Purchase Agreement and the seller will return to the Company the 308,079 shares issued to him in 2006 also originally part of the Purchase Agreement.  All shares will return to the Company’s Treasury.   The company will pay the seller a total of $200,000, which was accrued at December 31, 2011 and subject to timely monthly payments through March 2017.

A Network Service Provider – On October 26, 2011, the Company was served a complaint filed by a network service provider (“NSP”) against the Company asserting various causes of action.  The NSP claimed that the Company owed various charges totaling $150,926. The Company denies that it owes this amount and believes the NSP owes the Company higher amounts which offset this claim.   The Company filed a cross-complaint against the NSP on December 1, 2011 for charges owed the Company totaling $280,403.

Universal Service Administrative Company – The Universal Service Administrative Company (USAC) administers the Universal Service Fund (USF).  In 2008 and 2009 the Company did not make all of the payments claimed by the USAC in a timely manner and USAC transferred these unpaid amounts to the Federal Communications Commission (FCC) for collection.  The FCC has transferred some of these unpaid amounts to the Department of the Treasury which worked with the Company to establish long term payment plans.   Should any of the remaining unpaid amounts with the FCC transfer from the FCC to Treasury, additional fees, surcharges and penalties will be added to the amount due.  As of December 31, 2011, the Company has recorded an aggregate $1.3 million in connection with the USF.  The Company continues to work with the FCC and the Department of the Treasury to resolve these amounts under long term payment programs.  Failure to finalize any significant proposed payment plan would likely have a material adverse effect on the Company.
 
Item 4.  Mine Safety Disclosures
 
Not applicable
 
 
 
PART II
 
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Common Stock
 
Our common stock is listed on the OTC Pink Sheets and trades under the symbol “IMTO.” At the close of business on March 15, 2012, there were 70,262,798 issued and outstanding common shares which were held by approximately 86 shareholders of record, of which 17,127,048 shares were freely tradable. The balance is restricted stock as that term is used in Rule 144 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
 
There is currently minimal trading volume for our securities.  The following table sets forth certain information with respect to the high and low market prices of our common stock for the periods indicated.  These quotations, as provided by the OTC Pink Sheets, reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transaction prices between dealers.
 

Year
 
Quarter
 
High
   
Low
 
2012
 
First (thru March 15, 2012)
  $ 0.06     $ 0.04  
2011
 
Fourth
    0.06       0.04  
   
Third
    0.05       0.04  
   
Second
    0.05       0.01  
   
First
    0.06       0.03  
2010
 
Fourth
    0.06       0.01  
   
Third
    0.03       0.01  
   
Second
    0.02       0.01  
   
First
    0.02       0.01  
                     
 
Dividends
 
We have not declared or paid any cash dividends on our common stock and we do not expect to pay any cash dividends in the foreseeable future. The decision whether to pay cash dividends on our common stock will be made by our Board of Directors, in their discretion, and will depend on our financial condition, operating results, capital requirements and other factors that our Board of Directors considers significant. We currently intend to retain our earnings for funding growth and, therefore, do not expect to pay any dividends in the foreseeable future.
 
Issued and Outstanding Shares
 
Effective March 14, 2012, the Company settled a lawsuit brought by a former employee and the former president of Advanced Tel, Inc. (“ATI”), the Company’s wholly owned subsidiary.  See Note 12 for a description of this matter.  Pursuant to the settlement, the Company has voided a total of 4,089,930 shares that were originally issued to the employee as part of the consideration for the acquisition of ATI.
 
In addition, pursuant to the settlement, the employee will return 308,079 shares issued to him, also in connection with the Company’s acquisition of ATI.  Such 308,079 shares will be transferred back to the Company incrementally, subject to the Company’s payment by the Company of a total of $200,000 in monthly installments through March 2017.
 
Unregistered Sales of Securities in 2011
 
During 2011, the Company issued 1,232,305 shares of its common stock pursuant to the exercise of warrants.  The Company received proceeds of $9,858 in connection with the issuance. During 2011, the Company also issued 145,000 shares of its common stock with a fair market value of $5,800 pursuant to the settlement of a vendor obligation.
 
 
 
Equity Compensation Plan Information

Plan Category
Number of
Securities to be Issued
Upon Exercise of
Outstanding Stock Options
     
Weighted-Average
Exercise Price of
Outstanding Stock
Options
     
Number of
Securities
Remaining
Available for
Future Issuance
Under Equity
Compensation
Plans
           
Equity Compensation plans approved by security holders:
           
2004 Stock Option Plan
3,650,688
 
$
0.01
 
- 0-
2007 Omnibus Stock and Incentive Plan
2,950,000
 
$
0.25
 
9,602,181
 
2004 Stock Option Plan
 
Our Board of Directors voted unanimously to cause the Company to assume all stock options under the 2004 Stock Plan of InterMetro Delaware (the “2004 Plan”), which were issued and outstanding immediately prior to the closing of the Business Combination, which closed on or about December 29, 2006. All InterMetro Delaware stock options were converted into options to purchase shares of our common stock as of December 29, 2006. Upon the shareholders ratification of the 2004 Plan pursuant to the Schedule 14C Information Statement filed with the Securities and Exchange Commission declared effective May 10, 2007, we froze any further grants of stock options under the 2004 Plan. Any shares reserved for issuance under the 2004 Plan that are not needed for outstanding options granted under that plan will be cancelled and returned to treasury shares. The number of outstanding stock options and the exercise prices were adjusted in the same proportion as the exchange ratio for the outstanding common stock in the Business Combination. The exercise periods and other terms and conditions remained the same.
 
As of December 31, 2011, we had stock options to purchase 3,650,688 shares of our common stock outstanding under the 2004 plan all fully vested and exercisable for a period of ten years from the date of initial grant by InterMetro. On November 15, 2010, in order to provide continued economic incentive to option holders, most of whose options were issued at prices that were “out of the money”, the Board of Directors authorized a re-pricing of the stock options under the 2004 Plan to $0.01, the closing price of the Company’s common stock on that date. The Company recognized a charge of $14,000 related to the re-pricing.
 
For the fiscal years ended December 31, 2011 and 2010, InterMetro issued no stock options under the 2004 plan.  As of December 31, 2011, 1,232,320 of the Company’s outstanding stock options issued pursuant to the 2004 Plan have been exercised.
 
Omnibus Stock and Incentive Plan
 
Effective January 19, 2007, our Board of Directors approved the 2007 Omnibus Stock and Incentive Plan (the “2007 Plan”) for directors, officers, employees, and consultants. Our shareholders ratified the 2007 Plan pursuant to the Schedule 14C Information Statement filed with the Securities and Exchange Commission which was declared effective on May 10, 2007. The 2007 Plan allows any of the following types of awards, to be granted alone or in tandem with other awards: (1) Stock options which may be either incentive stock options (“ISOs”), which are intended to satisfy the requirements of Section 422 of the Internal Revenue Code of 1986, as amended, or nonstatutory stock options (“NSOs”), which are not intended to meet those requirements; (2) restricted stock which is common stock that is subject to restrictions, including a prohibition against transfer and a substantial risk of forfeiture, until the end of a “restricted period” during which the grantee must satisfy certain vesting conditions; (3) restricted stock units which entitle the grantee to receive common stock, or cash (or other property) based on the value of common stock, after a “restricted period” during which the grantee must satisfy certain vesting conditions or the restricted stock unit is forfeited; (4) stock appreciation rights which entitle the grantee to receive, with respect to a specified number of shares of common stock, any increase in the value of the shares from the date the award is granted to the date the right is exercised; and (5) other types of equity-based compensation which may include shares of common stock granted upon the achievement of performance objectives.
 
 
 
The 2007 Plan will be administered by the Compensation Committee once this committee is formed, which will at all times be composed of two or more members of the Board of Directors who are not our employees or consultants. Until a Compensation Committee is formed, the 2007 Plan is administered by a majority of independent directors.  Any employee or director of, or consultant for, us or any of our subsidiaries or other affiliates will be eligible to receive awards under the 2007 Plan. We have reserved 8,903,410 shares of common stock for awards under the 2007 Plan. In addition, on each anniversary of the 2007 Plan’s effective date on or before the fifth anniversary of the effective date, the aggregate number of shares of our common stock available for issuance under the 2007 Plan will be increased by the lesser of (a) 5% of the total number of shares of our common stock outstanding as of the December 31 immediately preceding the anniversary, (b) 4,713,570 shares, or (c) a lesser number of shares of our common stock that our board, in its sole discretion, determines. In general, shares reserved for awards that lapse or are canceled will be added back to the pool of shares available for awards under the 2007 Plan.
 
Awards under the 2007 Plan are forfeitable until they become vested. An award will become vested only if the vesting conditions set forth in the award agreement (as determined by the Compensation Committee or the independent directors administering the 2007 Plan) are satisfied. The vesting conditions may include performance of services for a specified period, achievement of performance objectives, or a combination of both. The Compensation Committee also will have authority to provide for accelerated vesting upon occurrence of an event such as a change in control. The 2007 Plan specifically prohibits the Compensation Committee (or the independent directors administering the 2007 Plan) from repricing any stock options or stock appreciation rights. In general, awards under the 2007 Plan may not be assigned or transferred except by will or the laws of descent and distribution. However, the Compensation Committee (or the independent directors administering the 2007 Plan) may allow the transfer of NSOs to members of a 2007 Plan participant’s immediate family or to a trust, partnership, or corporation in which the parties in interest are limited to the participant and members of the participant’s immediate family.
 
The Board of Directors or the Compensation Committee may amend, alter, suspend, or terminate the 2007 Plan at any time. If necessary to comply with any applicable law (including stock exchange rules), we will first obtain stockholder approval. Amendments, alterations, suspensions, and termination of the 2007 Plan generally may not impair a participant’s (or a beneficiary’s) rights under an outstanding award. However, rights may be impaired if necessary to comply with an applicable law or accounting principles (including a change in the law or accounting principles) pursuant to a written agreement with the participant. Unless it is terminated sooner, the 2007 Plan will terminate upon the earlier of June 23, 2016 or the date all shares available for issuance under the 2007 Plan have been issued and vested.
 
For the fiscal years ended December 31, 2011 and 2010, no shares of common stock under the 2007 plan were issued. As of December 31, 2011, none of the Company’s outstanding stock options issued pursuant to the 2007 Plan have been exercised.
 
Item 6. Selected Financial Data.
 
As a “smaller reporting company”, under SEC rules, this disclosure is not required.
 
Item 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition
 
The following discussion should be read in conjunction with our consolidated financial statements and notes to those statements.
 
Overview
 
History . InterMetro began business as a VoIP on December 29, 2006 and began generating revenue at that time. Since then, we have increased our revenue to approximately $21.0 million for the year ended December 31, 2011.

Our corporate headquarters is located in Simi Valley, California. We lease collocation space for our VoIP equipment in carrier-class telecommunications facilities in metropolitan markets throughout the U.S. and expect to add additional collocation facilities as we expand our VoIP network.

Trends in Our Industry and Business

A number of trends in our industry and business could have a significant effect on our operations and our financial results. These trends include:
 
Increased competition for end users of voice services . We believe there are an increasing number of companies competing for the end users of voice services that have traditionally been serviced by the large incumbent carriers. The competition has come from wireless carriers, competitive local exchange carriers, or CLECs, and interexchange carriers, or IXCs, and more recently from broadband VoIP providers, including cable companies and DSL companies offering broadband VoIP services over their own IP networks. All of these companies provide national calling capabilities as part of their service offerings, however, most of them do not operate complete national network infrastructures. These companies previously purchased national transport services exclusively from traditional carriers, but are increasingly purchasing transport services from us.
 
 
Regulation . Our business has developed in an environment largely free from regulation. However, the Federal Communications Commission (“FCC”) and many state regulatory agencies have begun to examine how VoIP services could be regulated, and a number of initiatives could have an impact on our business. These regulatory initiatives include, but are not limited to, proposed reforms for universal service, the intercarrier compensation system, FCC rulemaking regarding emergency calling services related to broadband IP devices, and the assertion of state regulatory authority over us. Complying with regulatory developments may impact our business by increasing our operating expenses, including legal fees, requiring us to make significant capital expenditures or increasing the taxes and regulatory fees applicable to our services. One of the benefits of our implementation of SS-7 technology is to enable us to purchase facilities from incumbent local exchange carriers under switched access tariffs. By purchasing these traditional access services, we help mitigate the risk of potential new regulation related to VoIP.

Our Business Model
 
Historically, we have implemented our business plan through the expansion of our VoIP infrastructure. Since our inception, we have grown our customer base, including the customers from our recent acquisition, to include over 70 customers, including several large publicly-traded telecommunications companies and retail distribution partners. In connection with the addition of customers and the provision of related voice services, we have expanded our national VoIP infrastructure.
 
In 2006, we also began to dedicate significant resources to acquisition growth, completing our first acquisition of ATI in  March 2006. We acquired ATI to add minutes to our network and to access new sales channels and customers. We plan to grow our business through direct sales activities and potentially through acquisitions.
 
Revenue . We generate revenue primarily from the sale of voice minutes that are transported across our VoIP infrastructure. In addition, ATI, as a reseller, generates revenues from the sale of voice minutes that are currently transported across other telecom service providers’ networks. However, we have migrated some of these revenues on to our VoIP infrastructure, and intend to migrate a significant portion of ATI’s revenues in the future. We negotiate rates per minute with our carrier customers on a case-by-case basis. The voice minutes that we sell through our retail distribution partners are typically priced at per minute rates, are packaged as calling cards and are competitive with traditional calling cards and prepaid services. Our carrier customer services agreements and our retail distribution partner agreements are typically one year in length with automatic renewals. We generally bill our customers on a weekly or monthly basis with either a prepaid balance required at the beginning of the week or month of service delivery or with net terms determined by the customers’ creditworthiness. Factors that affect our ability to increase revenue include:
 
 
·
Changes in the average rate per minute that we charge our customers.
  
Our voice services are sold on a price per minute basis. The rate per minute for each customer varies based on several factors, including volume of voice services purchased, a customer’s creditworthiness, and, increasingly, use of our SS-7 based services, which are priced higher than our other voice transport services.
 
 
·
Increasing the net number of customers utilizing our VoIP services.
 
Our ability to increase revenue is primarily based on the number of carrier customers and retail distribution partners that we are able to attract and retain, as revenue is generated on a recurring basis from our customer base. We expect increases in our customer base primarily through the expansion of our direct sales force and our marketing programs. Our customer retention efforts are primarily based on providing high quality voice services and superior customer service. We expect that the addition of SS-7 based services to our network will significantly increase the universe of potential customers for our services because many customers will only connect to a voice service provider through SS-7 based interconnections.
 
 
·
Increasing the average revenue we generate per customer.
 
We increase the revenue generated from existing customers by expanding the number of geographic markets connected to our VoIP infrastructure. Also, we are typically one of several providers of voice transport services for our larger customers, and can gain a greater share of a customer’s revenue by consistently providing high quality voice service.
 
 
·
Acquisitions.
 
We expect to expand our revenue base through the acquisition of other voice service providers. We plan to continue to acquire businesses whose primary cost component is voice services or whose technologies expand or enhance our VoIP service offerings.
 
We expect that our revenue will increase in the future primarily through the addition of new customers gained from our direct sales and marketing activities and from acquisitions.
 
 
Network Costs . Our network, or operating, costs are primarily comprised of fixed cost and usage based network components. In addition, ATI incurs usage based costs from its underlying telecom service providers. We generally pay our fixed network component providers at the beginning or end of the month in which the service is provided and we pay for usage based components on a weekly or monthly basis after the delivery of services. Some of our vendors require a prepayment or a deposit based on recurring monthly expenditures or anticipated usage volumes. Our fixed network costs include:
 
 
·
SS-7 based interconnection costs.
 
We added a significant amount of capacity, measured by the number of simultaneous phone calls our VoIP infrastructure can connect in a geographic market, by connecting directly to local phone companies through SS-7 based interconnections purchased on a monthly recurring fixed cost basis. As we expand our network capacity and expand our network to new geographic markets, SS-7 based interconnection capacity will be the primary component of our fixed network costs.
 
 
·
Competitive local exchange carrier costs.
 
The interconnections between our VoIP infrastructure and our customers’ end users, as well as our retail customers, have historically been purchased on a monthly recurring fixed cost basis from competitive local exchange carriers, or CLECs. Historically, CLEC interconnections had been our largest component of fixed network costs.
 
 
·
Other fixed costs.
 
Other significant fixed costs components of our VoIP infrastructure include private fiber-optic circuits and private managed IP bandwidth that interconnect our geographic markets, monthly leasing costs for the collocation space used to house our networking equipment in various geographic markets, local loop circuits that are purchased to connect our VoIP infrastructure to our customers and usage based vendors within each geographic market. Other fixed network costs include depreciation expense on our network equipment and monthly subscription fees paid to various network administrative services.
 
The usage-based cost components of our network include:
 
 
·
Off-net costs.
 
In order to provide services to our customers in geographic areas where we do not have existing or sufficient VoIP infrastructure capacity, we purchase transport services from traditional long distance providers and resellers, as well as from other VoIP infrastructure companies. We refer to these costs as “off-net” costs. Off-net costs are billed on a per minute basis with rates that vary significantly based on the particular geographic area to which a call is being connected.
 
 
·
SS-7 based interconnections with local carriers.
 
The SS-7 based interconnection services and those we intend to purchase for the provision of a majority of our future services, include a usage based, per minute cost component. The rates per minute for this usage based component are significantly lower than the per minute rates for off-net services. The usage based costs for SS-7 services are expected to be the largest cost component of our network as we grow revenue utilizing SS-7 technology.
 
Our fixed-cost network components generally do not experience significant price fluctuations. Factors that affect these network components include:
 
 
·
Efficient utilization of fixed-cost network components.
 
Our customers utilize our services in identifiable fixed daily and weekly patterns. Customer usage patterns are characterized by relatively short periods of high volume usage, leaving a significant amount of time during each day where the network components remain idle.
 
Our ability to attract customers with different traffic patterns, such as customers who cater to residential calling services, which typically spike during evening hours, with customers who sell enterprise services primarily for use during business hours, increases the overall utilization of our fixed-cost network components. This decreases our overall cost of operations as a percentage of revenues.
 

 
 
·
Strategic purchase of fixed-cost network components.
 
Our ability to purchase the appropriate amount of fixed-cost network capacity to (1) adequately accommodate periods of higher call volume from existing customers, (2) anticipate future revenue growth attributed to new customers, and (3) expand services for new and existing customers in new geographic markets is a key factor in managing the percentage of fixed costs we incur as a percentage of revenue.
 
From time to time, we also make strategic decisions to add capacity with newly deployed technologies, such as the SS-7 based services, which require purchasing a large amount of network capacity in many geographic markets prior to the initiation of customer revenue.
 
We expect that both our fixed-cost and usage-based network costs will increase in the future primarily due to the expansion of our VoIP infrastructure and use of off-net providers related to the expected growth in our revenues.
 
Our usage-based network components costs are affected by:
 
 
·
Fluctuations in per minute rates of off-net service providers.
 
Increasing the volume of services we purchase from our vendors typically lowers our average off-net rate per minute, based on volume discounts. Another factor in the determination of our average rate per minute is the mix of voice services we use by carrier type, with large fluctuations based on the carrier type of the end user which can be local exchange carriers, wireless providers or other voice service providers.
 
 
·
Sales mix of our VoIP infrastructure capacity versus off-net services.
 
Our ability to sell services connecting our on-net geographic markets, rather than off-net areas, affects the volume of usage based off-net services we purchase as a percentage of revenue.
 
 
·
Acquisitions of telecommunications businesses.
 
We expect to continue to make acquisitions of telecommunications companies. As we complete these acquisitions and add an acquired company’s traffic and revenue to our operations, we may incur increased usage-based network costs. These increased costs will come from traffic that remains with the acquired company’s pre-existing carrier and from any of the acquired company’s traffic that we migrate to our SS-7 services or our off-net carriers. We may also experience decreases in usage based charges for traffic of the acquired company that we migrate to our network. The migration of traffic onto our network requires network construction to the acquired company’s customer base, which may take several months or longer to complete.
 
Sales and Marketing Expense. Sales and marketing expenses include salaries, sales commissions, benefits, travel and related expenses for our direct sales force, marketing and sales support functions. Our sales and marketing expenses also include payments to our agents that source carrier customers and retail distribution partners. Agents are primarily paid commissions based on a percentage of the revenues that their customer relationships generate. In addition, from time to time we may cover a portion or all of the expenses related to printing physical cards and related posters and other marketing collateral. All marketing costs associated with increasing our retail consumer user base are expensed in the period in which they are incurred. We expect that our sales and marketing expenses will increase in the future primarily due to increases in our direct sales force.
 
General and Administrative Expense. General and administrative expenses include salaries, benefits and expenses for our executive, finance, legal and human resources personnel and include the costs of being a public company. In addition, general and administrative expenses include fees for professional services, occupancy costs and our insurance costs, and depreciation expense on our non-network depreciable assets. Our general and administrative expenses also include stock-based compensation on option grants to our employees and options and warrant grants to non-employees for goods and services received.

 
 
Results of Operations
 
The following table sets forth, for the periods indicated, the results of our operations expressed as a percentage of revenue:

   
Year Ended December 31,
 
   
2011
   
2010
 
   
 
   
 
 
Net revenues
    100 %     100 %
Network costs
    77       71  
Gross profit
    23       29  
Operating expenses:
               
Sales and marketing
    4       5  
General and administrative
    17       14  
Impairment of goodwill
    2       -  
Total operating expenses                                 
    23       19  
                 
Operating income (loss)
    0       10  
                 
Interest expense
    (6 )     (7 )
Accounts payable write off and gain on forgiveness of debt
    23       8  
Net income
    17 %     11 %
 
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010

Net Revenues.  Net revenues decreased $6.7 million, or 24.0%, to $21.3 million for the year ended December 31, 2011 from $28.0 million for the year ended December 31, 2010. Though we have continued to increase new customers, this has been offset by a reduction in offering third party low margin services and also attributable to both decreasing revenues from existing customers in certain areas and the loss of certain customers.  The addition of new customers contributed approximately $1.3 million to revenue in the twelve months ended December 31, 2011 with an additional $4.8 million attributable to increasing revenues from existing customers. The Company has developed an integration plan for utilizing the Company's network to carry ATI customer traffic.  This includes the expansion of additional ports through the use of recently acquired equipment.  The execution of this plan is expected to allow the Company to take increased traffic from ATI customers resulting in increased revenue.  These gains were offset by an approximate $12.8 million decrease in revenue attributable to the loss of customers or decreased revenue from existing customers.  Three customers accounted for 48% and 59% of net revenues for the years ended December 31, 2011 and 2010, respectively.
 
Network Costs.  Network costs decreased $3.4 million, or 17.3%, to $16.4 million for the year ended December 31, 2011 from $19.8 million for the year ended December 31, 2010.  Included within total network costs, variable network costs decreased by $3.6 million to $14.9 million (69.9% of revenues) for the year ended December 31, 2011 from $18.5 million (65.8% of revenues) for the year ended December 31, 2010.  Fixed network costs increased cost increased by $100,000 to $1.5 million for the year ended December 31, 2011 from $1.4 million for the year ended December 31, 2010.  Gross margin decreased to 23.2% for the year ended December 31, 2011 from a gross margin of 29.4% for the year ended December 31, 2010.  The increase in variable cost as a percentage of revenues and the decrease in gross margin were related primarily to changes in traffic patterns and increased network cost rates during the year ended December 31, 2011.  The execution of the ATI integration plan is expected to result in a cost structure that will make ATI more competitive, improving gross margin through cost savings.
 
Sales and Marketing. Sales and marketing expenses decreased $553,000, or 40.6% to $809,000 for the year ended December 31, 2011 from $1.4 million for the year ended December 31, 2010. Sales and marketing expenses as a percentage of net revenues were 3.8% and 4.9% for the year ended December 31, 2011 and 2010, respectively.  The decrease is primarily attributable to a decrease in commissions related to the decrease in ATI revenues from which agent commissions are paid.  In addition, a change in revenue mix resulted in a decrease in certain high percentage commissions.
 
General and Administrative. General and administrative expenses decreased $284,000 or 7.1% to $3.7 million for the year ended December 31, 2011 from $4.0 million for the year ended December 31, 2010. General and administrative expenses as a percentage of net revenues were 17.4% and 14.2% for the years ended December 31, 2011 and 2010, respectively. Bad debt expense is a component of general and administrative expense and was $72,000 for the year ended December 31, 2011 as compared to $466,000 for the year ended December 31, 2010.

Impairment of Goodwill.  The Company determined that due to the decline in revenue and operating income of ATI in 2011, the carrying value of the Company’s goodwill was not fully recoverable and took a charge for the impairment of goodwill in the amount of $450,000 in 2011.
 
 
 
Accounts Payable Write Off and Gain on Forgiveness of Debt.  During the year ended December 31, 2011, the Company entered into numerous cash payment plan agreements with vendors for amounts less than the liability recorded in accounts payable and accrued expenses and, in some cases, in exchange for the issuance of shares of the Company’s common stock.  As a result of these agreements, the Company recorded a gain on forgiveness of debt of $3,074,000 for the year ended December 31, 2011.  In addition, the Company wrote-off certain accounts payable for Competitive Local Exchange Carriers (“CLEC”) that resulted in a gain of $1,079,000 for the same period and is included in accounts payable write-off.  The CLEC accounts payable were written off based on advice of counsel and an October 2011 FCC ruling that CLEC access charges invoiced to VoIP carriers are invalid. In addition, most of the CLEC invoices were outside of a two year statute of limitations on such accounts payable balances. Also, the Company has a policy, based on the statute of limitations, to write-off accounts payable with written contracts more than four years old with no current activity and two years when there is no written agreement. The Company recorded gain of $688,000 related to these write-offs which is included in accounts payable write-off.

During the year ended December 31, 2010, the Company entered into numerous cash payment plan agreements with vendors for amounts less than the liability recorded in accounts payable and accrued expenses and, in some cases, in exchange for the issuance of shares of the Company’s common stock.  As a result of these agreements, the Company recorded a gain on forgiveness of debt of $1,243,000 for the year ended December 31, 2010.  In addition, the Company wrote-off certain accounts payable for CLECs that resulted in a gain of $963,000 for the same period and is included in accounts payable write-off.  The Company recorded gain of $147,000 which is included in accounts payable write-off, related to accounts payable with written contracts more than four years old and two years with no written contracts and no current activity..

Interest Expense, net. Interest expense, net decreased $824,000 to $1.2 million for the year ended December 31, 2011 from $2.0 million for the year ended December 31, 2010.  Interest expense related to the secured promissory notes was $346,000 for the year ended December 31, 2011 as compared to $322,000 for the year ended December 31, 2010. Interest expense for the year ended December 31, 2011 includes $458,000 amortization of debt discount and deferred loan costs related to the Moriah credit facility as compared to $517,000 for the year ended December 31, 2010. The decrease in interest expense in 2011 was also attributable to vendor settlements that resulted in the reduction of interest expense and late fees payable to those vendors.

Fourth Quarter Adjustments.  The Company recorded a number of adjustments during the fourth quarter of the year ended December 31, 2011 that included the gains noted above in “Accounts Payable Write Off and Gain on Forgiveness of Debt” that aggregated to $967,000 in the fourth quarter of the fiscal year.
 
Liquidity and Capital Resources
 
At December 31, 2011, we had $390,000 in cash as compared to $428,000 in cash at December 31, 2010.

The Company’s working capital position, defined as current assets less current liabilities, has historically been negative and was negative $12.9 million at December 31, 2011 as compared to negative $16.3 million at December 31, 2010. Working capital improved primarily due to settlements with vendors that resulted in payment plans over extended terms or amounts due written off. (see Note 6 to the Consolidated Financial Statements.)
 
Significant changes in cash flows for December 31, 2011 as compared to December 31, 2010:
 
Net cash provided by operating activities was $114,000 for the year ended December 31, 2011 as compared to net cash provided by operating activities of $1.4 million for the year ended December 31, 2010. The most significant components of the change that contributed to the decrease in cash from operating activities were non-cash gains of approximately $4.8 million and settlement payments of approximately $1.1 million that offset the $3.6 million net income contribution toward working capital in the twelve months ended December 31, 2011. The most significant adjustment increasing cash from operating activities in the twelve months ended December 31, 2011 was the decrease in accounts receivable of $1.4 million.
 
Net cash used in investing activities for the year ended December 31, 2011 was $42,000 which was attributable to the purchase of network-related equipment.  There was $70,000 in equipment purchases in 2010.
 
Net cash used in financing activities for the year ended December 31, 2011 was $110,000 as compared to cash used in financing activities of $957,000 for the year ended December 31, 2010. Net cash used in financing activities for the year ended December 31, 2011 included a $100,000 payment for a put stock repurchase and $20,000 of principal payments on a credit line. Net cash used in financing activities for the year ended December 31, 2010 included principal payments on lines of credit of $555,000, elimination of a $177,000 bank overdraft and $225,000 in principal payments on a capital lease note payable.
 
The Company had a working capital deficit of $12,696,000 and had a total stockholders’ deficit of $13,274,000 as of December 31, 2011.  The Company had a $2.9 million decrease in operating results for the year ended December 31, 2011. The Company’s ability to continue as a going concern will require additional financings if its ability to generate cash from operations does not fund required payments on our debt obligations.  Obligations to the Company’s debt holders include interest and principal payments to our secured note holders (see Note 7 to the Consolidated Financial Statements), principal and interest due on our revolving line of credit (see Note 11 to the Consolidated Financial Statements) and settlement payments due (see Note 6 to the Consolidated Financial Statements). The loan under the revolving line of credit is secured by substantially all of the Company’s assets. The Company has other significant matters of importance, including contingencies such as vendor disputes and lawsuits discussed in Note 12 that could have material adverse consequences to the Company such as cessation of its operations.
 
   The Company anticipates it will not have sufficient cash flows to fund its operations through fiscal 2012, or earlier, depending on the results of the negotiations with Moriah Capital, L.P. (“Moriah”). If the Company were to require additional financings in order to fund ongoing operations there can be no assurance that it will be successful in completing the required financings, that could ultimately cause the Company to cease operations.   The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.  There are many claims and obligations that could ultimately cause the Company to cease operations. The report from the Company’s independent registered public accounting firm states that there is substantial doubt about the Company’s ability to continue as a going concern.
 
 
As discussed in Note 11, the Company entered into agreements with Moriah under which it could borrow up to $2,400,000.  At December 31, 2011, the Company had borrowed $2,000,000. The availability of loan amounts under the agreements expires on March 30, 2012 and all amounts are due at that time. The Company’s management is currently in negotiation with Moriah to extend the due date.

Management believes that the losses in past years were primarily attributable to costs related to building out and supporting a telecommunications infrastructure, and the requirement for continued expansion of the customer base, in order for the Company to become profitable. This resulted in the Company taking on debt and delaying payment to certain vendors.  The Company may be required to obtain other financing during the next twelve months or thereafter as a result of future business developments, including any acquisitions of business assets or any shortfall of cash flows generated by future operations in meeting the Company’s ongoing cash requirements. Such financing alternatives could include selling additional equity or debt securities, obtaining long or short-term credit facilities, or selling operating assets. Management continues to work with its historical vendors in order to secure the continued extension of credit. Management believes that cash flows from operations and additional debt conversions are integral to management’s plan to retire past due obligations and be positioned for growth.  No assurance can be given, however, that the Company will be successful in restructuring its debt on terms favorable to the Company or at all. Should the Company be unsuccessful in this restructuring, material adverse consequences to the Company could occur such as cessation of operations.  Any sale of additional common stock or convertible equity or debt securities would result in additional dilution to the Company’s stockholders.
 
Credit Facilities

Revolving Credit Facility In April 2008, the Company entered into a convertible revolving credit agreement pursuant to which the Company may access funds up to $1.5 million.  In September 2008, the Company entered into Amendment No. 1 to the agreement which increased the access to $2.0 million, in November 2008 the Company entered into Amendment No 2 to the agreement which increased the access to $2.4 million and in May 2009 the Company entered into Amendment No. 4 to the agreement which increased the access to $2.55 million.  The availability of loan amounts at December 31, 2009 under the revolving credit agreement was to expire on April 30, 2009. The Company entered into Amendment No. 5 to the agreement as of January 31, 2010 that extended the expiration to April 30, 2010.  The Company entered into Amendment No. 6 on September 29, 2010, effective April 30, 2010, that extended the expiration to March, 30, 2011and Amendment No. 7 as of December 31, 2010 that lowered the amount of the principal reduction payments required as of December, 31, 2010. The Company entered into Amendment No. 8 as of March 30, 2011 that extended the expiration to June 30, 2011, Amendment No.9 as of June 30, 2011 that extended the expiration to September 30, 2011, Amendment No.10 as of September 30, 2011 that extended the expiration to November 30, 2011 and Amendment No. 11 that extended the expiration to March 30, 2012.  As of December 31, 2011, the Company is permitted to borrow an amount not to exceed 85% of its eligible accounts receivable. As of December 31, 2011, the Company had borrowed $2.0 million. The Company's obligations are secured by all of the assets of the Company.  Annual interest on the loans is equal to the greater of (i) the sum of (A) the Prime Rate (B) 4% or (ii) 15%, and shall be payable in arrears prior to the maturity date, on the first business day of each calendar month, and in full on March 30, 2012. (See Note 11 to the Consolidated Financial Statements for detailed discussion.)
 
Critical Accounting Policies and the Use of Estimates
 
Our financial statements are prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.
 
We believe that the following accounting policies involve the greatest degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.
 
Revenue Recognition. VoIP services are recognized as revenue when services are provided primarily based on usage. Revenues derived from sales of calling cards through retail distribution partners are deferred upon sale of the cards. These deferred revenues are recognized as revenue generally at the time card minutes are expended. The Company has revenue sharing agreements based on successful collections.  The Company recognizes revenue from these customers at the time of invoicing based on the history of collections with such customers. The Company recognizes revenue in the period that services are delivered and when the following criteria have been met: persuasive evidence of an arrangement exists, the fees are fixed and determinable, no significant Company obligations remain and collection is reasonably assured. Deferred revenue consists of fees received or billed in advance of the delivery of the services or services performed in which collection is not reasonably assured. This revenue is recognized when the services are provided and no significant Company obligations remain. The Company assesses the likelihood of collection based on a number of factors, including past transaction history and the credit worthiness of the customer. Generally, the Company does not request collateral from customers. If the Company determines that collection of revenues are not reasonably assured, amounts are deferred and recognized as revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.  The Company has revenue sharing agreements with certain customers and recognizes revenue at time of invoicing based on the history of collections with such customers.
 
 
 
Stock-Based Compensation. The Company has adopted FASB ASC 718 “Compensation – Stock Compensation”.   The Company is applying the “modified prospective transition method” under which it continues to account for nonvested equity awards outstanding at the date of adoption of FASB ASC 718 in the same manner as they had been accounted for prior to adoption, that is, it would continue to apply APB 25 in future periods to equity awards outstanding at the date it adopted FASB ASC 718, unless the options are modified or amended. 
 
For grants to employees under the 2004 plan and 2007 plan in the year ended December 31, 2008, the Company estimated the fair value of each option award on the date of grant using the Black-Scholes option-pricing model using the assumptions noted in the following table.  Expected volatility is based on the historical volatility of a peer group of publicly traded entities.  The expected term of the options granted is derived from the average midpoint between vesting and the contractual term, as described in the SEC’s Staff Accounting Bulletin No. 107, “Share-Based Payment.”  The risk-free rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
 
Accounts Receivable and the Allowance for Doubtful Accounts
 
Accounts receivable consist of trade receivables arising in the normal course of business. We do not charge interest on our trade receivables. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We review our allowance for doubtful accounts monthly. We determine the allowance based upon historical write-off experience, payment history and by reviewing significant past due balances for individual collectibility. If estimated allowances for uncollectible accounts subsequently prove insufficient, additional allowance may be required.
 
Impairment of Long-Lived Assets
 
We assess impairment of our other long-lived assets in accordance with the provisions of FASB ASC 360, “Property, Plant and Equipment”. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered by us include:
 
 
·   Significant underperformance relative to expected historical or projected future operating results;
 
 
·   Significant changes in the manner of use of the acquired assets or the strategy for our overall business; and
 
 
·   Significant negative industry or economic trends.
 
When we determine that the carrying value of a long-lived asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, an estimate is made of the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future undiscounted cash flows and eventual disposition is less than the carrying amount of the asset, an impairment loss is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset, based on the fair market value if available, or discounted cash flows if not. To date, we have not had an impairment of long-lived assets and are not aware of the existence of any indicators of impairment.
 
Goodwill

We record goodwill when consideration paid in a business acquisition exceeds the fair value of the net tangible assets and the identified intangible assets acquired. The Company accounts for goodwill and intangible assets in accordance with FASB ASC 350 “Goodwill and Other”. FASB ASC 350 requires that goodwill and intangible assets with indefinite useful lives not be amortized, but instead be tested for impairment at least annually or whenever changes in circumstances indicate that the carrying value of the goodwill may not be recoverable. FASB ASC 350 also requires the Company to amortize intangible assets over their respective finite lives up to their estimated residual values.  At September 30, 2011, using the present value calculation of a net cash flow analysis, the Company determined that due to the decline in revenue and operating income of ATI in 2011, the carrying value of the Company’s goodwill was not fully recoverable and took a charge for the impairment of goodwill in the amount of $450,000 (see Note 2). At December 31, 2011 management does not believe there is any further impairment in the value of goodwill.
 
 Accounting for Income Taxes
 
We account for income taxes using the asset and liability method in accordance with FASB ASC 740 “Income Taxes”, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of the assets and liabilities. We periodically review the likelihood that we will realize the value of our deferred tax assets and liabilities to determine if a valuation allowance is necessary. We have concluded that it is more likely than not that we will not have sufficient taxable income of an appropriate character within the carryforward period permitted by current law to allow for the utilization of certain of the deductible amounts generating deferred tax assets; therefore, a full valuation allowance has been established to reduce the deferred tax assets to zero at December 31, 2011 and 2010. In addition, we operate within multiple domestic taxing jurisdictions and are subject to audit in those jurisdictions. These audits can involve complex issues, which may require an extended period of time for resolution. Although we believe that our financial statements reflect a reasonable assessment of our income tax liability, it is possible that the ultimate resolution of these issues could significantly differ from our original estimates.
 
Net Operating Loss Carryforwards
 
As of December 31, 2011 and 2010, our net operating loss carryforwards for federal tax purposes were approximately $40 million and $46 million, respectively.  These net operating losses occurred subsequent to our business combination in December 2006.
 
 
 
Contingencies and Litigation
 
We evaluate contingent liabilities including threatened or pending litigation in accordance with FASB ASC 450 “Contingencies” and record accruals when the outcome of these matters is deemed probable and the liability is reasonably estimable. We make these assessments based on the facts and circumstances and in some instances based in part on the advice of outside legal counsel.
 
It is not unusual in our industry to occasionally have disagreements with vendors relating to the amounts billed for services provided. We currently have disputes with vendors that we believe did not bill certain charges correctly. While we have paid the undisputed amounts billed for these non-recurring charges based on rate information provided by these vendors, as of December 31, 2011, there is approximately $61,000 of unresolved charges in dispute. We are in discussion with these vendors regarding these charges and may take additional action as deemed necessary against these vendors in the future as part of the dispute resolution process. We are in discussion with this significant vendor that has sent invoices regarding these charges.
 
Contractual Obligations
 
We have no capital lease obligations at December 31, 2011. The operating lease for our corporate offices expires March 31, 2013 with a monthly lease payment of $14,000.  There are no significant provisions in our agreements with our network partners that are likely to create, increase, or accelerate obligations due thereunder other than changes in usage fees that are directly proportional to the volume of activity in the normal course of our business operations.
 
The following table reflects a summary of our contractual obligations at December 31, 2011:  
 
   
Payments Due by Period
(Dollars in Thousands)
 
Contractual Obligations
 
Total
 
Less Than
1 Year
 
1-3 Years
 
3-5 Years
 
More Than
5 Years
 
                       
Capital lease obligations
    $     $     $              
Operating lease obligations
      210       168       42              
Total
    $ 210     $ 168     $ 42     $     $  
 
Off-Balance Sheet Arrangements
 
We currently do not have any outstanding derivative financial instruments, off-balance sheet guarantees, interest rate swap transactions, foreign currency forward contracts or any other off-balance sheet arrangements.
 
Item 7A. Quantitative and Qualitative Disclosures Regarding Market Risk
 
Foreign Currency Market Risks . We currently do not have significant exposure to foreign currency exchange rates as all of our sales are denominated in U.S. dollars.
 
Interest Rate Market Risk . Our cash is invested in bank deposits and money market funds denominated in U.S. dollars. The carrying value of our cash, restricted cash, accounts receivable, deposits, other current assets, trade accounts payable, accrued expenses and deferred revenue and customer deposits approximate fair value because of the short period of time to maturity.
 
Recent Accounting Pronouncements

For a discussion of the impact of recently issued accounting pronouncements, see the subsection entitled "Recent Accounting Pronouncements" contained in Note 1 of the Notes to Consolidated Financial Statements under "Item 8. Financial Statements and Supplementary Data."
 
 
 
Item 8. Financial Statements and Supplementary Data
 
See the Index to Consolidated Financial Statements on Page F-1 attached hereto.
 
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
None
 
Item 9A. Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
As required by Rules 13a-15(e) and 15d-15(e) under the Exchange Act, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Annual Report. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer.
 
The Company has established a set of disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in the reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms. Disclosure controls are also designed with the objective of ensuring that this information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
Based upon their evaluation as of the end of the period covered by this report, the Company’s Chief Executive Officer and Chief Financial Officer were not able to conclude that the Company’s disclosure controls and procedures are effective to ensure that information required to be included in the Company’s periodic Securities and Exchange Commission filings is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and forms. Therefore, under Section 404 of the Sarbane’s-Oxley Act of 2002, they must conclude that these controls and procedures are not effective.
 
Internal Control over Financial Reporting
 
The Company’s board of directors was advised by Gumbiner Savett, Inc. (“GSI”), the Company’s independent registered public accounting firm, that during their performance of audit procedures for 2011, GSI identified material weaknesses as defined in Public Company Accounting Oversight Board Standard No. 5,  in the Company’s internal control over financial reporting and in the segregation of duties within the accounting department. The Company is not an accelerated filer and GSI did not perform an audit of the Company’s internal controls. These weaknesses were identified in connection with the audit of the financial statements and reported pursuant to the requirements under AU Section 380, Communications with Audit Committees.
 
The Company’s control over financial reporting has been identified based on the number of error corrections and adjustments to Company prepared audit schedules made by the Company as part of completing a timely audit process. Additionally, the Company identified significant deficiencies surrounding the financial reporting process. Collectively, these represent a material weakness in the financial reporting process.
 
It was also identified that the size of the Company’s accounting staff prohibited its ability to properly segregate duties, a material weakness that could lead to the inability of the Company’s internal control system to timely identify and resolve accounting and disclosure matters.
 
Management’s Annual Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods is subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
 
 
Management conducted, with the participation of our Chief Executive Officer and our Chief Financial Officer, an assessment, including testing of the effectiveness, of our internal control over financial reporting as of December 31, 2011. Management’s assessment of internal control over financial reporting was conducted using the criteria in Internal Control over Financial Reporting - Guidance for Smaller Public Companies issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
 
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. In connection with our management’s assessment of our internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002, we identified the following material weaknesses in our internal control over financial reporting as of December 31, 2011:
 
 
·
While we have implemented control procedures for reviewing all material financial reporting items, certain of our control procedures are not sufficient to prevent the risk that a potential material misstatement of the financial statements would occur without being prevented or detected, specifically with regards to dispute reserves for accounts payable, accruals for third party charges and certain equity accounts. In each case, the Company does not have adequate staffing to ensure that the monitoring  processes mitigate risks that external information used is correct and, in the case of equity accounts, that the Company has personnel with adequate understanding of the applicability of accounting principles.
 
 
·
We have not maintained sufficient evidence to support that certain of our internal controls over financial reporting activities were performed on a timely basis, specifically related to confirmation testing of disputes of information received from our vendors, variance analysis, accounts receivable analyses and equity accounts.
 
 
·
Due to the small size of our Company, we have not adequately divided, or compensated for, functions among personnel to reduce the risk that a potential material misstatement of the financial statements would occur without being prevented or detected with regards to certain of our equity accounts. Specifically, with regards to equity awards, at times information used in our financial reporting is not able to be given to additional competent staff to mitigate the risk of erroneous or inappropriate actions.
 
Because of the material weaknesses noted above, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2011, based on Internal Control over Financial Reporting - Guidance for Smaller Public Companies issued by (“COSO”).

Remediation of Material Weaknesses in Internal Control Over Financial Reporting
 
We are considering a process of implementing remediation efforts with respect to the material weaknesses noted above as follows:
 
 
·
We intend to improve our monitoring processes and add additional staff resources to monitor our dispute reserves, accruals for third party charges and equity reporting activities.
 
 
·
We intend on developing specific policies and procedures around the nature and retention of evidence of the operation of controls. For example, where other forms of sign-off and evidence of timeliness do not exist, reviews will be evidenced via sign-off (including signature and date).
 
 
·
We are considering re-assigning roles and responsibilities in order to improve segregations of duties with regards to control activities for our equity accounts.
 
We believe the foregoing efforts will enable us to improve our internal control over financial reporting. Management is committed to continuing efforts aimed at improving the design adequacy and operational effectiveness of its system of internal controls. The remediation efforts noted above will be subject to our internal control assessment, testing and evaluation process.
 
Changes in Internal Control Over Financial Reporting
 
There were no changes in our internal control over financial reporting during the three months  ended December 31, 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
This annual report does not include an attestation report of the Company’ registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permits us to provide only management’s report in this annual report.
 
Item 9B. Other Information
 
None
 
 
PART III
 
Item 10. Directors, Executive Officers and Corporate Governance
 
The following table lists our executive officers and directors as of December 31, 2011:
 
Name
     
Age
     
Position
   
             
   
Charles Rice
 
48
 
President, Chief Executive Officer and Chairman of the Board
Jon deOng
 
38
 
Chief Information Officer, Director
David Olert
 
 58
 
Chief Financial Officer
Christopher Fogel
 
38
 
Chief Technology Officer
Joshua Touber
 
49
 
Director
Robert Grden(1)
 
48
 
Director
Douglas Benson(1)
 
79
 
Director
(1) Member of the Audit Committee
 
Charles Rice has served as a Director and as our Chief Executive Officer and President since December 29, 2006.  Mr. Rice is the founder of InterMetro Delaware and has served as the Chairman, Chief Executive Officer and President since its inception in July 2003. Under Mr. Rice’s leadership, InterMetro Delaware was ranked 46th in Entrepreneur magazine’s June 2006 Hot 100 Fastest Growing Businesses in America. From 1999 to 2003, Mr. Rice was Chairman, Chief Executive Officer, and President of CNM Network, Inc., or CNM, a national VoIP carrier. Mr. Rice joined CNM in 1997 and became a member of its board of directors in 1998. From 1998 to 1999, Mr. Rice served as CNM’s Vice President and Chief Operating Officer. Prior to CNM, Mr. Rice spent over 15 years in executive positions. Mr. Rice attended California State University of Northridge.
 
Jon deOng has served as our Chief Information Officer since March 28, 2011, as our Chief Technology Officer since December 29, 2006 and as a Director since January 19, 2007. Mr. deOng has served as InterMetro Delaware’s Chief Information Officer or Chief Technology Officer and a director since its inception in July 2003. Prior to joining InterMetro Delaware, Mr. deOng served as the Chief Technology Officer for CNM from 1999 to 2003 and served as a member of CNM’s board of directors from 1999 to 2003. From 1998 to 1999, Mr. deOng served as Vice President of Technology at CNM. Prior to CNM, Mr. deOng was responsible for managing the development and deployment of Netcom On-line Communication Services, Inc.’s Business Center, the core infrastructure systems of Netcom’s web hosting service, later acquired by ICG Communications, Inc. Mr. deOng attended the University of Texas.

David Olert has served as Chief Financial Officer since May 2009.  Prior to this role, he was the Company’s Corporate Controller since 2007.  Prior to joining InterMetro Delaware, Mr. Olert was Controller of Optical Communication Products, Inc., a manufacturer of telecom fiber optic components and prior to that served as Corporate Controller for SMTEK, Inc., a contract manufacturer. Prior to SMTEK, Mr. Olert served twelve years in various entities, primarily publicly traded, as CFO or Corporate Controller and four years in public accounting.  Mr. Olert holds a Bachelor degree from Barry University.

Christopher Fogel has served as Chief Technology Officer since March 2011.  Previously, Mr. Fogel served as Vice President of Network and Provisioning since the Company's inception in July 2003.  Prior to joining InterMetro, Mr. Fogel served as Director of Provisioning for CNM Network from 1998 to 2003, responsible for deploying CNM’s 54 node national IP network.  From 1996 to 1998, Mr. Fogel served as Senior Systems Administrator at Netcom Communications, Inc., managing its web hosting platform. 
 
Joshua Touber has served as a director since January 19, 2007. Mr. Touber has served as a director of InterMetro Delaware since March 2004. Mr. Touber is currently President of TouberMedia, LLC, a media consulting firm. From 1998 to 2003, Mr. Touber was the Chief Operating Officer of Ascent Media Creative Services Group, a subsidiary of Liberty Media Group. In 1995, Mr. Touber founded Virtuosity, a telecommunication services provider that developed the “virtual assistant” product category under the “Wildfire” brand name and has served as its President since its inception.
 
Robert Grden has served as a director since January 19, 2007. Mr. Grden has served as a director of InterMetro Delaware since August 2004.  Mr. Grden is currently the Executive Director for the Wayne County Employee’s Retirement System where he oversees the defined benefit and defined contribution retirement plans. He has worked for the Wayne County since 1991 and held the position of Deputy County Treasurer/Investments. Prior to that, he was a management consultant with Ernst & Young LLP serving clients in a variety of industries.
 
Douglas Benson has served as a director since January 19, 2007. Dr. Benson has served as a director of InterMetro Delaware since May 2006. Dr. Benson is currently the Chief Executive Officer of the Edwin S. Johnston Company, a real estate investment and development company, a position he has held for the past 20 years. Dr. Benson was a founder and majority shareholder of Heritage Bank, a commercial bank in Michigan. Dr. Benson served on the board of directors of Andrews University for over 10 years. Dr. Benson holds a Bachelor of Arts degree from Andrews University and a Doctor of Medicine from Loma Linda University.
 
 
 
Limitation of Liability and Indemnification of Officers and Directors; Insurance
 
Our Articles of Incorporation limits the liability of directors to the maximum extent permitted by Nevada law. Nevada law provides that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary duties as directors, except liability for:
 
·  
any breach of their duty of loyalty to the corporation or its shareholders;
 
·  
acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law;
 
·  
unlawful payments of dividends or unlawful stock repurchases or redemptions; or
 
·  
any transaction from which the director derived an improper personal benefit.
 
Our Bylaws provide that we will indemnify our directors, officers, employees and other agents to the fullest extent permitted by law.
 
We have separate indemnification agreements with our directors and officers, in addition to the indemnification provided for in our Bylaws. These agreements, among other things, provide that we will indemnify our directors and officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by a director or executive officer in any action or proceeding arising out of such person’s services as one of our directors or officers, or rendering services at our request, to any of our subsidiaries or any other company or enterprise. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and officers.
 
Insofar as an indemnification for liabilities arising under the Securities Act may be permitted for directors, officers or persons controlling us pursuant to the foregoing provisions, we have been informed that in the opinion of the Securities and Exchange Commission each indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
 
Legal Proceedings
 
There is no pending litigation or proceeding involving any of our directors or officers as to which indemnification is required or permitted, and we are not aware of any threatened litigation or proceeding that may result in a claim for indemnification.
 
Executive Officers, Directors and Committees
 
Executive Officers
 
Our executive officers are appointed by and serve at the discretion of our Board of Directors. We have employment agreements with our executive officers, which are discussed below under the heading “Executive Compensation – Employment Agreements.”
 
Board of Directors
 
Our Board of Directors currently consists of five directors. Messrs. Benson and Grden are “independent” as defined in NASDAQ Marketplace Rule 4200(a)(15). Mr. Touber is not independent as he is being compensated for certain consulting projects.  Mr. Rice, who is our President and Mr. deOng, who is our Chief Technology Officer, are not independent. We plan to appoint additional independent directors so that a majority of our directors are independent.
 
The Board of Directors is divided into three classes, Class I, Class II and Class III, with each class serving staggered three-year terms.  Directors in each class will hold office until their successors are elected and qualified. The Company has not conducted an annual meeting of shareholders in recent years.  The terms of each of the classes of director terms has expired, but all directors continue to serve. All three classes of directors will be subject to shareholder election at the next annual shareholders meeting held by the Company. The members of the classes are divided as follows:
 
·  
Class I is comprised of Messrs. Joshua Touber and Douglas Benson;
 
·  
Class II is comprised of Mr. Robert Grden;
 
·  
Class III is comprised of Messrs. Charles Rice and Jon deOng.
 
 
 
Our Amended and Restated Bylaws provide that the number of persons constituting our Board of Directors may be fixed from time to time, but only by a resolution adopted by a majority of our Board of Directors and provided that such number cannot be less than three nor more than eleven. Vacancies on the Board of Directors and newly created directorships resulting from any increase in the authorized number of directors will be filled by a majority vote of the directors then in office, even if less than a quorum, or by the sole remaining director. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one-third (1/3) of the total number of directors. This classification of the Board of Directors may have the effect of delaying or preventing changes in the control of or management of the Company. Our directors may be removed only for cause by the affirmative vote of holders of at least 66 2/3% of our then outstanding capital stock voting together as a single class.
 
Committees of the Board of Directors
 
Our Board of Directors currently has a standing Audit Committee. We plan to establish a Compensation Committee and a Nominating and Governance Committee. Until such committees are established, matters otherwise addressed by such committees will be acted upon by the majority of independent directors. The following is a brief description of our committees and contemplated committees.
 
Audit Committee
 
Messrs. Benson and Grden are the current members of our Audit Committee. Mr. Grden has been appointed to serve as chairman of the Audit Committee. Mr. Grden meets the criteria under SEC rules for designation as an “Audit Committee Financial Expert.”
 
Pursuant to the Audit Committee charter, the functions of our Audit Committee includes:
 
·  
meeting with our management periodically to consider the adequacy of our internal controls and the objectivity of our financial reporting;
 
·  
engaging and pre-approving audit and non-audit services to be rendered by our independent auditors;
 
·  
recommending to our Board of Directors the engagement of our independent auditors and oversight of the work of our independent auditors;
 
·  
reviewing our financial statements and periodic reports and discussing the statements and reports with our management, including any significant adjustments, management judgments and estimates, new accounting policies and disagreements with management;
 
·  
establishing procedures for the receipt, retention and treatment of complaints received by us regarding accounting, internal accounting controls and auditing matters;
 
·  
administering and discussing with management and our independent auditors our code of ethics; and reviewing and approving all related-party transactions in accordance with applicable listing exchange rules.
 
Report of the Audit Committee
 
Our Audit Committee has reviewed and discussed our audited financial statements for the fiscal year ended December 31, 2011 with senior management. The Audit Committee has also discussed with GSI, our independent auditors, the matters required to be discussed by the Statement on Auditing Standards No. 61 (Communication with Audit Committees) and received the written disclosures and the letter from GSI required by Independence Standards Board Standard No. 1 (Independence Discussion with Audit Committees). The Audit Committee has discussed with GSI the independence of GSI as our auditors. Finally, in considering whether the independent auditors provision of non-audit services to the Company is compatible with the auditors’ independence for GSI, the Company’s Audit Committee has recommended to the Board of Directors that our audited financial statements be included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 for filing with the United States Securities and Exchange Commission. Our Audit Committee did not submit a formal report regarding its findings.
 
 
 
AUDIT COMMITTEE
 
Robert Grden
Douglas Benson
 
Notwithstanding anything to the contrary set forth in any of our previous or future filings under the Securities Act or the Exchange Act that might incorporate this report in future filings with the Securities and Exchange Commission, in whole or in part, the foregoing report shall not be deemed to be incorporated by reference into any such filing.
 
Code of Conduct
 
We have adopted a Code of Conduct that applies to all of our directors, officers and employees. The text of the Code of Conduct has been posted on InterMetro’s Internet website and can be viewed at http://www.intermetro.net/conduct.htm . Any waiver of the provisions of the Code of Conduct for executive officers and directors may be made only by the Audit Committee and, in the case of a waiver for members of the Audit Committee, by the Board of Directors. Any such waivers will be promptly disclosed to our shareholders.
 
Compliance with Section 16(A) of Exchange Act
 
Section 16(a) of the Exchange Act requires our officers and directors, and certain persons who own more than 10% of a registered class of our equity securities (collectively, “Reporting Persons”), to file reports of ownership and changes in ownership (“Section 16 Reports”) with the Securities and Exchange Commission. Reporting Persons are required by the Securities and Exchange Commission to furnish us with copies of all Section 16 Reports they file.
 
Based solely on its review of the copies of such Section 16 Reports received by it, or written representations received from certain Reporting Persons, all Section 16(a) filing requirements applicable to our Reporting Persons during and with respect to the fiscal year ended December 31, 2011 have been complied with on a timely basis, except for Mr. Christopher Fogel, who inadvertently failed to file a Form 3 upon his appointment as an executive officer of the Company.  Such filing has subsequently been made.
 
Item 11. Executive Compensation
 
Executive Officer Compensation
 
The following table summarizes compensation paid or accrued by the Company for the years ended December 31, 2011, 2010 and 2009 for services rendered in all capacities, by our chief executive officer and the other most highly compensated executive officers during the fiscal years ended December 31, 2011, 2010 and 2009.
 
Summary Compensation Table
 
Name and Principal Position
 
Year
 
Salary
   
Bonus
   
Option Awards
   
Non-Equity Incentive Plan Compensation
   
Non-Qualified Deferred Compensation Earnings
   
All Other Compensation(1)
   
Total
 
                                               
Charles Rice
 
2011
  $ 268,328       0       0       0       0     $ 11,805     $ 280,133  
Chief Executive
 
2010
    171,452       0       0       0       0       14,679       186,131  
Officer and President
 
2008
    150,348       0       0       0       0       14,704       165,052  
                                                             
Jon deOng
 
2011
  $ 126,505       0       0       0       0     $ 15,220     $ 141,725  
Chief Information
 
2010
    126,505       0       0       0       0       17,066       143,571  
Officer
 
2009
    126,019       0       0       0       0       15,775       141,794  
                                                             
David Olert
 
2011
  $ 148,537       0       0       0       0     $ 8,834     $ 157,371  
Chief Financial
 
2010
    148,459       0       0       0       0       8,960       157,419  
Officer
 
2009
    162,590       0       0       0       0       14,640       177,230  
 
(1)  Amounts primarily represent medical insurance premiums and reimbursements for automobile and electronic communication device expenses.
 
 
Employment Agreements
 
Effective on or about January 1, 2007, we assumed from InterMetro Delaware certain employment agreements with our Chief Executive Officer, Charles Rice and our Chief Information Officer, Jon deOng. Each of the agreements was originally entered into as of January 1, 2004 with a term ending after five years, with automatic one-year extensions thereafter, unless either we or the executive provides notice of intention not to renew the agreement at least 60 days prior to the end of its term.
 
The agreement with Mr. Rice provides for an initial base annual salary of $220,000 and a discretionary annual bonus target of up to 100% of his base annual salary.  Mr. Rice accepted a salary reduction to $150,000 in the year ended December 31, 2008.  The agreement with Mr. deOng provides for an initial base annual salary of $185,000 and a discretionary annual bonus target of up to 75% of his base annual salary.  Mr. deOng accepted a salary reduction to $125,000 in the year ended December 31, 2008.  We anticipate senior executive bonuses under each of these agreements will be determined based on various factors, including revenue achievement and operating income (loss) before depreciation and amortization targets, as well as personal contributions. These performance factors may change from year to year. Each of these agreements calls for an 11% yearly increase in annual base salary.
 
Pursuant to the employment agreements, Mr. Rice and Mr. deOng, were each granted, on January 2, 2004, options to purchase 308,080 shares of our common stock, as adjusted for the Business Combination. The options for Mr. Rice which had an exercise price of $0.0446 per share and an exercise period of five years, have been fully exercised. The options for Mr. deOng which had an exercise price of $0.0406 and an exercise period of ten years from the date of grant have been fully exercised.
 
These employment agreements may be terminated by us if the executive acts with gross negligence in the performance of his duties resulting in a breach of his fiduciary duties to us, our board, or our shareholders (provided that we give the executive notice of the basis for the termination and an opportunity for 30 days to cease committing the alleged conduct).
 
Severance benefits are payable under the agreements if the executive’s employment is terminated (i) if we materially breach the employment agreement or terminates the agreement other than for gross negligence (as described above), (ii) upon the death or disability of the executive, or (iii) on account of non-renewal of the employment agreement after a change in control of our ownership. These severance benefits include (i) a lump sum payment equal to the greater of the sum of the executive’s annual compensation and accrued but unpaid bonus payable through the end of the term of the employment agreement or one year of the executive’s annual base compensation, (ii) continuation medical insurance coverage and other benefits through the end of the term, and (iii) full vesting of all unvested stock options, with the ability to exercise all options granted under the agreement for the remainder of their term.
 
If the executive terminates his employment for reasons other than our breach of the agreement, he will not be entitled to severance benefits and will have a period of 90 days after notification of termination to exercise his vested options. If the executive’s employment is terminated for gross negligence (as described above), the executive will not be entitled to severance benefits, but he will be entitled to exercise his vested stock options for the remainder of their term.
 
Outstanding Equity Awards
 
The following table sets forth information for each of our executive officers regarding the number of shares subject to exercisable and unexercisable stock options to purchase shares of our common stock at the fiscal year ended December 31, 2011.
 
Outstanding Equity Awards at Fiscal Year-End

Name
Number of
Securities
Underlying
Unexercised
Options
Exercisable(1)
Number of
Securities
Underlying
Unexercised
Options
Unexercisable(1)
     
Option
Exercise
Price
     
Option
Expiration
Date
               
Charles Rice
- 0 -
- 0 -
 
$
0
 
-
Chairman, Chief Executive Officer, and President
             
               
Jon deOng
- 0 -
- 0 -
 
$
0
 
-
Chief Information Officer
             
               
David Olert
400,000
- 0 -
 
$
0.25
 
11/28/12
Chief Financial Officer
             
 
(1)
Stock options were granted under our 2007 Stock Plan and vested 40% on the date of grant and 1/12 of the balance each quarter thereafter until the remaining stock options were vested.
 
 
 
Director Compensation
 
As of January 19, 2007, we approved the following non-employee director compensation program. We generally pay our non-employee directors $1,000 per board meeting attended in person and $500 for each telephonic meeting. In addition, we generally compensate members of our board committees as follows: (i) each member of our Audit Committee receives $500 per meeting and (ii) each member of our Compensation Committee and Nominating and Governance Committee receives $350 per meeting. The Chairman of our Audit Committee also receives an annual retainer of $5,000 per year. We intend to grant our directors options under our 2007 Plan in an amount to be determined prior to grant.  Not withstanding the generally applicable non-employee director compensation program described above, directors were not compensated in the year ended December 31, 2011 for board member duties.
 
The following table sets forth the compensation paid or accrued by InterMetro for the year ended December 31, 2011 to InterMetro’s directors.
 
Director Compensation

Name
 
Fees
Earned or
Paid in
Cash
 
Stock
Awards
     
Option
Awards
         
Non-Equity
Incentive Plan
Compensation
 
Change in
Pension Value
and Nonqualified
Deferred
Compensation
Earnings
 
All Other
Compensation(1)
 
Total
               
                     
               
Joshua Touber, Director
 
0
 
0
    0  
0
 
0
 
$
175,000
 
$
175,000
Robert Grden, Director
 
0
 
0
    0  
0
 
0
   
0
 
$
0
Douglas Benson, Director
 
0
 
0
    0  
0
 
0
   
0
 
$
0
 
(1)Amount represents consulting fees for special projects and medical insurance premiums.
 
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
The following table sets forth certain information regarding the beneficial ownership of our common stock as of March 30, 2012, by (i) each director, (ii) each executive officer, (iii) all directors and executive officers as a group, and (iv) each person who beneficially owns more than five percent of our common stock. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission.  Such rules require not only the disclosure of shares over which an individual holds sole voting and investment power, but also shares over which such individual shares voting and investment power. As a consequence, and as indicated in the footnotes below, in many instances this results in duplication in the numbers and percentages reported for the individuals in the table; the aggregate shares held by all officers and directors as a group counts shares beneficially owned by more than one person only once without duplication.  In computing the number of shares beneficially owned by a person and the percentage of ownership of that person, shares of common stock subject to a convertible security (e.g. options, warrants or convertible notes) held by that person that are currently exercisable or convertible or become exercisable or convertible within 60 days of March 30, 2012 are deemed outstanding even if they have not actually been issued through exercise or conversion of the convertible security.  Those shares, however, are not deemed outstanding for the purpose of computing the percentage ownership of any other person. The percentage ownership of each beneficial owner is based on 70,262,798 outstanding shares of common stock as of March 30, 2012. Except as otherwise listed below, the address of each person is c/o InterMetro Communications, Inc., 2685 Park Center Drive, Building A, Simi Valley, California 93065.
 
 
 
Name and Title of Beneficial Owner
     
Number of
Shares Beneficially
Owned(1)
        
Percentage
Ownership
                                                                                                
 
 
 
 
Charles Rice
   
33,602,977
(2)
 
  
41.4
%   
Chairman, President,
               
Chief Executive Officer
               
Jon deOng
   
2,943,162
(3)
   
4.2
%
Chief Information Officer
               
Chris Fogel
   
1,670,188
(4)
   
2.3
%
Chief Technology Officer
               
David Olert
   
900,000
(5)
   
1.3
%
Chief Financial Officer
               
Joshua Touber
   
8,486,317
(6)
   
11.3
%
Director
               
Robert Grden
   
434,848
(7)
   
*
 
Director, Corporate Secretary
               
Douglas Benson
   
3,863,091
(8)
   
5.4
%
Director
               
                 
Directors and executive officers
   
45,387,233
     
52.8
%
as a group (7 persons)
               
David Marshall
               
11845 Olympic Blvd. Ste 1125 W, Los Angeles, CA 90064
   
9,903,949
(9)
   
13.8
%
Moriah Capital Management
               
444 Madison Avenue, Suite 201, New York, NY 10022
   
3,691,000
(10)
   
4.9
%
* Indicates beneficial ownership of less than one percent.

(1)
Unless otherwise indicated and subject to applicable community property laws, to our knowledge each stockholder named in the table possesses sole voting and investment power with respect to all shares of common stock, except for those owned jointly with that person’s spouse.

(2)
Includes 50,000 shares subject to warrants and 1,500,000 shares subject to stock options, each of which are exercisable within 60 days of March 30, 2012; 290,626 shares which may be acquired pursuant to terms of a convertible promissory note that is convertible at the option of the holder within 60 days of March 30, 2012; 10,631,691  shares over which Mr. Rice would have voting power pursuant to voting agreements upon the exercise of stock options under the 2004 Plan and 2007 Plan; 698,981 shares from the exercise of stock options under the 2004 Plan by certain current and former employees over which shares Mr. Rice maintains voting control; and an additional 3,700,747 shares owned by certain of our current and former employees over which Mr. Rice maintains voting control.

(3)
Includes 2,693,162 shares subject to a voting agreement with Mr. Rice over which Mr. Rice has voting control and 250,000 shares subject to stock options that are exercisable within 60 days of March 30, 2012, all of which are subject to a voting agreement with Mr. Rice.

(4)
Includes 462,111 shares subject to a voting agreement with Mr. Rice over which Mr. Rice has voting control and 1,208,077 shares subject to stock options that are exercisable within 60 days of March 30, 2012, all of which are subject to a voting agreement with Mr. Rice.

(5)
Includes 900,000 shares subject to stock options that are exercisable within 60 days of March 30, 2012, all of which are subject to a voting agreement with Mr. Rice.

(6)
Includes 700,000 shares subject to warrants and 1,184,848 shares subject to stock options, of which 1,000,000 shares of the options are subject to a voting agreement with Mr. Rice, each of which are exercisable within 60 days of March 30, 2012; 2,738,517 shares which may be acquired pursuant to terms of convertible promissory notes that are convertible at the option of the holder within 60 days of March 30, 2012; and 123,246 shares owned by Laurel Research, Inc., of which Mr. Touber is President.
 
 
 
(7)  
Includes 434,848 shares subject to stock options that are exercisable with 60 days of March 30, 2012.

(8)  
Includes 619,694 shares subject to stock options that are exercisable within 60 days of March 30, 2012.

(9)  
Includes 680,065 shares owned by David Marshall Inc., of which David Marshall is the chief executive officer; 3,122,240 shares owned by the David Marshall Pension Trust, of which Mr. Marshall is the trustee; 325,000 shares which may be purchased by the David Marshall Pension Trust pursuant to warrants that are exercisable within 60 days of  March 30, 2012; 1,428,936 shares which may be acquired by the David Marshall Pension Trust pursuant to terms of convertible promissory notes that are convertible at the option of the holder within 60 days of March 30, 2012; 648,588 shares owned by Glenhaven Corporation, of which Mr. Marshall is the chief executive officer; and 3,500,000 shares owned by Santa Monica Capital, LLC, of which Mr. Marshall is the manager. Also includes 199,120 shares purchased by David Marshall as reported on his Form 13G filed June 24, 2009.

(10)  
 Includes 3,691,000 shares that may be purchased pursuant to warrants that are exercisable within 60 days of March 30, 2012.  Each of the subject warrants provide that the holder shall not be entitled to purchase shares under the warrant in an amount that would cause the holder to beneficially own more than 4.99% of the issued and outstanding common shares of the Company, with such limitation voidable by the holder upon 75 days prior notice to the Company.  Accordingly, a total of 10,442,503 additional shares subject to the subject warrants are not deemed to be beneficially owned and are excluded from the total.
 
Item 13. Certain Relationships and Related Transactions, and Director Independence
 
Certain Relationships and Related Transactions
 
Voting Agreements
 
Holders of options under our 2004 Plan and 2007 Plan, other than independent directors, are required to enter into an agreement granting Mr. Rice voting rights with respect to the common stock issued upon exercise of their options, which agreements expire ten years after execution thereof.
 
Holders of common stock purchased from Mr. Rice pursuant to options have entered into a shareholders’ agreement granting Mr. Rice voting rights with respect to the common stock issued upon exercise of their options, which agreements expire ten years after execution thereof.
 
Indemnification Agreements
 
We have indemnification agreements with each of our directors, officers and certain employees. The indemnification agreements provide that the director or officer will be indemnified to the fullest extent not prohibited by law for claims arising in such person’s capacity as a director or officer no later than 30 days after written demand to us. The agreements further provide that in the event of a change of control, we would seek legal advice from a special independent counsel selected by us and approved by the officer or director, who has not performed services for either party for five years, to determine the extent to which the officer or director would be entitled to an indemnity under applicable law. We believe that these agreements are necessary to attract and retain skilled management with experience relevant to our industry.
 
Director Independence
 
See “Item 10. Directors, Executive Officers and Corporate Governance.”
 
 
 
Item 14. Principal Accountant Fees and Services
 
Gumbiner Savett, Inc. (“GSI”) is our principal accountant firm.  GSI has not provided any non-audit services to us during the years ended December 31, 2011 and 2010. The Audit Committee of our Board of Directors has considered whether the provision of non-audit services are compatible with maintaining GSI independence.
 
Each year the independent auditor’s retention to audit our financial statements, including the associated fee, is approved by the Board before the filing of the previous year’s Annual Report on Form 10-K.
 
Audit Fees (in thousands):

   
2011
   
2010
 
                                                                                                                 
 
 
   
 
 
Audit Fees (1)
  $ 135     $ 125  
All other fees
    -       -  
    $ 135     $ 125  
(1)
Audit Fees paid to Gumbiner Savett consist of fees for the audit of our financial statements and review of the interim financial statements included in our quarterly reports.
 
Pre-Approval Policies and Procedures of Audit and Non-Audit Services of Independent Registered Public Accounting Firm
 
The Audit Committee’s policy is to pre-approve, typically at the beginning of our fiscal year, all audit and non-audit services, other than de minimis non-audit services, to be provided by an independent registered public accounting firm. These services may include, among others, audit services, audit-related services, tax services and other services and such services are generally subject to a specific budget. The independent registered public accounting firm and management are required to periodically report to the full Board regarding the extent of services provided by the independent registered public accounting firm in accordance with this pre-approval, and the fees for the services performed to date. As part of the Board’s review, the Board will evaluate other known potential engagements of the independent auditor, including the scope of work proposed to be performed and the proposed fees, and approve or reject each service, taking into account whether the services are permissible under applicable law and the possible impact of each non-audit service on the independent auditor’s independence from management. At Audit Committee meetings throughout the year, the auditor and management may present subsequent services for approval. Typically, these would be services such as due diligence for an acquisition, that would not have been known at the beginning of the year.
 
The Audit Committee has considered the provision of non-audit services, if any, provided by our independent registered public accounting firm to be compatible with maintaining their independence. The Audit Committee will continue to approve all audit and permissible non-audit services provided by our independent registered public accounting firm.
 
 
 
PART IV
 
Item 15. Exhibits and Financial Statement Schedules

(a)(1)  Financial Statements.
The index to the consolidated financial statements required by this item is set forth on page F-1.

(a)(2)  Financial Statement Schedules.
None.

(a)(3)  Exhibits.

3.1
 
Amended and Restated Articles of Incorporation (1)
3.2
 
Amended and Restated Bylaws (2)
4.1
 
Specimen Certificate for Common Stock
4.2 *
 
2004 Stock Option Plan (1)
4.3 *
 
2007 Omnibus Stock and Incentive Plan (1)
4.4 *
 
Form of Stock Option Agreement
4.5
 
Form of Placement Agent Warrant (3)
4.6
 
Form of Bridge Financing Warrant (3)
4.7
 
Form of Exchange Agreement, dated as of December 29, 2006 (4)
4.8
 
Credit Term Agreement for the Bridge Financing, dated December 14, 2006 (4)
4.9
 
Initial Registration Rights Agreement, dated as of December 29, 2006 (4)
4.10
 
Additional Registration Rights Agreement, dated as of December 29, 2006 (4)
4.11
 
Stock Purchase Agreement dated as of March 30, 2006 between InterMetro and David Singer (3)
4.12
 
Common Stock Purchase Warrant (5)
4.12.1
 
Form of Secured Note Financing Warrant (6)
9.1
 
Voting Trust Agreement, dated as of December 29, 2006 (4)
9.2
 
Voting Trust Agreement, dated as of December 29, 2006 (4)
10.1 *
 
Employment Agreement dated as of January 1, 2004 between InterMetro and Charles Rice, as amended (3)
10.2 *
 
Employment Agreement dated as of January 1, 2004 between InterMetro and Jon deOng, as amended (3)
10.3 *
 
Employment Agreement dated as of January 1, 2004 between InterMetro and Vincent Arena, as amended (3)
10.4 *
 
Employment Agreement dated as of March 31, 2006 between Advanced Tel, Inc. and David Singer (3)
10.5†
 
Strategic Agreement dated as of May 2, 2004 between InterMetro and Qualitek Services, Inc. (3)
10.6†
 
Strategic Agreement dated as of May 2, 2006 between InterMetro and Cantata Technology, Inc. (3)
10.7
 
Office Lease between InterMetro and Pacific Simi Associates, LLC dated as of April 6, 2006 (3)
10.8†
 
Services Agreement between InterMetro and 99¢ Only Stores (3)
10.9 *
 
Form of Indemnification Agreement (3)
10.10
 
Placement Agent Agreement for the Private Placement, dated December 14, 2006 (4)
10.11
 
Consulting Agreement with Advisor, dated as of December 29, 2006 (4)
10.12
 
Loan and Security Agreement, dated January 16, 2008 (7)
10.13
 
Form of Secured Convertible Promissory Note (7)
10.14
 
Loan and Security Agreement, dated April 20, 2008 (8)
10.15
 
Amendment No. 6 to Loan and Security Agreement and Loan Documents (5)
21.1 +
 
31.1 +
 
31.2 +
 
32.1 +
 
32.2 +
 
 
 
 
(1)
Incorporated by reference to Exhibits A, B and C of the Schedule 14C Information Statement filed with the Securities and Exchange Commission on March 9, 2007.
 
(2)
Incorporated by reference to Exhibit 3.1 of the Form 8-K filed with the Securities and Exchange Commission on July 3, 2007.
 
(3)
Incorporated by reference to Exhibits 4.5, 4.6, 4.11, 10.1, 10.2, 10.4, 10.5, 10.6, 10.7, 10.8 and 10.9 of the Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on February 9, 2007.
 
(4)
Incorporated by reference to Exhibits 99.1, 99.2, 99.4.1, 99.4.2, 99.6.1, 99.6.2, 99.3 and 99.7 of the Form 8-K filed with the Securities and Exchange Commission on January 9, 2007.
 
(5)
Incorporated by reference to Exhibits 4.1 and 10.1 of the Quarterly Report o Form 10-Q for the Quarter ended September 30, 2010 as filed with the Securities and Exchange Commission
 
(6)
Incorporated by reference to Exhibit 4.12.1 of the Form 10-K for the fiscal year ended December 31, 2010 as filed with the Securities and Exchange Commission.
 
(7)
Incorporated by reference to Exhibits 10.12 and 10.13 of the Form 10-KSB for the fiscal year ended December 31, 2007 as filed with the Securities and Exchange Commission.
 
(8)
Incorporated by reference to Exhibit 10.14 of the Form 10-K for the fiscal year ended December 31, 2008 as filed with the Securities and Exchange Commission.
 
+
Filed herewith
 
*
Management contract or compensatory plan or arrangement
 
Confidential treatment has been requested for portions of this Exhibit which have been filed separately with the Securities and Exchange Commission pursuant to Rule 406 promulgated under the Securities Act.
 
 
 
SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

     
   
INTERMETRO COMMUNICATIONS, INC.
     
Dated: March 30, 2012                                        
By:  
/s/ Charles Rice
   
Charles Rice, Chairman of the Board,
   
Chief Executive Officer, and President
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

       
 
Principal Executive Officer
   
By:  
/s/ Charles Rice
                                          
Dated: March 30, 2012
 
Charles Rice, Chairman of the Board,
   
 
Chief Executive Officer, and President
   
       
 
Principal Financial Officer
   
By:  
/s/ David Olert
 
Dated: March 30, 2012
 
David Olert
   
 
Chief Financial Officer
   
       
By:  
/s/ Jon deOng
 
Dated: March 30, 2012
 
Jon deOng
   
 
Chief Information Officer and Director
   
       
By:  
/s/ Joshua Touber
 
Dated: March 30, 2012
 
Joshua Touber
   
 
Director
   
       
By:  
/s/ Robert Grden
 
Dated: March 30, 2012
 
Robert Grden
   
 
Director
   
       
By:  
/s/ Douglas Benson
 
Dated: March 30, 2012
 
Douglas Benson
   
 
Director
   
 
 

 

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
The Board of Directors and Stockholders
 
InterMetro Communications, Inc.
 
We have audited the accompanying consolidated balance sheets of InterMetro Communications, Inc. and subsidiaries (the “Company”) as of December 31, 2011 and 2010 and the related consolidated statements of operations, stockholders’ deficit and cash flows for each of the years in the two-year period ended December 31, 2011.  The Company’s management is responsible for these consolidated financial statements. 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 consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern.  As discussed in Note 1 to the consolidated financial statements, the Company incurred net losses in previous years, and as of December 31, 2011 the Company had a working capital deficit of approximately $12,696,000 and a total stockholders’ deficit of approximately $13,274,000.  The Company anticipates that it will not have sufficient cash flow to fund its operations in the near term and through fiscal 2012 without the completion of additional financing. 

These factors, among others discussed below and in Note 1 to the consolidated financial statements, raise substantial doubt about the Company’s ability to continue as a going concern.  Management’s plans in regard to these matters are described in Note 1.  The consolidated financial statements do not include any adjustments relating to the recoverability and classification of assets carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.

As discussed in Note 11 to the consolidated financial statements, the Company entered into agreements with Moriah Capital, L.P. (“Moriah”) under which it could borrow up to $2,400,000.  At December 31, 2011, the Company had borrowed $2,000,000.  The availability of loan amounts under the agreements, as amended, expires on March 30, 2012 and all amounts are due at that time.  The Company’s management is currently in negotiation with Moriah to extend the due date.
 
The Company has other significant contingencies such as lawsuits that are discussed in Note 12 to the consolidated financial statements.

The matters detailed in the preceding paragraphs, individually or in the aggregate, could have material adverse consequences, including a cessation of operations, to the Company at any time.



/S/ GUMBINER SAVETT INC.
GUMBINER SAVETT INC.
Santa Monica, California
March 30, 2012
 
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
 
   
2011
   
2010
 
ASSETS
           
Cash
  $ 390     $ 428  
Accounts receivable, net of allowance for doubtful accounts of $401 and  $850 at
December 31, 2011 and 2010, respectively
    1,637       3,494  
Deposits
    46       105  
Prepayments and other current assets
    338       259  
Total current assets
    2,411       4,286  
Property and equipment, net
    118       109  
Goodwill
    450       900  
Other assets
    4       12  
Total Assets
  $ 2,983     $ 5,307  
                 
LIABILITIES AND STOCKHOLDERS’ DEFICIT
               
                 
Accounts payable, trade, net of disputed amounts of $61 in 2011 and $1,016 in 2010
  $ 2,833     $ 9,898  
Accrued expenses
    4,561       3,808  
Deferred revenues and customer deposits
    195       323  
Borrowings under line of credit facilities net of debt discount of $5 and $82 at December 31, 2011 and 2010, respectively
    2,167       2,110  
Current portion of note payable to former ATI shareholder
    30        
Amount due to former ATI shareholder
          75  
Current portion of vendor settlements
    2,204       2,140  
Current portion of secured promissory notes, including $875 from related parties and net of debt discount of $4 and $12 at December 31, 2011 and 2010, respectively
    2,380       1,488  
Liability for warrant put feature
    737       717  
Total current liabilities
    15,107       20,559  
                 
Long-term portion of note payable to former ATI shareholder
    170        
Long-term vendor settlements
    980       701  
Long-term secured promissory notes
          883  
Total liabilities
    16,257       22,143  
                 
Commitments and contingencies (Note 12)
               
                 
Stockholders’ Deficit
               
Preferred stock — $0.001 par value; 10,000,000 shares authorized; 25,000 shares issued and outstanding at December 31, 2011 and 2010
           
Common stock — $0.001 par value;150,000,000 shares authorized; 74,352,728 and 72,975,423 shares issued and outstanding at December 31, 2011 and 2010, respectively
    74       73  
Additional paid-in capital
    29,089       29,145  
Accumulated deficit
    (42,437 )     (46,054 )
Total stockholders’ deficit
    (13,274 )     (16,836 )
Total Liabilities and Stockholders’ Deficit
  $ 2,983     $ 5,307  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
INTERMETRO COMMUNICATIONS, INC.  AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
      Year Ended December 31,
 
     
2011
    
2010
 
                 
Net revenues
 
$
21,307
   
$
28,034
 
Network costs
   
16,365
     
19,800
 
Gross profit
   
4,942
     
8,234
 
Operating expenses
               
Sales and marketing
   
809
     
1,362
 
General and administrative
   
3,709
     
3,993
 
Impairment of goodwill
   
450
     
 
Total operating expenses
   
4,968
     
5,355
 
Operating (loss) income
   
(26
)
   
2,879
 
Interest expense, net (includes amortization of debt discount of $257 and $288 for the years ended December 31, 2011 and 2010, respectively)
   
1,198
     
2,022
 
Accounts payable write-off
   
(1,767
)
   
(1,111
)
Gain on forgiveness of debt
   
(3,074
)
   
(1,243
)
Net income
 
$
3,617
   
$
3,211
 
Basic net income per common share
 
$
0.05
   
$
0.04
 
Diluted net income per common share
 
$
0.04
   
$
0.04
 
Shares used to calculate basic net income per common share
   
74,067
     
72,172
 
Shares used to calculate diluted net income per common share
   
88,443
     
80,365
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
(Dollars in Thousands)
 
    Preferred Stock    
Common Stock
   
Additional
Paid-In
Capital
   
Accumulated
Deficit
   
Total
Stockholders’
Deficit
 
   
Shares
   
Amount
   
Shares
   
Amount
                   
Balance at December 31, 2009
    25,000     $       71,365,354     $ 71     $ 28,725     $ (49,265 )   $ (20,469 )
Amortization of stock-based compensation
                            34             34  
Warrant issuance
                            70             70  
Reclassification of common stock put liability to equity
                            288             288  
Restricted stock issued to vendors for debt
                1,610,069       2       28             30  
Net income for the year ended December 31, 2010
                                  3,211       3,211  
Balance at December 31, 2010
    25,000             72,975,423       73       29,145       (46,054 )     (16,836 )
Warrants exercised
                1,232,305       1       9             10  
Stock issued for debt
                145,000             6             6  
Common stock to be cancelled on settlement of lawsuit
                                (125 )           (125 )
Warrants issued in connection with line of credit financing
                            52             52  
Warrants issued for  debt
                            2             2  
Net income for the year ended December 31, 2011
                                      3,617       3,617  
Balance at December 31, 2011
    25,000     $       74,352,728     $ 74     $ 29,089     $ (42,437 )   $ (13,274 )
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)

   
2011
   
2010
 
Cash flows from operating activities:
           
   Net income
  $ 3,617     $ 3,211  
   Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    40       65  
Stock based compensation
          34  
Amortization of debt discount
    257       288  
Provision for bad debts
    72       466  
Impairment of goodwill
    450          
Accounts payable write-off
    (1,767     (1,111
Gain on forgiveness of debt
    (3,074 )       (1,243 )  
(Increase) decrease in operating assets:
               
Accounts receivable
    1,081       (1,396
Deposits
    58       20  
Other current assets
    (78     (132
Increase (decrease) in operating liabilities:
               
Accounts payable, trade
    (192 )       (130 )  
Accrued expenses
    862       1,767  
Vendor settlements
    (1,084     (386
Deferred revenues and customer deposits
    (128     (97
Net cash provided by operating activities
    114       1,356  
                 
Cash flows from investing activities:
               
Purchase of equipment
    (42 )     (70 )
                 
Cash flows from financing activities:
               
Principal payments of lines of credit
    (20     (555
Payment for put stock repurchase
    (100        
Bank overdraft
          (177
Proceeds from exercise of warrants
    10        
Principal payments on note payable
          (225 )
Net cash used in financing activities
    (110     (957
                 
Net (decrease) increase in cash
    (38     329  
Cash at beginning of year
    428       99  
Cash at end of year
  $ 390     $ 428  

The accompanying notes are an integral part of these consolidated financial statements.

 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1 — Nature of Operations and Summary of Significant Accounting Policies

Company Background - InterMetro Communications, Inc., (hereinafter, “InterMetro” or the “Company”) is a Nevada corporation which, through its wholly owned subsidiary, InterMetro Communications, Inc. (Delaware) (hereinafter, “InterMetro Delaware”), is engaged in the business of providing voice over Internet Protocol (“VoIP”) communications services. The Company owns and operates state-of-the-art VoIP switching equipment and network facilities that are utilized to provide traditional phone companies, wireless phone companies, calling card companies and marketers of calling cards with wholesale voice and data services, and voice-enabled application services. The Company’s customers pay the Company for minutes of utilization or bandwidth utilization on its national voice and data network and the Company’s calling card marketing customers pay per calling card sold. The Company’s headquarters is located in Simi Valley, California.  
 
Going Concern - The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company had a working capital deficit of $12,696,000 and had a total stockholders’ deficit of $13,274,000 as of December 31, 2011.  The Company had a $2.9 million decrease in operating results for the year ended December 31, 2011. The Company’s ability to continue as a going concern will require additional financings if its ability to generate cash from operations does not fund required payments on its debt obligations.  Obligations to the Company’s debt holders include interest and principal payments to its secured note holders (see Note 7), principal and interest due on its revolving line of credit (see Note 11) and settlement payments due (see Note 6). The loan under the revolving line of credit is secured by substantially all of the Company’s assets. The Company has other significant matters of importance, including contingencies such as vendor disputes and lawsuits discussed in Note 12 that could have material adverse consequences, including cessation of operations, to the Company at any time.
 
   The Company anticipates it will not have sufficient cash flows to fund its operations through fiscal 2012, or earlier, depending on the results of the negotiations with Moriah Capital, L.P. (“Moriah”) regarding the Company’s indebtedness to Moriah discussed in Note 11. If the Company were to require additional financings in order to fund ongoing operations there can be no assurance that it will be successful in completing the required financings, that could ultimately cause the Company to cease operations.   The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.  There are many claims and obligations that could ultimately cause the Company to cease operations. The report from the Company’s independent registered public accounting firm states that there is substantial doubt about the Company’s ability to continue as a going concern.

As discussed in Note 11, the Company entered into agreements with Moriah under which it could borrow up to $2,400,000.  At December 31, 2011, the Company had borrowed $2,000,000. The availability of loan amounts under the agreements expires on March 30, 2012 and all amounts are due at that time. The Company’s management is currently in negotiation with Moriah to extend the due date.

Management believes that the losses in past years were primarily attributable to costs related to building out and supporting a telecommunications infrastructure, and the requirement for continued expansion of the customer base, in order for the Company to become profitable. This resulted in the Company taking on debt and delaying payment to certain vendors.  The Company may be required to obtain other financing during the next twelve months or thereafter as a result of future business developments, including any acquisitions of business assets or any shortfall of cash flows generated by future operations in meeting the Company’s ongoing cash requirements. Such financing alternatives could include selling additional equity or debt securities, obtaining long or short-term credit facilities, or selling operating assets. Management continues to work with its historical vendors in order to secure the continued extension of credit. Management believes that cash flows from operations and additional debt conversions are integral to management’s plan to retire past due obligations and be positioned for growth.  No assurance can be given, however, that the Company will be successful in restructuring its debt on terms favorable to the Company or at all. Should the Company be unsuccessful in this restructuring, material adverse consequences to the Company could occur such as cessation of operations.  Any sale of additional common stock or convertible equity or debt securities would result in additional dilution to the Company’s stockholders.
  
Principles of Consolidation - The consolidated financial statements include the accounts of InterMetro, InterMetro Delaware, and InterMetro Delaware’s wholly-owned subsidiary, Advanced Tel, Inc. (“ATI”). All intercompany balances and transactions have been eliminated in consolidation.
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Use of Estimates - In the normal course of preparing financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions 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.

Revenue Recognition - VoIP services are recognized as revenue when services are provided primarily based on usage. Revenues derived from sales of calling cards through retail distribution partners are deferred upon sale of the cards. These deferred revenues are recognized as revenue generally at the time card minutes are expended. The Company has revenue sharing agreements based on successful collections.  The company recognizes revenue from these customers at time of invoicing based on the history of collections with such customers. The Company recognizes revenue in the period that services are delivered and when the following criteria have been met: persuasive evidence of an arrangement exists, the fees are fixed and determinable, no significant Company obligations remain and collection is reasonably assured. Deferred revenue consists of fees received or billed in advance of the delivery of the services or services performed in which collection is not reasonably assured. This revenue is recognized when the services are provided and no significant Company obligations remain. The Company assesses the likelihood of collection based on a number of factors, including past transaction history with the customer and the credit worthiness of the customer. Generally, the Company does not request collateral from customers. If the Company determines that collection of revenues are not reasonably assured, amounts are deferred and recognized as revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.
 
Accounts Receivable - Accounts receivable consist of trade receivables arising in the normal course of business. The Company does not charge interest on its trade receivables. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company reviews its allowance for doubtful accounts periodically. The Company determines the allowance based upon historical write-off experience, payment history and by reviewing significant past due balances for individual collectibility. If estimated allowances for uncollectible accounts subsequently prove insufficient, additional allowance may be required.  Bad debt expense during 2011 and 2010 amounted to $72,000 and $466,000, respectively.
 
Network Costs - The Company’s network costs consist of telecommunication costs, leasing collocation facilities and certain build-outs, and depreciation of equipment related to the Company’s network infrastructure. It is not unusual in the Company’s industry to occasionally have disagreements with vendors relating to the amounts billed for services provided between the recipient of those services and the vendor. As a result, the Company currently has disputes with vendors that it believes did not bill certain network charges correctly.  The Company’s policy is to include amounts that it intends to dispute or that it has disputed in a reserve account as an offset to accounts payable if management believes that the facts and circumstances related to the dispute provide probable support that the dispute will be resolved in the Company’s favor.
 
Depreciation and Amortization - Depreciation and amortization of property and equipment is computed using the straight-line method based on the following estimated useful lives:
 
Telecommunications equipment
     
2-3 years
Telecommunications software
 
18 months to 2 years
Computer equipment
 
2 years
Office equipment and furniture
 
3 years
Leasehold improvements
 
Useful life or remaining lease term, which ever is shorter
  
Impairment of Long-Lived Assets - The Company assesses impairment of its other long-lived assets in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360, “Property, Plant and Equipment”.  An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered by the Company include:
 
 
·
significant underperformance relative to historical or projected future operating results;
 
 
·
significant changes in the manner of use of the acquired assets or the strategy for the Company’s overall business; and
     
  · significant negative industry or economic trends.
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
When management of the Company determines that the carrying value of a long-lived asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, an estimate is made of the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future undiscounted cash flows and eventual disposition is less than the carrying amount of the asset, an impairment loss is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset, based on the fair market value if available, or discounted cash flows if not. To date, the Company has not had an impairment of long-lived assets and is not aware of the existence of any indicators of impairment.
 
Goodwill and Intangible Assets - The Company records goodwill when consideration paid in a business acquisition exceeds the fair value of the net tangible assets and the identified intangible assets acquired. The Company accounts for goodwill and intangible assets in accordance with FASB ASC 350 “Goodwill and Other”. FASB ASC 350 requires that goodwill and intangible assets with indefinite useful lives not be amortized, but instead be tested for impairment at least annually or whenever changes in circumstances indicate that the carrying value of the goodwill may not be recoverable. FASB ASC 350 also requires the Company to amortize intangible assets over their respective finite lives up to their estimated residual values.  At September 30, 2011, using the present value calculation of a net cash flow analysis, the Company determined that due to the decline in revenue and operating income of ATI in 2011, the carrying value of the Company’s goodwill was not fully recoverable and took a charge for the impairment of goodwill in the amount of $450,000 (see Note 2). At December 31, 2011 and 2010, management does not believe there is any further impairment in the value of Goodwill.

Vendor Disputes - The Company’s policy is to include amounts that it intends to dispute or that it has disputed in a reserve account as an offset to accounts payable if management believes that the facts and circumstances related to the dispute provide probable support that the dispute will be resolved in the Company’s favor.

Stock-Based Compensation - The Company has adopted FASB ASC 718 “Compensation – Stock Compensation”.   For grants to employees under its 2004 plan and 2007 plan, the Company estimates the fair value of each option award on the date of grant using the Black-Scholes option-pricing model. Expected volatility is based on the historical volatility of a peer group of publicly traded entities.  The expected term of the options granted is derived from the average midpoint between vesting and the contractual term, as described in the SEC’s Staff Accounting Bulletin No. 107, “Share-Based Payment.”  The risk-free rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The Company did not grant any options during the years ended December 31, 2011 and 2010.

Concentration of Credit Risk - Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, accounts receivable, accounts payable, accrued expenses, and short term debt. The Company maintains its cash with a major financial institution located in the United States. Some balances are insured by the Federal Deposit Insurance Corporation up to $250,000. As of December 31, 2011, the Company had no uninsured cash balances. Periodically throughout the year the Company maintained balances in excess of federally insured limits. The Company encounters a certain amount of risk as a result of a concentration of revenue from a few significant customers and services provided from vendors. Credit is extended to customers based on an evaluation of their financial condition. The Company generally does not require collateral or other security to support accounts receivable. The Company performs ongoing credit evaluations of its customers and records an allowance for potential bad debts based on available information. To date, such losses, if any, have been within management’s expectations.
 
The Company had three customers that accounted for 48% and 59% of net revenue for the years ended December 31, 2011 and 2010, respectively.
 
The Company had an accounts receivable balance from two and three customers that accounted for 41% and 70% of total accounts receivable at December 31, 2011 and 2010, respectively.
 
Income Taxes - The Company accounts for income taxes in accordance with FASB ASC 740, “Income Taxes,” which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using presently enacted tax rates in effect. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
 
Segment and Geographic Information - The Company operates in one principal business segment primarily in the United States. All of the operating results and identified assets are located in the United States.
 
Basic and Diluted Net Loss per Common Share - Basic net income per common share excludes dilution for potential common stock issuances and is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted net income per common share includes dilution for potential common stock issuances when the warrants, options or common stock conversion rights underlying those potential issuances are below the then fair market value of the Company’s common stock and have intrinsic value.  A total of 14,376,633 potential common stock issuances were included in the calculation of diluted net income for the year ended December 31, 2011. A total of 8,192,937 potential common stock issuances were included in the calculation of diluted net income for the year ended December 31, 2010.
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Recently Adopted Accounting Pronouncements - In May 2011, the FASB issued ASU 20 11-04, "Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards ("IFRSs")." Under ASU 2011-04, the guidance amends certain accounting and disclosure requirements related to fair value measurements to ensure that fair value has the same meaning in U.S. GAAP and in IFRSs and that their respective fair value measurement and disclosure requirements are the same.  ASU 2011-04 is effective for public entities during interim and annual periods beginning after December 15, 2011.  Early adoption by public entities is not permitted. The Company does not believe that the adoption of ASU 20 11-04 will have a material impact on the Company's consolidated results of operation and financial condition.

In September 2011, the FASB issued ASU No. 20 11 -08, "Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment," ("ASU 2011-08") which simplifies how entities test goodwill for impairment. This accounting update permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. ASU 2011-08 will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early adoption permitted. The Company does not believe that the adoption of ASU 2011-08 will have a material impact on the Company's consolidated results of operation and financial condition.

Management does not believe that any other recently issued, but not yet effective, accounting standards or pronouncements, if currently adopted, would have a material effect on the Company’s consolidated financial statements.

2 — Acquisition and Intangible Assets
 
In March 2006, the Company acquired all of the outstanding stock of Advanced Tel, Inc. (“ATI”), a switchless reseller of wholesale long-distance services, for a combination of shares of its common stock and cash. The Company acquired ATI to increase its customer base, to add minutes and revenue to its network and to access new sales channels. The initial portion of the purchase price included 308,079 shares of the Company’s common stock, a payable of $250,000 to be paid over the six-month period following the closing and a $150,000 two-year unsecured promissory note in an amount tied to ATI’s working capital of $150,000.  These amounts were payable to the former selling shareholder of ATI who was appointed President of ATI at the acquisition closing date. As of December 31, 2011, $75,000 that remained unpaid to the former selling shareholder was converted into a note payable per the settlement reached on March 14, 2012 (see note 12). The fair value of the shares issued was based on the guaranteed price of $4.87 per share.  The number of shares of common stock consideration paid to the selling shareholder of ATI was subject to an adjustment (or the payment of additional cash in lieu thereof at the option of the Company) if the trading price of the Company’s common stock did not reach a minimum price of $4.87 per share during the two years following the closing date.   The selling shareholder of ATI was also entitled to contingent consideration of common shares and cash during the two succeeding years from the acquisition date upon meeting certain performance targets tied to revenue and profitability.  In December 2008, the Company issued 4,089,930 shares of common stock, with a fair value of $611,043, as full payment of the contingent consideration.  During 2009, the President of ATI departed from the Company.  On March 31, 2011, the former President of ATI filed a law suit against the Company that was arbitrated and settled on March 14, 2012 (see Note 12).

At September 30, 2011, using the present value calculation of a net cash flow analysis, the Company determined that due to the decline in revenue and operating income of ATI in 2011, the carrying value of the Company’s goodwill was not fully recoverable and took a charge for the impairment of goodwill in the amount of $450,000. At December 31, 2011 management does not believe there is any further impairment in the value of Goodwill.
 
3 — Prepayments and Other Current Assets
 
The following is a summary of the Company’s prepayments and other current assets (in thousands):

   
December 31,
 
                                                                                          
 
2011
   
2010
 
   
 
   
 
 
Employee advances
  $ 69     $ 63  
Deferred loan costs
    72       96  
Prepaid expenses
    197       100  
Other current assets
  $ 338     $ 259  
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
4 — Property and Equipment
 
The following is a summary of the Company’s property and equipment (in thousands):

   
December 31,
 
                                                                                                                           
 
2011
   
2010
 
   
 
   
 
 
Telecommunications equipment
  $ 3,340     $ 3,327  
Computer equipment
    203       174  
Telecommunications software
    107       107  
Leasehold improvements, office equipment and furniture
    86       86  
Total property and equipment
    3,736       3,694  
Less: accumulated depreciation and amortization
    (3,618 )     (3,585 )
Property and equipment, net
  $ 118     $ 109  
 
Depreciation expense included in network costs was $27,000 and $28,000 for the years ended December 31, 2011 and 2010, respectively. Depreciation and amortization expense included in general and administrative expenses was $13,000 and $37,000 for the years ended December 31, 2011 and 2010, respectively.
 
In May 2004, the Company entered in an agreement with a vendor to provide certain network equipment. Under the terms of this agreement, the Company could obtain certain telecommunications equipment with a total purchase price of approximately $5.2 million to expand its operations. At December 31, 2010, the Company had purchased telecommunications equipment under this agreement totaling $1,439,000.  In January 2010, the Company executed a modification to the purchase agreement that set the total amount due to be $249,500 which was subsequently reduced to $100,000 and is subject to timely payments by the Company. As part of the modification, the vendor was awarded 200,000 warrants with a strike price of $0.01 and a fair value of $1,179.  The amount was fully paid at December 31, 2011. The amount due under the settlement agreement was $95,000 at December 31, 2010.

In May 2006, the Company entered into a strategic agreement with Cantata Technology, Inc. (“Cantata”), a VoIP equipment and support services provider. Under the terms of this agreement, the Company obtained VoIP equipment to expand its operations. Payments were scheduled to be based on either the actual underlying traffic utilized by each piece of equipment or fixed cash payments. Through December 31, 2009, the Company had purchased VoIP equipment under this agreement totaling $691,000.  The value of the equipment was based on the present value of future scheduled payments.  At December 31, 2009, the Company had accrued $1,096,000 due to Cantata, which was equal to the undiscounted future scheduled payments.  The difference between the undiscounted future payments and the purchase price was recorded to interest expense.  The Company was previously sued by Cantata for breach of contract and lack of payment and the lawsuit was settled in January 2010 for $500,000. The settlement contains a long-term payment plan and is subject to timely payments by the Company. As of December 31, 2011 and 2010, the remaining amount due under the settlement agreement was $242,000 and $340,000, respectively.
 
5 — Accrued Expenses
 
The following is a summary of the Company’s accrued expenses (in thousands):

   
December 31,
 
   
2011
   
2010
 
             
Commissions, network costs and other general accruals
  $ 1,374     $ 1,136  
Accrued USF and Sales Tax
    878       762  
Deferred payroll and other payroll related liabilities
    554       560  
Interest due on convertible promissory notes and other debt
    1,243       1,000  
Payments due to third party providers
    512       350  
Accrued expenses
  $ 4,561     $ 3,808  
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6 — Vendor Settlements, Contingent Gains and Gain on Forgiveness of Debt

During the year ended December 31, 2011, the Company entered into numerous cash payment plan agreements with vendors for amounts less than the liability recorded in accounts payable and accrued expenses and, in some cases, in exchange for the issuance of shares of the Company’s common stock.  As a result of these agreements, the Company recorded a gain on forgiveness of debt of $3,074,000 for the year ended December 31, 2011.  In addition, the Company wrote-off certain accounts payable for Competitive Local Exchange Carriers (“CLEC”) that resulted in a gain of $1,079,000 for the same period and is included in accounts payable write-off.  The CLEC accounts payable were written off based on a two year statute of limitations on such accounts payable balances. Also, the Company has a policy, based on the statute of limitations, as prescribed by law, to write-off accounts payable with written contract more than four years old with no current activity and two years when there is no written agreement. The Company recorded a gain of $688,000 related to these write-offs which is included in accounts payable write-off.  At December 31, 2011, the balance in vendor settlements payable was $3,184,000 including $1,164,000 of deferred gains subject to timely payments. The Company also issued 145,000 shares of its common stock and 145,000 warrants with a fair market value of $5,800 and $2,000, respectively, pursuant to the settlement of vendor obligations. The settlements will be paid in periods ranging from one to thirty months with an aggregate monthly payment of approximately $81,000.   The Company will continue to approach vendors to enter into similar agreements.
 
During the year ended December 31, 2010, the Company entered into numerous cash payment plan agreements with vendors for amounts less than the liability recorded in accounts payable and accrued expenses and, in some cases, in exchange for the issuance of shares of the Company’s common stock.  As a result of these agreements, the Company recorded a gain on forgiveness of debt of $1,243,000 for the year ended December 31, 2010.  In addition, the Company wrote-off certain accounts payable for CLECs that resulted in a gain of $963,000 for the same period and is included in accounts payable write-off.  The CLEC accounts payable were written off based on a two year statute of limitations on such accounts payable balances. Also, the Company has a policy, based on the statute of limitations, to write-off accounts payable more than four years old with no current activity and two years when there is no written agreement. The Company recorded gain of $147,000 related to these write-offs which is included in accounts payable write-off.  These transactions also resulted in vendor settlements payable of $2,841,000 at December 31, 2010 including $1,283,000 of deferred gains subject to timely payments and issuance of 1,610,069 shares of common stock valued at $30,000.
 
7 — Secured Promissory Notes and Advances
 
2008 Bridge Loan - In November and December 2007, the Company received $600,000 in advance payments, pursuant to the sale of secured notes with individual investors, including $330,000 from related parties.  In 2008 the Company received an additional $1,320,000, including $170,000 from related parties, pursuant to the sale of additional secured notes with individual investors, for a total of $1,920,000.  The secured notes were issued on January 16, 2008 and were scheduled to mature 13 to 18 months after issuance (“2008 Bridge Loan”).  The 2008 Bridge Loan was extended in 2009 to July 15, 2010, and then modified on October 5, 2010 (“2008 Bridge Loan Modification”)  to be paid in quarterly installments, of interest, fees and principal, commencing March 31, 2011 and concluding on July 15, 2012.  A partial interest-only payment of $42,600 was made on March 31, 2011 and the June 30, 2011 and September 30, 2011 installment payments on principal and interest were not made. Partial interest-only payments of $6,625 and $6,411 were also made on November 23, 2011 and December 16, 2011, respectively, and, subsequent to December 31, 2011, partial interest-only payments of $6,624 and $3,277 were made in January and February 2012, respectively.  The 2008 Bridge Loan bears interest at a rate of 13% per annum and contain an origination and documentation fee equal to 3% and 2.5%, respectively, of the original principal amount of the note.  All amounts from the installment payment schedule of the 2008 Bridge Loan Modification that became overdue and remain unpaid, bear interest at a rate of 13% per annum. The holder of each note has the right, at any time, to convert the entire principal plus accrued interest and origination and documentation fee, or any portion thereof, into shares of common stock by dividing the conversion amount by $0.25. The 2008 Bridge Loan is collateralized by substantially all of the assets of the Company.  Since inception, the Company has incurred $1,109,000 in interest and fees, including $284,000 and $250,000 during the years ended December 31, 2011 and 2010, respectively.
 
In connection with the notes, the Company originally issued two common stock purchase warrants for every dollar received or 3.84 million common stock purchase warrants with an exercise price of $1.00, (the “Initial Warrants” and the “Additional Warrants”, collectively the “2008 Bridge Origination Warrants”).  These 2008 Bridge Origination Warrants contained terms which resulted in 3.84 million shares of common stock being issued in 2009, in accordance with those terms, to extinguish the 2008 Bridge Origination Warrants.  In exchange for the first extension of the due date from July 15, 2009 to July 15, 2010 the holder received a common stock purchase warrant (“Extension Warrants”) for each dollar of principal with an exercise price of $0.50 per share that were set to expire on July 14, 2016.  The 2008 Bridge Loan Modification extends the term of Extension Warrants to July 14, 2018. In exchange for the 2008 Bridge Loan Modification the holder received a common stock purchase warrant (“2010 Extension Warrants”) for each dollar of principal with an exercise price of $0.01 per share that will expire on October 5, 2017.  The value associated with the 2010 Extension Warrants was $11,000 and was recorded as an offset to the principal balance of the secured notes and is being amortized into interest expenses over the term of the notes using the effective interest method.  The warrants were valued using the Black-Scholes formula.
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
The “Initial Warrants” also contained a put feature which gave the holder the option to put the warrant back to the Company for $0.15 per share and had been carried as a liability in the Company’s financial statements. The put feature was eliminated pursuant to the 2008 Bridge Loan Modification and the $288,000 related liability was reclassified to equity.

2009 Bridge Loan- In November and December 2008, two related party secured note holders advanced an additional $310,000 and in 2009 there were advances of an additional $152,500 from existing note holders, including $65,000 from related parties, paying 13% interest per annum.  On June 12, 2009, the Company entered into a Short Term Loan and Security Agreement (“2009 Bridge Loan”) with the advance lenders.  Per the 2009 Bridge Loan, the maturity date of the loans was extended from June 30, 2009 to February 28, 2010, and then subsequently modified on October 5, 2010 (“2009 Bridge Loan Modification”)  to be paid in quarterly installments, of interest, fees and principal, commencing November 30, 2010 and concluding February 28, 2012.  On November 30, 2010 the note holders waived their initial installment payment for 60 days to receive their first installment payment as of January 31, 2011.  The first installment of $59,300 in interest only was made and then the February 28, 2011, May 31, 2011, August 31, 2011, and November 30, 2011 installment payments on principal and interest were not made. Subsequent to December 31, 2011, the February 28, 2012 final installment payment has also not been made. The 2009 Bridge Loan accrues interest at 13% per annum and contain an origination and documentation fee equal to 3% and 2.5%, respectively, of the original principal amount of the note.  All amounts from the installment payment schedule of the 2009 Bridge Loan Modification that become over and remain unpaid, bear interest at a rate of 13% per annum. The holder of each note has the right, at any time and from time to time, to convert the entire principal plus accrued interest and origination and documentation fee, or any portion thereof, into shares of common stock by dividing the conversion amount by $0.25.  The 2009 Bridge Loan is collateralized by substantially all of the assets of the Company.   Since inception, the Company has incurred $213,000 in interest and fees, including $68,000 and $60,000 during the years ended December 31, 2011 and 2010, respectively.
 
As was the case for the 2008 Bridge Loan warrants, the provisions of the 2009 Bridge Loan warrants included terms that resulted in the company providing shares of common stock in lieu of exercise under certain conditions, which conditions occurred on June 12, 2009 and resulted in the issuance of 1,387,500 common stock to extinguish the 2009 Bridge Original Warrants.  In exchange for the 2009 Bridge Loan Modification the holder received a common stock purchase warrant (“2010 Extension Warrants”) for each dollar of principal with an exercise price of $0.01 per share that expire on October 5, 2017.  The value associated with the 2010 Extension Warrants was $3,000 and was recorded as an offset to the principal balance of the secured notes and is being amortized into interest expenses over the term of the notes using the effective interest method.  The warrants were valued using the Black-Scholes formula.

The total expense recorded by the Company for amortization of the debt discount related to all warrants was $8,000 and $7,000 for the years ended December 31, 2011 and 2010, respectively.  The net amount of the notes was $2,380,000 and $2,371,000 as of December 31, 2011 and 2010, respectively. The Company did not make certain scheduled interest and principal payments on both the 2008 and 2009 Bridge Loans during the year ended December 30, 2011. It has not received a notice of cure or default from any of the note holders in response to the non-payments.
 
8 — Long-Term Debt
 
The Company’s long-term debt consisted of the following:
 
   
December 31,
2011
   
December 31,
2010
 
Vendor settlements
  $ 3,184     $ 2,841  
Secured promissory notes
    2,380       2,371  
Less: Current portion of long-term debt
    (4,584 )     (3,628 )
Long-term debt
  $ 980     $ 1,584  
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
A summary of future maturities of long-term debt are as follows:
2012
  $ 4,584  
2013
    817  
2014
    163  
    $ 5,564  
 
9 — Preferred and Common Stock
 
Preferred Stock - On May 31, 2007, the Company filed an Amended and Restated Articles of Incorporation authorizing 10,000,000 shares of preferred stock, par value $0.001 per share, none of which are issued and outstanding.  On November 19, 2009, the Company filed its Certificate of Designation (“C.D.”) and designated a Series A Preferred stock by resolution of the board of directors.  The C.D. authorized the sale of 250,000 shares of Series A preferred stock at $1.00 per share, with additional rights, preferences, restrictions and privileges as filed with the Nevada Secretary of State.  As of December 31, 2011 and 2010, 25,000 shares of Series A Preferred stock were issued and outstanding at $1.00 per share to a stockholder and secured note holder.
 
Common Stock - As of December 31, 2011, the total number of authorized shares of common stock, par value $0.001 per share, was 150,000,000, of which 74,352,728 shares were issued and outstanding.

Private Placement of Securities – During 2011, the Company issued 1,232,305 shares of its common stock pursuant to the exercise of warrants.  The Company received proceeds of $9,858 in connection with the issuance. During 2011, the Company also issued 145,000 shares of its common stock with a fair market value of $5,800 pursuant to the settlement of a vendor obligation.
 
10 — Stock Options and Warrants

2004 Stock Option Plan - Effective January 1, 2004, the Company’s Board of Directors adopted the 2004 Stock Option Plan for Directors, Officers, and Employees of and Consultants to InterMetro Communications, Inc. (the “2004 Plan”).  A total of 5,730,222 shares of the Company’s common stock had been reserved for issuance under the 2004 Plan. Upon shareholder ratification of the 2004 Plan pursuant to the definitive Information Statement on Schedule 14C filed with the Securities and Exchange Commission on March 6, 2007, the Company froze any further grants of stock options under the 2004 Plan. Any shares reserved for issuance under the 2004 Plan that were not needed for outstanding options granted under that plan were cancelled and returned to treasury shares. 
 
As of  December 31, 2011, the Company has granted a total of 5,714,819 stock options under the 2004 Plan to the officers, directors, and employees, and consultants of the Company, of which 308,077 expired in September 2007 and an additional 523,734 expired during the year ended December 31, 2008.  In the three months ended March 31, 2008, the Company issued 1,143,165 shares of common stock on the cashless exercise of 1,232,320 stock purchase options.  The remaining 3,650,688 are fully vested at December 31, 2011 and were originally granted with exercise prices ranging from $0.04 to $0.97 per share.  On November 15, 2010, in order to provide continued economic incentive to option holders, most of whose options were issued at prices that were “out of the money”, the Board of Directors authorized a re-pricing of all the stock options under the 2004 Plan to $0.01, the closing price of the Company’s common stock on that day. The incremental compensation cost computed using the Black-Scholes option pricing model was $14,000 which was charged to expense on that date.
 
Omnibus Stock and Incentive Plan Effective January 19, 2007, our Board of Directors approved the 2007 Omnibus Stock and Incentive Plan (the “2007 Plan”) for directors, officers, employees, and consultants. Our shareholders ratified the 2007 Plan pursuant to the Schedule 14C Information Statement filed with the Securities and Exchange Commission which was declared effective on May 10, 2007.   Any employee or director of, or consultant for, us or any of the Company’s subsidiaries or other affiliates will be eligible to receive awards under the 2007 Plan. The Company has reserved 12,552,181 shares of common stock for awards under the 2007 Plan. The 2007 Plan specifically prohibits the re-pricing of any stock options awarded under this plan.
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
In November 2007, InterMetro granted 2,350,000 stock options to purchase shares of common stock under the 2007 Plan at an average exercise price of $0.25 per share to employees and directors. 1,095,000 of the shares granted were immediately vested at date of grant.  In October 2008, InterMetro granted 600,000 stock options to purchase shares of common stock under the 2007 Plan at an average exercise price of $0.25 per share to employees and directors. 30% vested at date of grant with the remaining vesting 1/12 per subsequent quarter over the succeeding 3 years expiring 5 years from date of grant.
 
For the years ended December 31, 2011 and 2010 there were no grants under the 2007 Plan. As of December 31, 2011, none of the Company’s outstanding stock options under the 2007 Plan have been exercised.
 
The following presents a summary of activity under the Company’s 2004 and 2007 Plans for the years ended December 31, 2011 and 2010: 
 
   
Number of Shares
   
Price per Share
   
Weighted Average Exercise Price
   
Weighted Average Remaining Contractual Term
   
Aggregate Intrinsic Value
 
                               
Options outstanding at December 31, 2009
    6,600,688     $     $ 0.21       6.16     $ 0.0  
Granted
                                 
Exercised
                                 
 Forfeited/expired
                                 
                                   
Options outstanding at December 31, 2010
    6,600,688               0.12       5.16     $ 182,534  
Granted
                                 
Exercised
                                 
 Forfeited/expired
                                 
                                         
Options outstanding at December 31, 2011
    6,600,688     $       $ 0.12       4.16     $ 146,028  
                                         
Options exercisable at December 31, 2011
    6,600,688     $       $ 0.12       4.16     $ 146,028  
 
The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last day of the year ended December 31, 2011 and the exercises price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2011.  This amount changes based on the fair market value of the Company’s stock.  As of December 31, 2011, there remain 9,602,181 shares available for grant.
 
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Additional information with respect to the outstanding options at December 31, 2011 is as follows:

     
Options Outstanding
         
Options Exercisable
 
Exercise Prices
   
Number
of Shares
   
Average
Remaining
Contractual
Life
(in Years)
   
Weighted
Average
Exercise
Price
   
Number
of Shares
   
Weighted
Average
Exercise Price
 
 
   
 
   
 
   
 
   
 
   
 
 
$ 0.01       1,478,748       2.00     $ 0.01       1,478,748     $ 0.01  
  0.01       154,039       2.25       0.01       154,039       0.01  
  0.01       431,307       2.50       0.01       431,307       0.01  
  0.01       123,231       3.00       0.01       123,231       0.01  
  0.01       277,269       3.75       0.01       277,269       0.01  
  0.25       2,950,000       5.75       0.25       2,950,000       0.25  
  0.01       338,884       3.75       0.01       338,884       0.01  
  0.01       643,880       4.00       0.01       643,880       0.01  
  0.01       110,907       4.00       0.01       110,907       0.01  
  0.01       92,423       4.25       0.01       92,423       0.01  
          6,600,688                       6,600,688          
 
As of December 31, 2011, there was no unrecognized compensation cost related to unvested share based compensation arrangements granted under the 2004 and 2007 option plans.
 
Warrants – Historically, the Company has issued warrants to providers of equipment financing.  For a detailed description of the warrants issued in connection with equipment financing arrangements, see Note 4.

On April 30, 2008, the Company negotiated a revolving line of credit, which, as amended in September 2008, November 2008, May 2009, January 2010, September 2010 and December 2010, March 31, 2011, June 30, 2011, September 30, 2011 and November 30, 2011, allows the company to borrow up to $2.4 million.  Warrants to purchase 14,133,503 shares of the Company’s common stock at an exercise price of $0.01 to $0.05 per share were granted in connection with securing and amending this credit facility.  See Note 11 for a detail of the warrants issued in connection with this credit facility.

The Company has issued warrants to its secured note holders in connection with the execution of the loan agreements and subsequent amendments.  Warrants to purchase an aggregate of 4,302,500 shares of the Company’s common stock with exercise prices ranging from $0.01 to $0.50 were outstanding with these note holders as of December 31, 2011 and 2010. See Note 7 for further details of these warrants.
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
11 — Credit Facilities

ATI Bank Lines of Credit – ATI has two $100,000 lines of credit.  The line of credit with Bank of America has an interest rate of 7.13% per annum.  The line of credit with Wells Fargo Bank has an interest rate of 6.75 % per annum.   The lines of credit had been personally guaranteed by the former stockholder of ATI. Borrowings under these lines of credit amounted to approximately $172,000 and $192,000 at December 31, 2011 and 2010, respectively.  On March 31, 2011 the former stockholder of ATI filed a lawsuit against the Company.  On November 30, 2011, the parties arbitrated a settlement with precedent conditions to be performed by the Company in March 2012, which resulted in the payoff of one line for $99,000 and the refinance of the other (see Note 12).

Revolving Credit Facility - The Company entered into certain agreements, including a Loan and Security Agreement (as subsequently amended, the “Agreement”), effective as of April 30, 2008 with Moriah Capital, L.P. (“Moriah”), pursuant to which the Company could borrow up to $2,400,000 which, per Amendments No. 1, No. 2 and No. 3 to the Agreement, was increased to $2,575,000 per an over-advance in Amendment No. 4. (the “Amendments), $25,000 of the over-advance was due and payable on July 31, 2009 and was paid in November, 2009 with the additional $50,000 over-advance paid during the year ended December 31, 2010.  The Company also paid $500,000 in principal during 2010.
 
Pursuant to the Agreement, the Company was permitted to borrow an amount not to exceed 80% of its eligible accounts (as defined in the Agreement), net of all discounts, allowances and credits given or claimed. Pursuant to the Amendments, from September 10, 2008 through November 4, 2008 this borrowing base increased to 110% of eligible accounts, from November 5, 2008 through December 15, 2008 increased to 135% of eligible accounts, from December 16, 2008 to January 15, 2009 decreased to 120% of eligible accounts, from January 16, 2009 through May 1, 2009 decreased to 110% of the eligible accounts, from May 1, 2009 to July 31, 2009 increased to 120% of eligible accounts, from August 1, 2009 to September 30, 2009 decreased to 100% and thereafter decreased to 85%.  The Company's obligations under the loans are secured by all of the assets of the Company, including but not limited to accounts receivable; provided, however, that Moriah’s lien on the collateral other than accounts receivable (as such terms are defined in the Agreement) are subject to the prior lien of the holders of the Company’s outstanding secured notes.  The Agreement includes covenants that the Company must maintain including financial covenants pertaining to cash flow coverage of interest and fixed charges, limitations on the ratio of debt to cash flow and a minimum ratio of current assets to current liabilities. The Company is not in compliance with one of the financial covenants as of December 31, 2011. Amendment No. 8 extended the term to June 30, 2011, Amendment No. 9 extended the term to September 30, 2011, Amendment No. 10 extended the term to November 30, 2011 and Amendment No. 11 extended the term to March  30, 2012. The Company is currently in negotiations for a further extension of the due date.

Annual interest on the credit facility is equal to the greater of (i) the sum of (A) the Prime Rate as reported in the “Money Rates” column of The Wall Street Journal, adjusted as and when such Prime Rate changes plus (B) 4% or (ii) 15%, and is payable in arrears prior to the maturity date, on the first business day of each calendar month, and in full on March 30, 2012.  (See Note 1.)

In accordance with the agreement, the outstanding amount of the loan at any given time may be converted into shares of the Company's common stock at the option of the lender. The conversion price was $1.00, subject to adjustments and limitations as provided in the Agreements.
 
The Company has also agreed to register the resale of shares of the Company's common stock issuable under the Agreement and the shares issuable upon conversion of the convertible note if the Company files a registration statement for its own account or for the account of any holder of the Company’s common stock.

As part of the original transaction, Moriah received Warrant #1 to purchase 2,000,000 shares of the Company’s common stock with an exercise price of $1.00 which expire on April 30, 2015.  As part of the Amendments No.1 and No. 2, Moriah received warrants to purchase an additional 1,000,000 and 3,000,000 shares, respectively, of the Company’s common stock under the same terms as the original 2,000,000 warrants.   The Company accounts for the issuance of detachable stock purchase warrants in accordance with FASB ASC 470-20 “Debt With Conversion and Other Options”, whereby it separately measures the fair value of the debt and the detachable warrants, and in the case of detachable warrants with put features to the Company for cash, it also values the put feature as a separate component of the detachable warrant, and allocates the proceeds from the debt on a pro-rata basis to each. The resulting discount from the fair value of the debt allocated to the warrant and put feature for cash, which are accounted for as paid-in capital and a liability, respectively, is amortized over the estimated life of the debt.   The warrants were valued using the Black-Scholes option-pricing model using the assumptions noted in the table below.  The value associated with the 6,000,000 warrants was $928,000 and was recorded as an offset to the principal balance of the revolving credit facility and was amortized on a straight-line basis through April 2009.  As discussed below, the put option liability was $250,000 and the $678,000 difference was credited to Additional Paid in Capital.
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Pursuant to Amendment No. 4 dated May 22, 2009, effective as of April 30, 2009, Moriah received 1,000,000 seven year warrants with an exercise price of $0.01. The warrants were valued using the Black-Scholes option-pricing model using assumptions in the table below.  The value associated with the 1,000,000 warrants was $45,000 and was recorded as an offset to the principal balance of the revolving credit facility and was amortized on a straight-line basis through January 2010.  The warrant put option liability was increased to $437,500 and the $187,500 increase in the liability was recorded as an offset to the principal balance of the revolving credit facility and was amortized on a straight-line basis through January 2010.  In addition, Amendment No. 4 reduced the exercise price per share of the previous 6,000,000 warrants from $1.00 to $0.25.  As a result of re-pricing, incremental cost of $19,000 was recorded as debt discount.  Of this an amount $19,000 was recorded as debt discount and was fully amortized as of December 31, 2010.

Pursuant to Amendment No. 5 effective January 31, 2010, Moriah received 2,000,000 seven year warrants with an exercise price of $0.01.  The warrants have been valued using the Black-Scholes option-pricing model.  The value associated with the 2,000,000 warrants was $11,800 and was amortized on a straight-line basis in full during 2010. Also pursuant to Amendment No.5, the previously issued 6,000,000 warrants were restated with the exercise price reduced to $0.05 from $0.25 thereby resulting in an incremental cost of $8,400 amortized fully during 2010.  In addition, pursuant to Amendment No. 5 the interest rate for the facility was increased from 10% to 11%.

Pursuant to Amendment No. 6 entered into September 29, 2010 and effective April 30, 2010, the Company agreed to make regular principal reductions that would permanently reduce the maximum amount borrowed to $1,450,000 by December 31, 2010. As previously amended, the Company had issued to Moriah Warrants #1 to #6 to purchase a total of 9,000,000 shares of the Company's common stock, 6,000,000 of which have an exercise price of $0.05 and 3,000,000 of which have an exercise price of $0.01 and which collectively expire on various dates between April 30, 2015 and February 28, 2017.   The Company had also previously granted Moriah an option, as part of the Agreement, pursuant to which Moriah could sell the 2,000,000 shares subject to Warrant #1 back to the Company for $437,500.  The Company, as part of Amendment No. 6, issued to Moriah an additional warrant (Warrant #8) to purchase 1,500,000 shares of common stock with an exercise price of $0.01 and a term of seven years, which, in combination with the aforementioned Warrant #1 (exercisable for a total of 3,500,000 shares) could be sold back to the Company for $437,500 between July 1, 2011 and July 30, 2011.  In addition, as part of Amendment No. 6, the Company issued to Moriah a warrant (Warrant #7) to purchase 2,000,000 shares of the Company's common stock with an exercise price of $0.01 and a term of seven years and also granted Moriah an option to sell this warrant (Warrant #7) back to the Company for $280,000 between July 1, 2011 and July 30, 2011.  The warrants issued pursuant to Amendment No. 6 have been valued using the Black-Scholes option-pricing model.  The value associated with the 3,500,000 warrants is $20,400 and was amortized on a straight-line basis over the extended term of the agreement, of which $6,000 wa amortized during the twelve months ended December 31, 2011.

Pursuant to Amendment No. 7 entered into in March 2011 and effective December 31, 2010, the maximum amount that could be borrowed at December 31, 2010 is $2,400,000.  The Company has made payments on the line of credit that have reduced the outstanding advances to $2,000,000 at December 31, 2011.  Also pursuant to Amendment No. 7, the term of all warrants issued to Moriah was extended by two years.  The extension of the warrants has been valued using the Black-Scholes option-pricing model. The value associated with the extension was $14,000 and was charged to interest expense during 2011.

  Pursuant to Amendment No. 8 entered into in May 2011 and effective March 30, 2011, the term of the Agreement was extended to June 30, 2011 and the Company incurred loan costs of $30,000 that was amortized during the three months ended June 30, 2011.

Pursuant to Amendment No. 9 entered into in August 2011 and effective June 30, 2011, the term of the Agreement was extended to September 30, 2011 and the Company incurred loan costs of $36,000 that were amortized during the three months ended September 30, 2011. Also pursuant to Amendment No. 9, the Company issued to Moriah warrants to purchase 1,000,000 and 500,000 shares of the Company’s common stock at July 31, 2011 and August 31, 2011, respectively, (Warrant #9 and Warrant #10). The warrants have an exercise price of $0.10 and will expire on July 31, 2020 and August 31, 2020, respectively. The aggregate value associated with the Warrant #9 and #10 issuance was $30,000 and was amortized during the three months ended September 30, 2011.

In connection with Amendment No. 9, Moriah exercised its put option related to Warrant #1 and surrendered 766,497 shares subject to Warrant #1 for an amount of $100,000. Further, in consideration for inclusion of the put interest for Warrants #9 and #10 in the Warrant #7 put interest, the Warrant #7 put price was increased from $280,000 to $350,000.
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Pursuant to Amendment No. 10 entered into in November 2011 and effective September 30, 2011, the term of the Agreement was extended to November 30, 2011 and the Company incurred loan costs of $24,000 that were amortized over the extended term of the agreement. Also pursuant to Amendment No. 10, the Company issued to Moriah warrants to purchase 600,000 shares of the Company’s common stock (Warrant #11). The warrant had an exercise price of $0.05 and will expire on September 30, 2020. The value associated with the Warrant #11issuance was $15,000 and was amortized over the extended term of the agreement.  In consideration for inclusion of the put interest for Warrant #11 in the Warrant #7 put interest, the Warrant #7 put price, as previously modified in Amendment No. 9, was increased from $350,000 to $400,000.
 
 Pursuant to Amendment No. 11 entered into in January 2012 and effective November 30, 2011, the term of the Agreement was extended to March 30. 2012 and the Company incurred loan costs of $96,000 that are being amortized over the extended term of the agreement. Also pursuant to Amendment No. 11, the Company issued to Moriah warrants to purchase 300,000 shares of the Company’s common stock (Warrant #12). The warrant has an exercise price of $0.05 and will expire on November 29, 2020. The value associated with the Warrant #12 issuance is $6,900 and is being amortized on a straight-line basis over the extended term of the agreement.  Seventy five percent (75%) of the put interest for Warrant #12 is to be included in the Warrant #7 put interest. The availability of loan amounts under the Agreement expires at March 30, 2012 and all amounts will be due at that time. The Company is engaged in discussions with Moriah to extend the due date of the Agreement.

The expense recognized by the Company in the years ended December 31, 2011 and 2010 from the amortization of the debt discount related to warrants was $52,000 and $57,000, respectively.  The Company calculated the fair value of the warrants using the following assumptions:

   
December 31, 2011
   
December 31, 2010
 
Risk-free interest rate
  0.4% to 2.7 %     0.7% to 2.7 %  
Expected lives (in years)  
 
3.2 to 4.5 years
   
3.2 to 4.4 years
 
Dividend yield
    0 %     0 %
Expected volatility
    82.0 %     86.0 %
Forfeiture rate
    0 %     0 %
 
Pursuant to various Agreements and Amendments Moriah may sell certain warrants back to the Company for $437,500 at any time during the 30 day period commencing on the earlier of the prepayment in full of all loans or January 31, 2010. As noted above, as part of Amendment No. 6 the Company granted Moriah an additional option pursuant to which Moriah can sell warrants back to the Company for $280,000, subsequently increased to $400,000 by Amendment No. 10.  The Company has determined that the put options associated with the warrants causes the instrument to contain a net cash settlement feature. In accordance with FASB ASC 480 “Distinguishing Liabilities from Equity,” the put option requires liability treatment.  As a result, the put warrant liability was recorded at the warrant purchase price of $737,500 as of December 31, 2011.  The debt discount associated with the put liability for the warrant put feature is amortized over the extended terms of the agreement.  An amount of $196,000 and $224,000 was amortized during the years ended December 31, 2011 and 2010, respectively.

Pursuant to various amendments to the Agreement, the Company recognized interest expense of $304,000 and $327,000 for the years ended December 31, 2011 and 2010, respectively and amortization of loan costs of $210,000 and $236,000 for the same periods, respectively.  At December 31, 2011 and 2010, the Company recorded deferred loan costs of $72,000 and $96,000, respectively.
 
12 — Commitments and Contingencies
 
Facility Lease – The Company leases its facilities under a non-cancelable operating lease that expires on March 31, 2013 at an annual expense of approximately $168,000.  Rent expense for the Company’s facilities for the years ended December 31, 2011 and 2010 was $192,000 and $213,000, respectively.
 
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Vendor Agreements – The Company has entered into agreements with its network partners and other vendors for various services which are, in general, for periods of twelve months and provide for month to month renewal periods.

Vendor Disputes – It is not unusual in the Company’s industry to occasionally have disagreements with vendors relating to the amounts billed for services provided between the recipient of those services and the vendor, or in some cases, to receive invoices from companies that the Company does not consider a vendor. The Company currently has disputes with a vendor that it believes did not bill certain charges correctly or should not have billed any charges at all. The Company’s policy is to include amounts that it intends to dispute or that it has disputed in a reserve account as an offset to accounts payable if management believes that the facts and circumstances related to the dispute provide probable support that the dispute will be resolved in the Company’s favor.  As of December 31, 2011, there were approximately $61,000 of disputed payables that were recorded as an offset to accounts payable at December 31, 2011. The Company is in discussion with the significant vendor that has sent invoices regarding these charges. Management does not believe that any settlement would have a material adverse effect on the Company’s financial position or results of operations. Management reviews available information and determines the need for recording an estimate of the potential exposure when the amount is probable, reasonable and estimable based on FASB ASC 450 “Contingencies.”

The Company has periodically received “credit hold” and disconnect notices from major telecommunications carriers.  Suspension of service by any major carrier could have a material adverse effect on the Company’s operations and financial condition.  These disconnect notices were generated primarily due to the non-payment of charges claimed by each carrier, including some amounts disputed by the Company.  Service has been maintained with each carrier, although further notices are possible if the Company is unable to make timely payments to its counterparties or to resolve the disputed amounts.  Such payments would be in addition to current charges generated with such carriers.

The Company has received several notices from state and local regulatory and taxing authorities for its possible failure to file certain documents pertaining to the Company’s wholly-owned subsidiary ATI.  The amounts at issue with these potential filings are not material.

Legal Proceedings

A Network Service Provider – On October 12, 2010, the Company was served a complaint filed by a network service provider (“NSP”) against the Company asserting various causes of action.  The NSP claims that the Company owes various charges totaling $505,583. The Company denied that it owed this amount.  The Company and NSP settle the complaint on August 12, 2011 for $100,000, subject to timely payment through January 2013. The remaining amount due under the settlement was $65,000 at December 31, 2011.

On March 31, 2011, the Company was notified that the seller and the former president of Advanced Tel, Inc, (“ATI”) the Company’s wholly owned subsidiary, had filed suit against the Company asserting, among other things, that the Company owed said seller certain amounts related to the agreement entered into by the parties (“Purchase Agreement”) when the Company purchased ATI in 2006.  On November 30, 2011, the parties arbitrated a settlement with precedent conditions to be performed by the Company in the first quarter of 2012, conditions that were met on March 14, 2012 resulting in dismissal of the suit on March 14, 2012.  As part of the settlement the Company will void the disputed 4,089,930 shares originally issued to the seller in 2008 as part of the stock compensation in the Purchase Agreement and the seller will return to the Company the 308,079 shares issued to him in 2006 also originally part of the Purchase Agreement.  All shares will return to the Company’s Treasury.   The company will pay the seller a total of $200,000, which was accrued at December 31, 2011 and subject to timely monthly payments through March 2017.

A Network Service Provider – On October 26, 2011, the Company was served a complaint filed by a network service provider (“NSP”) against the Company asserting various causes of action.  The NSP claimed that the Company owed various charges totaling $150,926. The Company denies that it owes this amount and believes the NSP owes the Company higher amounts which offset this claim.   The Company filed a cross-complaint against the NSP on December 1, 2011 for charges owed the Company totaling $280,403.
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Universal Service Administrative Company – The Universal Service Administrative Company (USAC) administers the Universal Service Fund (USF).  In 2009 and 2010 the Company did not make all of the payments claimed by the USAC in a timely manner and USAC transferred these unpaid amounts to the Federal Communications Commission (FCC) for collection.  The FCC has transferred some of these unpaid amounts to the Department of the Treasury which worked with the Company to establish long term payment plans.   Should any of the remaining unpaid amounts with the FCC transfer from the FCC to Treasury, additional fees, surcharges and penalties will be added to the amount due.  As of December 31, 2011, the Company has recorded an aggregate $1.3 million in connection with the USF.  The Company continues to work with the FCC and the Department of the Treasury to resolve these amounts in long term payment programs.  Failure to finalize any significant proposed payment plan would likely have a material adverse effect on the Company.

Consulting Agreement – Commencing in December 2006, the Company entered into a three-year consulting agreement with an affiliate of a stockholder and debt holder pursuant to which the Company received services related to strategic planning, investor relations, acquisitions, and corporate governance.  The Company was obligated to pay $13,000 a month for these services, subject to annual increases.  In June 2008, the parties orally agreed to cancel the agreement and any future obligation.  Included in accounts payable is $182,000 at December 31, 2011 and 2010 for unpaid amounts.
 
13 — Income Taxes
 
At December 31, 2011, the Company had net operating loss carryforwards to offset future taxable income, if any, of approximately $40 million for Federal and State taxes. The Federal net operating loss carryforwards begin to expire in 2021. The State net operating loss carryforwards began to expire in 2008.
 
 The following is a summary of the Company’s deferred tax assets and liabilities (dollars in thousands):
 
   
December 31,
 
   
2011
   
2010
 
             
Current assets and liabilities:
           
Deferred revenue
  $ 78     $ (88 )
     Allowance for doubtful accounts
    160       340  
Accrued expenses
    668       1,523  
      906       1,775  
Valuation allowance
    (906     (1,775 )
                 
Net current deferred tax asset
  $     $  
                 
Non-current assets and liabilities:
               
Depreciation and amortization
  $ 127     $ (23 )
Net operating loss carryforward
    15,956       18,421  
      16,083       18,398  
Valuation allowance
    (16,083 )     (18,398 )
Net non-current deferred tax asset
  $     $  
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
The reconciliation between the statutory income tax rate and the effective rate is as follows:

  
 
For the Year Ended
December 31,
 
   
2011
   
2010
 
   
 
   
 
 
Federal statutory tax rate
    (34 )%     (34 )%  
State and local taxes
    (6 )     (6 )
Valuation reserve for income taxes                               
    40       40  
Effective tax rate
    %     %
 
Management has concluded that it is more likely than not that the Company will not have sufficient taxable income within the carryforward period permitted by current law to allow for the utilization of certain of the deductible amounts generating the deferred tax assets; therefore, a full valuation allowance has been established to reduce the net deferred tax assets to zero at December 31, 2011 and 2010.
 
The Company has adopted the provision of FASB ASC 740, “Income Tax” which clarifies the accounting for uncertainty in tax positions.  FASB ASC 740 requires the recognition of the impact of a tax position in the financial statements if that position is more likely than not of being sustained on a tax return upon examination by the relevant taxing authority, based on the technical merits of the position.  The adoption of FASB ASC 740 had no effect on the Company’s financial position or results of operations.  At December 31, 2011 and 2010, the Company had no unrecognized tax benefits.
 
The Company recognizes interest and penalties related to income tax matters in interest expense and operating expenses, respectively.  As of December 31, 2011 and 2010, the Company has no accrued interest and penalties related to uncertain tax positions.
 
The Company is subject to taxation in the United States of America (“U.S.”) and files tax returns in the U.S. federal jurisdiction and California (or various) state jurisdiction (s). The Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years before 2007. The Company currently is not under examination by any tax authority.  The Company is currently in the process of filing amended tax returns for the year 2010.
 
14 — Cash Flow Disclosures
 
The table following presents a summary of the Company’s supplemental cash flow information (dollars in thousands):

   
Year Ended December 31,
 
   
2011
   
2010
 
             
Cash paid:
           
Interest
  $ 544     $ 474  
                 
Non-cash information:                                                                                
               
Stock and warrant issued for debt
  $ 60     $ 72  
                 
Fair value of debt discount
  $     $ 348  
                 
Note payable due to former stockholder
  $ 125     $  
                 
 Liability for warrant and shares put feature
  $ 120     $ 280  
                 
Reclassification of shares and warrants put liability to equity
  $     $ 288  
                 
 
 
 
INTERMETRO COMMUNICATIONS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
15 — Consulting Fee
 
Effective September 1, 2009, the Company entered into a consulting agreement with one of its board members to provide consulting services.  The Company was obligated to pay $6,250 per month plus out of pocket expenses for these services for the period September 1, 2009 to October 31, 2009, then $10,000 per month plus out of pocket expense through January 2011and $15,000 and out of pocket expenses beginning in February 2011.  The Company incurred consulting fees under this agreement in the amount of $175,000 and $120,000 for the years ended December 31, 2011 and 2010, respectively.
 
16 — Quarterly Results (Unaudited)

                         
   
First Quarter
   
Second Quarter
   
Third Quarter
   
Fourth Quarter
 
For the Year Ended December 31, 2011                 
 
 
   
 
   
 
   
 
 
Net revenues
  $ 6,256     $ 5,359     $ 4,940     $ 4,752  
Operating income (loss)
    506       197       (756 )     27  
Net income
    2,027       345       541       704  
Basic earnings per share
  $ 0.03     $ 0.00     $ 0.01     $ 0.01  
Diluted earnings per share
  $ 0.02     $ 0.00     $ 0.01     $ 0.00  
For the Year Ended December 31, 2010
                               
Net revenues
  $ 5,919     $ 5,770     $ 7,593     $ 8,752  
Operating income
    526       248       989       1,116  
Net income
    1,116       124       750       1,221  
Basic earnings per share
  $ 0.02     $ 0.00     $ 0.01     $ 0.01  
Diluted earnings per share
  $ 0.02     $ 0.00     $ 0.01     $ 0.01  

 The Company recorded a number of adjustments during the fourth quarter of the year ended December 31, 2011 including  the gains described in Note 6 that aggregated to $967,000 in the fourth quarter of the fiscal year.