PINX:TNIX Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 

 
FORM 10-Q
 

 
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended June 30, 2012

or

o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from           to          

Commission file number 000-51995

TELANETIX, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
77-0622733
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
11201 SE 8th Street, Suite 200
Bellevue, Washington
 
98004
(Address of principal executive offices)
 
(Zip Code)

(206) 621-3500
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x    No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company x

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

As of August, 10, 2012, 4,820,098 shares (post reverse stock split) of the issuer's common stock, par value $0.0001 per share, were outstanding.  The common stock is the issuer's only class of stock currently outstanding.
 
 
Telanetix, Inc.
 
Quarterly Report on Form 10-Q
 
For the Three Months Ended June 30, 2102
 
TABLE OF CONTENTS

 

 
In this report, unless the context indicates otherwise, the terms "Telanetix," "Company," "we," "us," and "our" refer to Telanetix, Inc., a Delaware corporation, and its wholly-owned subsidiaries.

On June 1, 2011, the Company effected a 1 to 75 reverse stock split of its authorized common stock and preferred stock. The number of shares outstanding has been adjusted retrospectively to reflect the reverse stock split in all periods presented. Also, the exercise price and the number of common shares issuable under the Company’s share-based compensation plans and the authorized and issued share capital have been adjusted retrospectively to reflect the reverse stock split.
 
FORWARD LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, or the "Securities Act," and Section 21E of the Securities Exchange Act of 1934 or the "Exchange Act."  In some cases, you can identify forward looking statements by terms such as "may," "intend," "might," "will," "should," "could," "would," "expect," "believe," "anticipate," "estimate," "predict," "potential," or the negative of these terms.  These terms and similar expressions are intended to identify forward-looking statements.  Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected, including those set forth under the heading "Risk Factors" and elsewhere in, or incorporated by reference into, this report.
 
The forward-looking statements in this report are based upon management's current expectations, which management believes are reasonable.  We cannot assess the impact of each factor on our business or the extent to which any factor or combination of factors, or factors we are unaware of, may cause actual results to differ materially from those contained in any forward-looking statements.  You are cautioned not to place undue reliance on any forward-looking statements.  These statements represent our estimates and assumptions only as of the date of this Quarterly Report on Form 10-Q.  Except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
 
You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including:

 
·  
new competitors and new technologies may further increase competition;
 
·  
our operating costs may increase beyond our current expectations and we may be unable to fully implement our current business plan;
 
·  
our ability to obtain future financing or funds when needed;
 
·  
our ability to successfully obtain a diverse customer base;
 
·  
our ability to protect our intellectual property through patents, trademarks, copyrights and confidentiality agreements;
 
·  
our ability to attract and retain a qualified employee base;
 
·  
our ability to respond to new developments in technology and new applications of existing technology before our competitors;
 
·  
acquisitions, business combinations, strategic partnerships, divestures, and other significant transactions may involve additional uncertainties; and
 
·  
 our ability to maintain and execute a successful business strategy.     
                                                                                              
You should consider carefully the statements under "Item 1A. Risk Factors" in Part II of this report and other sections of this report, which address factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition.  All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the applicable cautionary statements.
 
 
PART I--FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS
 
TELANETIX, INC.
Condensed Consolidated Balance Sheets
 
    June 30, 2012     December 31, 2011  
   
(Unaudited)
         
ASSETS
               
Current assets
               
  Cash
 
$
2,305,954
   
 $
1,840,265
 
  Accounts receivable, net
   
1,790,877
     
1,925,955
 
  Inventory
   
52,363
     
113,305
 
  Prepaid expenses and other current assets
   
1,025,716
     
675,045
 
        Total current assets
   
5,174,910
     
4,554,570
 
Property and equipment, net
   
1,235,084
     
1,683,337
 
Goodwill
   
7,044,864
     
7,044,864
 
Purchased intangibles, net
   
7,878,337
     
8,978,337
 
Other assets
   
364,850
     
379,496
 
        Total assets
 
$
21,698,045
   
 $
22,640,604
 
                 
LIABILITIES AND STOCKHOLDERS' DEFICIT
               
Current liabilities
               
  Accounts payable
 
$
1,569,931
   
 $
1,524,645
 
  Accrued liabilities
   
2,649,722
     
2,538,829
 
  Deferred revenue
   
1,065,794
     
1,063,548
 
  Current portion of capital lease obligations
   
533,632
     
356,227
 
  Current portion of long-term debt
   
4,604,426
     
3,502,213
 
        Total current liabilities
   
10,423,505
     
8,985,462
 
Non-current liabilities
               
  Deferred revenue, net of current portion
   
137,436
     
170,219
 
  Capital lease obligations, net of current portion
   
820,885
     
353,860
 
  Long-term, accounts payable
   
26,988
     
39,444
 
  Long-term debt, net of current portion
   
2,960,195
     
4,306,218
 
        Total non-current liabilities
   
3,945,504
     
4,869,741
 
        Total liabilities
   
14,369,009
     
13,855,203
 
Stockholders' equity (deficit)
               
Common stock, $.0001 par value; Authorized: 8,000,000 shares;
Issued and outstanding: 4,820,098 at June 30, 2012
and December 31, 2011, respectively
482
     
482
 
  Additional paid in capital
   
44,288,802
     
44,084,429
 
  Warrants
   
56,953
     
56,953
 
  Accumulated deficit
   
           (37,017,201)
     
 (35,356,463)
 
        Total stockholders' equity (deficit)
   
7,329,036
     
      8,785,401
 
        Total liabilities and stockholders' equity (deficit)
 
$
21,698,045
   
$
22,640,604
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
 
 
 TELANETIX, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
 
   
Three months ended June 30,
   
Six months ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Revenues
  $ 7,861,644     $ 6,994,902     $ 15,681,668     $ 13,929,303  
                                 
Cost of revenues
    3,311,487       2,991,432       6,479,434       5,861,829  
                                 
Gross profit
    4,550,157       4,003,470       9,202,234       8,067,474  
                                 
Operating expenses
                               
Selling and marketing
    1,625,866       1,727,112       3,351,190       3,475,405  
General and administrative
    1,817,640       1,839,118       3,753,903       3,740,197  
Research, development and engineering
    507,205       464,625       977,015       943,135  
Depreciation
    155,160       159,070       317,166       311,884  
Amortization of purchased intangibles
    550,000       550,000       1,100,000       1,100,000  
Total operating expenses
    4,655,871       4,739,925       9,499,274       9,570,621  
                                 
Operating loss
    (105,714 )     (736,455 )     (297,040 )     (1,503,147 )
                                 
Other income (expense)
                               
Interest income
    25       64       58       197  
Interest expense
    (647,292 )     (919,411 )     (1,307,082 )     (1,763,928 )
Total other income (expense)
    (647,267 )     (919,347 )     (1,307,024 )     (1,763,731 )
                                 
(Loss) from continuing operations before taxes
    (752,981 )     (1,655,802 )     (1,604,064 )     (3,266,878 )
                                 
Income tax (expense)
    (49,200 )           (56,674 )      
                                 
                                 
Net (loss)
  $ (802,181 )   $ (1,655,802 )   $ (1,660,738 )   $ (3,266,878 )
                                 
Net (loss) per share – basic and diluted
                               
Net (loss) per share
  $ (0.17 )   $ (0.35 )   $ (0.34 )   $ (0.70 )
                                 
Weighted average shares outstanding – basic and diluted
    4,820,098       4,753,091       4,820,098       4,674,115  

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


TELANETIX, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
    Six months ended June 30,  
    2012     2011  
Cash flows from operating activities:
               
Net loss
 
$
(1,660,738
)
 
$
(3,266,878
)
Adjustments to reconcile net loss to cash provided by operating activities:
               
Provision for doubtful accounts
   
18,129
     
(8,342
)
Depreciation
   
1,263,263
     
893,616
 
(Gain) loss on disposal of fixed assets
   
(3,360
)
   
(4,678
)
Amortization of deferred financing costs
   
19,116
     
145,383
 
Amortization of intangible assets
   
1,100,000
     
1,100,000
 
Stock based compensation
   
204,373
     
250,445
 
Amortization of note discounts
   
843,685
     
1,011,339
 
Non-cash interest expense
   
112,505
     
444,432
 
Changes in assets and liabilities:
               
Accounts receivable
   
116,949
     
(308,016
)
Inventory
   
60,942
     
(55,641
)
Prepaid expenses and other assets
   
(41,420)
     
102,970
 
Accounts payable and accrued expenses
   
143,723
     
52,295
 
Deferred revenue
   
(30,537
)
   
(10,198)
 
Net cash provided by operating activities
   
2,146,630
     
346,727
 
                 
Cash flows from investing activities:
               
Purchase of property and equipment
   
(234,618
)
   
(312,171
)
Proceeds from disposal of fixed assets
   
3,620
     
7,938
 
Net cash used by investing activities
   
(230,998
)
   
(304,233
)
                 
Cash flows from financing activities:
               
Payments on capital leases
   
(249,943
)
   
(294,187
)
Payments on convertible debenture
   
(1,200,000
)
   
-
 
Net cash used by financing activities
   
(1,449,943
)
   
(294,187
)
                 
Net increase (decrease) in cash
   
465,689
     
(251,693
)
Cash at beginning of the period
   
1,840,265
     
2,330,111
 
Cash at end of the period
 
$
2,305,954
   
$
2,078,418
 
                 
Supplemental disclosures of cash flow information:
               
Interest paid
 
$
332,174
   
$
162,774
 
                 
Non-cash investing and financing activities:
               
Property and equipment acquired through capital leases
 
$
229,099
   
$
230,248
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


TELANETIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.   Description of Business

We are a cloud based IP voice services company.  Our company is built on the belief that business telecommunication need not be expensive or complicated.  Through our AccessLine-branded Voice Services, we provide customers with a range of business phone services and applications that are easy to purchase, easy to install, easy to use and most importantly provide significant savings.  Our customers have the ability to easily configure their service to meet the unique needs of their business.  At the core of our cloud based, hosted service is our proprietary software, which is developed internally and runs on standard commercial grade servers.  By delivering business phone service to the market in this manner, our Voice Services offer flexibility and ease of use to any sized business customer, at an affordable price point.
 
AccessLine offers the following cloud based, hosted Voice over IP services: Digital Phone System (DPS), SIP Trunking Service and a la carte, individual phone services.  DPS replaces a customer's existing telephone lines and phone system with a Voice over IP alternative. It is sold as a complete turn-key solution where we bundle business-class phone equipment which is manufactured by third parties, along with our reliable voice network services.  This service is primarily targeted at small businesses looking for a fully integrated solution that does not require expert assistance to install or manage.  SIP Trunking Service replaces high-cost telephone lines with a low cost yet high quality IP alternative.  SIP Trunking is for larger businesses that already have their own on premise equipment (PBX) and is targeted at those businesses with large calling volumes looking for cost effective alternatives to traditional carrier offerings. SIP Trunking Service can support businesses with hundreds to thousands of employees.
 
AccessLine-branded services also offer a la carte phone services and features including conferencing calling services, find-me and follow-me services, toll-free services, automated attendant services, fax services, and voice messaging services.  Each a la carte service can be purchased individually through AccessLine’s various websites.  All services include easy-to-use web interfaces for simple management and customizations.
 
Our revenues principally consist of: monthly recurring fees, activation, and usage fees from the communication services and the solutions outlined above. There are some ancillary one time equipment charges associated with our DPS solution.

2. Basis of Presentation
 
The accompanying unaudited financial statements, consisting of the consolidated balance sheet as of June 30, 2012, the consolidated statements of operations for the three and six months ended June 30, 2012 and 2011, and the consolidated statements of cash flows for the six months ended June 30, 2012 and 2011, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q. Accordingly, these condensed consolidated financial statements do not include all of the information and footnotes typically found in the audited consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K. In the opinion of management, all adjustments (primarily consisting of normal recurring adjustments) considered necessary for a fair statement have been included.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.
 
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and equity and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant estimates include those related to the allowance for doubtful accounts; valuation of inventories; valuation of goodwill, intangible assets and property and equipment; valuation of stock based compensation expense; the valuation of conversion features; and other contingencies.  Management evaluates these estimates on an on-going basis.  Management bases its estimates on historical experience and on various other assumptions that are believed 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.  Actual results could differ from those estimates under different assumptions or conditions. Operating results for the three and six months ended June 30, 2012, are not necessarily indicative of the results that may be expected for the full fiscal year ending December 31, 2012.
 
 
On June 1, 2011, the Company effected a 1 for 75 reverse stock split of its authorized common stock and preferred stock. As a result, the number of shares of common stock outstanding has been adjusted retrospectively to reflect the reverse stock split in all periods presented. Also, the exercise price and the number of common shares issuable under the Company’s share-based compensation plans and the authorized and issued share capital have been adjusted retrospectively to reflect the reverse stock split.
 
Liquidity:

At June 30, 2012, we had cash of $2.3 million, accounts receivable of $1.8 million and a working capital deficit of $5.3 million. However, current liabilities include certain items that will likely settle without future cash payments or otherwise not require significant expenditures by the Company including: deferred revenue of $1.1 million (primarily deferred up front customer activation fees), deferred rent of $0.1 million and accrued vacation of $0.5 million. The aforementioned items represent $1.7 million of total current liabilities as of June 30, 2012. We do not anticipate being in a positive working capital position in the near future.  However, based on our projected 2012 results and, if necessary, our ability to reduce certain variable operating expenses, we believe that our existing capital, together with anticipated cash flows from operations, will be sufficient to finance our operations through at least July 1, 2013.

If our cash reserves prove insufficient to sustain operations, we plan to raise additional capital by selling shares of capital stock or other equity or debt securities.  However, there are no commitments or arrangements for future financings in place at this time, and we can give no assurance that such capital will be available on favorable terms or at all.  We may need additional financing thereafter until we can achieve profitability.  If we cannot, we may be forced to curtail our operations or possibly be forced to evaluate a sale or other strategic alternative.  Any future financing may involve substantial dilution to existing investors.
 
In addition, if our cash flows from operations are not sufficient to make interest payments owed on the 2010 Notes (as defined below) in cash in 2012 or we are unable to make the payments due on the 2010 Notes in 2012 through maturity in 2014, we would be in default under such notes.  If this were to occur, we would need to evaluate other equity financing opportunities, the proceeds of which could be used to make interest payment and/or repay the 2010 Notes.  If we do not pay the 2010 Notes in accordance with their terms, the holder of such notes would be entitled to additional default interest of 4%, which will accrue on the outstanding principal balance.  In addition, we may be required to redeem all or any portion of the 2010 Notes at a price equal to 125% of the sum of the principal amount that such holder requests that we redeem plus accrued but unpaid interest on such principal amount plus any accrued or unpaid late charges with respect to such principal and interest.  In addition, the holder would have the right to foreclose on all of our assets pursuant to the terms of the security agreement we entered into with such holders and they would have the right to take possession of our assets and operate our business.  Further, a monthly penalty calculated as one percent of the aggregate Hale shares purchase price, as set forth in the Hale Securities Purchase Agreement (as defined below) could be imposed if the Company is unable to register the Hale shares.  We have been unable to register any portion of the Hale shares and at this time we anticipate that a significant number of the Hales shares will remain unregistered as of December 31, 2012.  As such, we may need to seek a waiver from Hale or incur the aforementioned penalties.  While we have successfully obtained waivers in the past we can give no assurance that additional waivers will be available.

3. Recapitalization
 
Debenture Repurchase
 
On June 30, 2010, the Company entered into a securities purchase agreement with the holders of its outstanding debentures in the principal amount of $29.6 million. Under the terms of the agreement, the Company repurchased all of its outstanding debentures in exchange for payment of $7.5 million in cash, the holders of the Company's debentures exchanged all outstanding warrants they held for shares of the Company's common stock and the Company issued to such holders an additional number of shares of common stock, such that the holders collectively beneficially owned approximately 221,333 shares of common stock immediately following the completion of the transactions contemplated by the agreement. The Company paid the $7.5 million from the proceeds of its senior secured note private placement described below.

After giving effect to the transactions contemplated by the debenture repurchase described above and the transactions contemplated by the senior secured note private placement described below, the Company had $10.5 million of senior secured notes outstanding and all of its previously issued debentures, which had a principal amount of $29.6 million, were cancelled.
 
Senior Secured Note Private Placement
 
On June 30, 2010, the Company entered into a securities purchase agreement (the "Hale Securities Purchase Agreement") with affiliates of Hale Capital Management, LP (collectively, "Hale"), pursuant to which in exchange for $10.5 million, the Company issued to Hale $10.5 million of senior secured notes (the "2010 Notes"), and 3,833,356 shares of its common stock.  The carrying value assigned to the debt and equity was based on the relative fair value of each component as determined by a third party valuation specialist.  The allocation between debt and equity resulted in a $5.7 million debt discount which will be amortized over the term of the 2010 Notes using the effective interest method.  A summary of the material terms of the 2010 Notes is set forth in Note 4—2010 Notes, below.
 
 
Under the terms of the Hale Securities Purchase Agreement, the Company agreed to conduct a rights offering.  In connection with the rights offering, depending on the amount of capital it raised, the Company and Hale agreed that the Company would either redeem up to $3.0 million of principal of the 2010 Notes or that Hale would exchange up to $3.0 million of principal of the 2010 Notes for shares of the Company's common stock.  As discussed below the Company has cancelled the rights offering and no longer has any obligation to conduct the same.
 
                In August 2011, the independent directors of the Company approved, and the Company and Hale entered into a settlement agreement, pursuant to which (1) Hale released the Company from any obligation to conduct the rights offering, and (2) the Company released Hale from its "backstop" obligation to convert up to $3.0 million of the 2010 Notes into common stock.  As a result of the amendment, the original principal amount of the 2010 Notes outstanding remained at approximately $10.5 million, plus interest that was accrued to principal through June 30, 2012.  In addition, under the settlement agreement, Hale granted the Company the right to defer cash payment of the interest on up to $3.0 million of principal (plus associated “PIK Interest”) through June 30, 2012 and to have any such amounts added to principal.  The Company's scheduled payment obligations under the 2010 Notes, assuming that it pays all of the interest current, will average approximately $431,000 per month through June 30, 2013 and will average approximately $400,000 per month for the remaining twelve months until maturity.
 
The Company agreed to a number of provisions in the Hale Securities Purchase Agreement that protect Hale's investment, including:
 
Most Favored Nation.  For so long as the 2010 Notes are outstanding and until Hale ceases to own at least ten percent of the Company's outstanding common stock, if the Company (i) issues debt on terms that are more favorable than the terms of the 2010 Notes, or (ii) issues common stock, preferred stock, equivalents or any other equity security on terms more favorable than those set out in the Hale Securities Purchase Agreement, then the terms of the 2010 Notes and/or the Hale Securities Purchase Agreement shall automatically be amended such that Hale receives the benefit of the more favorable terms.
 
Right of First Refusal.  For so long as the 2010 Notes are outstanding and until Hale ceases to own at least ten percent of the Company's outstanding common stock, Hale shall have a right of first refusal on any subsequent placement that the Company makes of common stock or common stock equivalents or any securities convertible into or exchangeable or exercisable for shares of its common stock.
 
Fundamental Transactions.  For so long as the 2010 Notes are outstanding and thereafter for as long as any of the Hale purchasers continue to own at least twenty percent of the common stock that they purchased under the Hale Securities Purchase Agreement, the Company cannot effect a transaction in which it consolidates or merges with another entity, conveys all or substantially all of its assets, permit another person or group to acquire more than fifty percent of its voting stock, or reorganize or reclassify its common stock without the majority consent Hale.  Additionally, the Company cannot effect such a transaction without obtaining the foregoing requisite consent if such transaction would trigger the most favored nation provision in the Hale Securities Purchase Agreement described above or if such transaction would otherwise involve the issuance of any equity securities or the incurrence of debt at a price that is less than the price paid in connection with the transaction consummated pursuant under the Hale Securities Purchase Agreement.
 
Post-Closing Adjustment Shares.  The Company is required to make payment on certain identified contingent liabilities up to an aggregate amount of $369,539, then it will issue additional shares of common stock to Hale, such that the total percentage ownership of its fully diluted common stock immediately after the payment of such liabilities will equal the same percentage ownership that Hale would have had if the contingent payable had been paid prior to the closing under the Hale Securities Purchase Agreement.  To date $214,052 of these contingent liabilities have been incurred as expenses.  Accordingly, in April of 2011 we issued to Hale an additional 225,576 shares of our common stock under the terms of the Hale Securities Purchase Agreement and are currently in the process of issuing the remaining shares.  During the third quarter 2012, the remaining shares in the amount of 300,004 shares of common stock will be issued to Hale as final settlement of the contingent liabilities.

Registration Rights Agreement
 
In connection with the Hale Securities Purchase Agreement, the Company entered into a registration rights agreement with Hale pursuant to which the Company agreed to file a registration statement with the SEC for the resale of the shares issued and issuable to Hale under the Hale Securities Purchase Agreement.  The Company filed the registration statement with the SEC on September 30, 2010. The registration rights agreement contains penalty provisions in the event that the Company failed to secure the effectiveness of the registration statement by November 29, 2010, fails to file other registration statements the Company is required to file under the terms of the registration rights agreement in a timely manner or if the Company fails to maintain the effectiveness of any registration statement it is required to file under the terms of the registration rights agreement until the shares issued to Hale are sold or can be sold under Rule 144 without restriction or limitation (including volume restrictions) and without the requirement that the Company be in compliance with Rule 144(c)(1).  In the event of any such failure, and in addition to other remedies available to Hale, the Company agreed to pay Hale as liquidated damages an amount equal to 1% of the purchase price for the shares to be registered in such registration statement. Such payments are due on the date we fail to comply with our obligation and every 30th day thereafter (pro-rated for periods totaling less than 30 days) until such failure is cured.  The registration statement covering the resale of the shares issued to Hale has not been declared effective. Hale and the Company have agreed to amend the term “Initial Effectiveness Deadline” set forth in Section 1(o) of the Registration Rights Agreement to read in its entirety as follows “Initial Effectiveness Deadline” means December 31, 2012.
 
 
Impact of Debenture Repurchase and Senior Secured Note Private Placement
 
In connection with the Hale Securities Purchase Agreement, on July 2, 2010, the Company received gross proceeds of $10.5 million.  The Company incurred expenses of approximately $1.5 million in connection with the transactions contemplated by the Hale Securities Purchase Agreement, resulting in net proceeds of approximately $9.0 million.  The Company used $7.5 million of these proceeds to repurchase its outstanding debentures and allotted the remaining $1.5 million for working capital purposes, including advertising and distribution programs for its Digital Phone Service products.
 
Merriman Curhan Ford acted as the Company's financial advisor in the transaction and was paid a fee of $682,500 in connection with the transaction.  The Company also issued to Merriman Curhan Ford warrants to purchase 31,152 shares of its common stock.  The warrants are exercisable at $2.889 per share for a period of 5 years.

4. The 2010 Notes
 
The following summarizes other terms of the 2010 Notes as follows:
 
Term.  The 2010 Notes are due and payable on July 2, 2014.
 
Interest.  Interest accrues at a rate equal to the prime rate as published in The Wall Street Journal as of the first business day of each interest period plus 4.75% per annum and is payable at the end of each month, with the first payment due on July 2, 2010.  Through June 30, 2011, the Company had the option to defer the monthly interest payments otherwise due and have the amount of deferred interest added to the principal balance of the 2010 Notes. In connection with the August 2011 amendment to the 2010 Notes, through June 30, 2012, the Company has the option to defer the monthly interest payments otherwise due on $3.0 million of the 2010 Notes and have any such amount of deferred interest added to the principal balance of the 2010 Notes.
 
Principal Payment.  In July 2011 and continuing for the 11 months thereafter, principal payments of $200,000 per month are due on the last day of each month.  Thereafter, the Company is required to pay principal in a monthly amount equal to the sum of (a) $383,702 and (b) the quotient determined by dividing the (i) aggregate amount of interest added to the principal amount by (ii) 24.  Any remaining principal amount, if not paid earlier, is due and payable on July 2, 2014.
 
August 2011 Amendment.  As discussed in more detail below under the heading entitled, "Rights Offering," the Company had the right to redeem up to $3.0 million of the 2010 Notes prior to maturity.  In August 2011, the Company and Hale amended the Hale Securities Purchase Agreement to (1) cancel the Company's obligation to conduct the rights offering, and (2) cancel Hale’s obligation to convert up to $3.0 million of the 2010 Notes into common stock.  As a result of the amendment, the original principal amount of the 2010 Notes outstanding remained at approximately $10.5 million, plus interest that was accrued to principal through June 30, 2012. The Company's scheduled payment obligations under the 2010 notes will average approximately $431,000 per month through June 30, 2013 and average approximately $400,000 per month for the remaining 12 months until maturity.
  
No Conversion Rights.  The 2010 Notes are not convertible.
 
Security.  The 2010 Notes are secured by all of the Company's assets under the terms of a pledge and security agreement that the Company and its subsidiaries entered into with Hale.  Each of the Company's subsidiaries also entered into guarantees in favor of Hale, pursuant to which each subsidiary guaranteed the complete payment and performance by the Company of its obligations under the 2010 notes and related agreements.
 
Covenants.  The 2010 Notes impose certain covenants on the Company, including: restrictions against incurring additional indebtedness, creating any liens on its property, entering into a change in control transaction, redeeming or paying dividends on shares of its outstanding common stock, entering into certain related party transactions, changing the nature of its business, making or investing in a joint venture, disposing of any of its assets outside of the ordinary course of business, effecting any subsequent offering of debt or equity, amending its articles of incorporation or bylaws, limiting its ability to enter into lease arrangements.
 
 
Events of Default.  The 2010 Notes define certain events of default, including: failure to make a payment obligation under the 2010 Notes, failure to pay other indebtedness when due if the amount exceeds $250,000, bankruptcy, entry of a judgment against the Company in excess of $250,000 which is not discharged or covered by insurance,  failure to observe other covenants of the 2010 Notes or related agreements (subject to applicable cure periods), breach of representation or warranty, failure of Hale’s security documents to be binding and enforceable, and casualty loss of any of the Company's assets that would have a material adverse effect on its business, and failure to meet 80% of quarterly financial targets from its annual operating budget, including cash, revenues and EBITDA.  In the event of default, additional default interest of 4% will accrue on the outstanding balance.  In addition, in the event of default, the Company may be required to redeem all or any portion of the 2010 Notes at a price equal to 125% of the sum of the principal amount that such holder requests that it redeems plus accrued but unpaid interest on such principal amount plus any accrued and unpaid late charges with respect to such principal and interest.  
 
Change of Control.  The Company is required to obtain the consent of the holders of the 2010 Notes representing at least a majority of the aggregate principal amount of the 2010 Notes then outstanding in order to enter into a change of control transaction.  If such consent is obtained, the holders of the 2010 Notes may require the Company to redeem all or any portion of such notes at a price equal to 125% of the sum of the principal amount that such holder requests that it redeems plus accrued but unpaid interest on such principal amount plus any accrued and unpaid late charges with respect to such principal and interest.
 
            Rights Offering, Under the terms of the Hale Securities Purchase Agreement, the Company agreed to conduct a rights offering pursuant to which it would distribute at no charge to holders of its common stock non-transferable subscription rights to purchase up to an aggregate of 1,038,414 shares of common stock at a subscription price of $2.889 per share. Under the terms of the 2010 Notes, the Company agreed to use the gross proceeds of the rights offering to redeem an aggregate of up to $3.0 million of principal amount of the 2010 Notes. To the extent the gross proceeds of the rights offering were less than $3.0 million, the Company and Hale agreed that Hale would exchange the principal amount to be redeemed (up to $3.0 million) for shares of our common stock at an exchange price equal to the subscription price of the subscription rights.  The Company paid Hale an aggregate of $60,000 in consideration of the foregoing. In addition, the Company agreed to pay Hale upon completion of the rights offering an amount of cash equal to the accrued and unpaid interest in respect of the principal amount of the 2010 Notes redeemed or exchanged for shares of common stock in connection with the rights offering.  As discussed below the Company has cancelled the rights offering and related obligations.
 
In August 2011, the independent directors of the Company approved, and the Company and Hale entered into a settlement agreement, pursuant to which (1) Hale released the Company from any obligation to conduct the rights offering, and (2) the Company released Hale from its "backstop" obligation to convert up to $3.0 million of the 2010 Notes into common stock.  As a result of the amendment, the original principal amount of the 2010 Notes outstanding remained at approximately $10.5 million, plus interest that was accrued to principal through June 30, 2012.  In addition, under the settlement agreement, Hale granted the Company the right to defer cash payment of the interest on up to $3.0 million of principal (plus associated “PIK Interest”) through June 30, 2012 and to have any such amounts added to principal.  The Company's scheduled payment obligations under the 2010 Notes, assuming that it pays all of the interest current, will average approximately $431,000 per month through June 30, 2013 and will average approximately $400,000 per month for the remaining twelve months until maturity.

The following table summarizes information relative to the 2010 Notes at June 30, 2012:
 
   
June 30, 2012
 
Face value of debt
 
$
10,500,000
 
Plus: accreted interest
   
1,108,852
 
Less: principal payments
   
(2,400,000)
 
Less: unamortized debt discounts
   
(1,644,231
)
2010 Notes, net of discounts
   
7,564,621
 
Less current portion
   
(4,604,426
)
2010 Notes, long term portion
 
$
2,960,195
 
 

Aggregate annual principal payments of long-term debt plus accreted interest for the periods ending December 31, are stated below:

2012
 
$
2,302,213
 
2013
 
$
4,604,426
 
2014
 
$
2,302,213
 
Total
 
$
9,208,852
 
 
The value assigned to the debt and related discount and equity associated with issuance of the Recapitalization were calculated by an independent valuation firm using relative fair values.
 
5. Warrants and Warrant Liabilities
 
There were 36,661 shares subject to warrants at a weighted average exercise price of $22.84 as of June 30, 2012 and December 31, 2011.

The following table summarizes information about warrants outstanding at June 30, 2012:

Exercise Prices
   
Number of Shares Subject to
Outstanding Warrants and
Exercisable
   
Weighted Average Remaining
Contractual Life (years)
 
$ 2.90       31,152       3.00  
$ 93.75       1,400       0.92  
$ 129.75       2,667       0.74  
$ 144.00       1,042       0.74  
$ 300.00       400       0.63  
          36,661          

6. Business Risks and Credit Concentration
 
The Company’s cash is maintained with a limited number of commercial banks, and is invested in the form of demand deposit accounts.  Deposits in these institutions may exceed the amount of FDIC insurance provided on such deposits.
 
The Company markets its products to resellers and end-users primarily in the United States.  Management performs ongoing credit evaluations of the Company’s customers and maintains an allowance for potential credit losses.  There can be no assurance that the Company’s credit loss experience will remain at or near historic levels.  Two customers accounted for 36% of gross accounts receivable at June 30, 2012.  One customer accounted for 12% of gross accounts receivable at June 30, 2011.
 
One customer accounted for 12% of revenue during the three months ended June 30, 2012 and 10% during the six months ended June 30, 2012.  No one customer accounted for more than 10% of the Company’s revenue during the three and six months ended June 30, 2011.  
 
 
The Company relies on primarily one third party network service provider for network services.  If this service provider failed to perform on its obligations to the Company, such failure could materially impact future operating results, financial position and cash flows.
 
7. Commitments and Contingencies
 
Leases
 
The Company has non-cancelable operating and capital leases for corporate facilities and equipment.

Minimum Third Party Network Service Provider Commitments
 
The Company has a contract with a third party network service provider that facilitates interconnects with a number of third party network service providers.  The contract contains a minimum usage guarantee of $0.2 million per monthly billing cycle and expires in July 2013.  The cancellation terms are a ninety (90) day written notice prior to the extended term expiring.
 
Litigation
 
From time to time and in the course of business, we may become involved in various legal proceedings seeking monetary damages and other relief.  The amount of the ultimate liability, if any, from such claims cannot be determined.  However, in the opinion of our management, there are no legal claims currently pending or threatened against us that would be likely to have a material adverse effect on our financial position, results of operations or cash flows.

On November 11, 2011, the Company was named as a defendant in a lawsuit, Klausner Technologies, Inc. v. AccessLine Communications Corporation (Case number 6;11-cv-586) filed in the Federal District Court for the Eastern District of Texas.  The case alleges patent infringement and seeks unspecified damages and other relief.  As this matter is in an early stage, and discovery has not yet commenced the Company is not in a position to estimate potential liability or other ramifications, if any, that may result.
 
8. Stock Based Compensation
 
Stock Option Plan
 
The Company maintains two equity plans: the 2005 Equity Incentive Plan (the “2005 Plan”) and the 2010 Stock Incentive Plan (the “2010 Plan”).
 
The 2005 Plan, which was approved by the Company’s stockholders in August 2006, permits the Company to grant shares of common stock and options to purchase shares of common stock to the Company’s employees for up 66,667 shares of common stock.  The Company believes that such awards better align the interests of its employees with those of its stockholders.  Option awards are generally granted with an exercise price that equals the market price of the Company's stock at the date of grant; these option awards generally vest based on 3 years of continuous service and have 10-year contractual terms.  On November 8, 2007, the Board of Directors approved an amendment to the 2005 Plan to increase the number of shares of common stock available for grant to 113,333 shares. On December 11, 2008, the Board of Directors approved an additional amendment to the 2005 Plan to increase the number of shares of common stock available for grant to 206,667 shares.  At June 30, 2012 there were 91,313 options outstanding under the 2005 plan.  The Board of Directors has indicated that it does not intend to make any further option grants under the 2005 Plan.
 
 
The 2010 Plan, which was approved by the Company’s stockholders in July 2010, permits the Company to grant options to purchase, and other stock-based awards covering, in the aggregate 1,189,198 shares of the Company’s common stock to the Company’s employees, directors or consultants.   The Company believes that such awards will aid in recruiting and retaining key employees, directors or consultants and to motivate such employees, directors or consultants to exert their best effort on behalf of the Company.  Option awards are granted in four Tranches with Tranche 1 shares having an option price of $3.00 per share and Tranches 2, 3, and 4 having an option price of $5.778 per share.  Tranche 1 option awards vest fifty percent (50%) of the awarded shares upon Hale receiving cash proceeds in return on its Invested Capital in the Company and its subsidiaries which cash proceeds equal no less than one times its Invested Capital (as defined in the 2010 Plan) plus a four percent (4%) annual return on such Invested Capital, compounded annually (the “Tranche 1 Return”).  Notwithstanding the foregoing and the failure of Hale to have achieved the Tranche I Return, Tranche 1 shares shall vest with respect to ten percent (10%) of such Tranche 1 shares on each of the first, second, and third anniversaries of the Effective Date, irrespective of whether such Tranche 1 shares were issued as of such dates subject to the Participant’s continued employment in good standing with the Company on each such anniversary.   Tranche 2 option awards vest sixteen and sixty-fifth one hundredths percent (16.65%) upon Hale receiving cash proceeds in return on its Invested Capital in the Company and its subsidiaries which cash proceeds equal no less than two times its Invested Capital plus four percent (4%) annual return on such Invested Capital, compounded annually and subject to the Participant’s continued employment in good standing with the Company on the Tranche 2 vesting date.  Tranche 3 option awards vest sixteen and sixty-fifth one hundredths percent (16.65%) upon Hale receiving cash proceeds in return on its Invested Capital in the Company and its subsidiaries which cash proceeds equal no less than three times its Invested Capital plus four percent (4%) annual return on such Invested Capital, compounded annually and subject to the Participant’s continued employment in good standing with the Company on the Tranche 3 vesting date.  Tranche 4 option awards vest sixteen and seventieth one hundredths percent (16.67%) upon Hale receiving cash proceeds in return on its Invested Capital in the Company and its subsidiaries which cash proceeds equal no less than four times its Invested Capital plus four percent (4%) annual return on such Invested Capital, compounded annually and subject to the Participant’s continued employment in good standing with the Company on the Tranche 4 vesting date.  Option under the 2010 Plan shall be exercisable at such time and upon such terms and conditions as may be determined by the Compensation Committee of the Company’s Board of Directors, but in no event shall an Option be exercisable more than ten years after the date it is granted.

An amendment to the 2010 Plan (the “2010 Plan Amendment”) was approved by the Company’s stockholders and became effective in May 2011.   The 2010 Plan Amendment was adopted in connection with the terms of the Hale Securities Purchase Agreement dated June 30, 2010.  Pursuant to Section 1(e) of the Hale Securities Purchase Agreement the Company agreed to grant shares of common stock to Hale, in the event that the Company received a notice  that it is obligated to pay certain specified contingent liabilities within two years of the closing (a “Contingent Share Issuance”).  The Company received such notice in April 2011, and in accordance with the terms of the Hale Securities Purchase Agreement, the Company issued an aggregate of 225,576 shares of common stock to Hale.  During the third quarter of 2012, the Company will issue an aggregate of 300,004 shares of common stock to Hale in settlement of the contingent liabilities.  The Hale Securities Purchase Agreement provides that in the event of a Contingent Share Issuance a proportionate adjustment would be made to the number of shares of our common stock reserved under the 2010 Plan.  Based on the Contingent Share Issuance, the Company’s board of directors approved an increase in the number of shares of common stock subject to the 2010 Plan from 1,189,198 to 1,232,121 shares.  In addition the 2010 Plan Amendment provides that the maximum aggregate number of shares available for issuance under the Plan will increase automatically by one share for every four shares issued in any future Contingent Share Issuance up to a maximum of 1,493,333 shares.  During the third quarter of 2012 and based on the Contingent Share Issuance, the number of shares is set to increase by 75,001 shares.  At June 30, 2012 there were 1,040,388 options outstanding under the 2010 plan.

A summary of option activity under the 2005 Plan and 2010 Plan as of June 30, 2012 is presented below:

   
Shares
   
Weighted-Average Exercise Price
 
Outstanding at December 31, 2011
   
1,152,632
   
$
5.49
 
Granted
   
     
 
Exercised
   
     
 
Forfeited or expired
   
(20,931
)
   
4.37
 
Outstanding at June 30, 2012
   
1,131,701
   
$
5.51
 
 
The options outstanding and currently exercisable by exercise price at June 30, 2012 are as follows:
 
   
Stock options outstanding
 
Stock Options Exercisable
Range of Exercise Prices
 
Number Outstanding
 
Weighted-Average Remaining Contractual Term (Years)
 
Weighted-Average Exercise Price
 
Number Exercisable
 
Weighted-Average Remaining Contractual Term (Years)
 
Weighted-Average Exercise Price
$
3.00 to 4.50
 
522,566
 
8.75
 
$
3.01
 
173,161
 
8.56
 
$
3.02
$
4.50 to 7.50
 
594,186
 
8.42
 
$
5.70
 
73,637
 
6.00
 
$
5.19
$
7.50 to 11.25
 
9,535
 
3.62
 
$
7.97
 
9,535
 
3.62
 
$
7.97
$
191.22 to 262.43
 
5,414
 
5.08
 
$
221.91
 
5,414
 
5.08
 
$
221.91
   
1,131,701
 
8.52
 
$
5.51
 
261,747
 
7.59
 
$
8.34
 
 
As of June 30, 2012, 261,747 options were exercisable at an aggregate average exercise price of $8.34.  The aggregate intrinsic value of stock options outstanding and stock options exercisable at June 30, 2012 was less than $0.1 million.

As of June 30, 2012, total compensation cost related to non-vested stock options not yet recognized was $2.2 million. Of the $2.2 million, $1.0 million is expected to be recognized ratably over the next three years, and such amount includes stock options with contingent vesting which it is deemed probable that such options will become exercisable.  The remaining $1.2 million is related to stock options in Tranches 2, 3 and 4 with contingent vesting that will be recognized when it is probable that such options will become exercisable.

Valuation and Expense Information
 
The Company measures and recognizes compensation expense for all share-based payment awards made to employees and directors based upon estimated fair values.  The following table summarizes stock-based compensation expense recorded for the three and nine months ended June 30, 2012 and 2011, and its allocation within the Consolidated Statements of Operations:
 
   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Selling and marketing
 
$
16,204
   
$
31,534
   
$
32,339
   
$
62,934
 
General and administrative
   
59,450
     
58,227
     
119,814
     
100,993
 
Research and development
   
26,260
     
38,842
     
52,220
     
86,518
 
Total stock-based compensation expense related to employee equity awards
   
101,914
     
128,603
     
204,373
     
250,445
 
 
Valuation Assumptions:
 
The Company uses the Black Scholes option pricing model in determining its option expense.  There were zero options granted during the three and six months ended June 30, 2012.  
 
As the stock-based compensation expense recognized in the Consolidated Statements of Operations is based on awards ultimately expected to vest, such amounts have been reduced for estimated forfeitures estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
 
9. Computation of Net Loss Per Share
 
Basic net loss per share is based upon the weighted average number of common shares outstanding.  Diluted net loss per share is based on the assumption that all potential common stock equivalents (convertible preferred stock, convertible debentures, stock options, and warrants) are converted or exercised.  The calculation of diluted net loss per share excludes potential common stock equivalents if the effect is anti-dilutive.  The Company's weighted average common shares outstanding for basic and dilutive are the same because the effect of the potential common stock equivalents is anti-dilutive.  The Company has the following dilutive common stock equivalents for the three and nine months ended June 30, 2012 and 2011, which were excluded from the net loss per share calculation because their effect is anti-dilutive.
 
   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Stock Options
   
1,131,701
     
1,028,997
     
1,131,701
     
1,028,997
 
Warrants
   
36,661
     
36,661
     
36,661
     
36,661
 
    Total
   
1,168,362
     
1,065,638
     
1,168,362
     
1,065,638
 

 
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes and other financial information appearing elsewhere in this report. Readers are also urged to carefully review and consider the various disclosures made by us that attempt to advise interested parties of the factors that affect our business, including without limitation, the disclosures made under "Item 1A. Risk Factors" included in Part II of this report.
 
Overview
 
Business
 
We are a cloud based IP voice services company.  Our company is built on the belief that business telecommunication need not be expensive or complicated.  Through our AccessLine-branded Voice Services, we provide customers with a range of business phone services and applications that are easy to purchase, easy to install, easy to use and most importantly provide significant savings.  Our customers have the ability to easily configure their service to meet the unique needs of their business.  At the core of our cloud based, hosted service is our proprietary software, which is developed internally and runs on standard commercial grade servers.  By delivering business phone service to the market in this manner, our Voice Services offer flexibility and ease of use to any sized business customer, at an affordable price point.
 
AccessLine offers the following cloud based, hosted Voice over IP services: Digital Phone System (DPS), SIP Trunking Service and a la carte, individual phone services.  DPS replaces a customer's existing telephone lines and phone system with a Voice over IP alternative. It is sold as a complete turn-key solution where we bundle business-class phone equipment which is manufactured by third parties, along with our reliable voice network services.  This service is primarily targeted at small businesses looking for a fully integrated solution that does not require expert assistance to install or manage.  SIP Trunking Service replaces high-cost telephone lines with a low cost yet high quality IP alternative.  SIP Trunking is for larger businesses that already have their own on premise equipment (PBX) and is targeted at those businesses with large calling volumes looking for cost effective alternatives to traditional carrier offerings. SIP Trunking Service can support businesses with hundreds to thousands of employees.
 
AccessLine-branded services also offer a la carte phone services and features including conferencing calling services, find-me and follow-me services, toll-free services, and automated attendant service.  Each a la carte service can be purchased individually through AccessLine’s various websites.  All services include easy-to-use web interfaces for simple management and customizations.
 
Our revenues principally consist of: monthly recurring fees, activation, and usage fees from the communication services and solutions outlined above. There are some ancillary one time equipment charges associated with our DPS solution.
 
Recapitalization

Our overriding objective is to grow revenue while achieving operating profitability and generating cash from operations.  In 2010 we addressed this objective through the growth in our core voice businesses and a recapitalization that substantially reduced our outstanding debt, and provided additional working capital.
 
We experienced growth in revenue and gross profit for our AccessLine division in 2011 and the first half of 2012. Our increased revenue during 2011 and the first half of 2012 was due, in part, to greater efficiency in our advertising and also through our success in selling our SIP Trunking Service through direct and agent channels. Our Digital Phone Service and SIP Trunking Service continues to grow month over month. We manage our gross profit percentage through our continued progress in optimizing our network configuration. Additionally, we carefully monitor our discretionary operating expenses and staffing levels. 

Debenture Repurchase
 
On June 30, 2010, we entered into a securities purchase agreement with the holders of our outstanding debentures in the principal amount of $29.6 million.  Under the terms of the agreement, we repurchased and cancelled all of our outstanding debentures in exchange for payment of $7.5 million in cash.  Additionally, the holder of the debentures exchanged all outstanding warrants they held for shares of our common stock and we issued to such holders an additional number of shares of our common stock, such that the holders collectively and beneficially owned approximately 221,333 shares of our common stock immediately following the completion of the transactions contemplated by the agreement.  We paid $7.5 million from the proceeds of our senior secured note private placement described below.
 
 
After giving effect to the transactions contemplated by the debenture repurchase described above and the transactions contemplated by the senior secured note private placement described below, we currently have $10.5 million of senior secured notes outstanding and all our previously issued debentures, which had a principal balance of $29.6 million, were cancelled.  
 
Senior Secured Notes Private Placement
 
On June 30, 2010, we entered into a securities purchase agreement, which we refer to as the “Hale Securities Purchase Agreement” in this report, with affiliates of Hale Capital Management, LP, whom we refer to collectively as “Hale” in this report, pursuant to which, in exchange for $10.5 million, we issued to Hale $10.5 million of senior secured notes, which we refer to as the “2010 Notes” in this report, and 3,833,356 unregistered shares of our common stock.  For a summary of material terms of the 2010 Notes see “Commitments and Contingencies” below.
 
We agreed to a number of provisions in the Hale Securities Purchase Agreement that protect Hale’s investment, including:
 
Most Favored Nation.  For so long as the 2010 Notes are outstanding and until Hale ceases to own ten percent of our outstanding common stock, if we (i) issue debt on terms that are more favorable than the terms of the 2010 Notes, or (ii) issue common stock, preferred stock, equivalents or any other equity security on terms more favorable than those set out in the Hale Securities Purchase Agreement, then the terms of the 2010 Notes and/or the Hale Securities Purchase Agreement shall automatically be amended such that Hale receives the benefit of the more favorable terms.
 
Right of First Refusal.  For so long as the 2010 Notes are outstanding and until Hale ceases to own ten percent of our outstanding common stock, Hale shall have a right of first refusal on any subsequent placement that we make of common stock or common stock equivalents or any securities convertible into or exchangeable or exercisable for shares of our common stock.
 
Fundamental Transactions.  For so long as the 2010 Notes are outstanding and thereafter for as long as any of the Hale purchasers continue to own twenty percent of the common stock that they purchased under the Hale Securities Purchase Agreement, we cannot effect a transaction in which we consolidate or merge with another entity, convey all or substantially all of our assets, permit another person or group to acquire more than fifty percent of our voting stock, or reorganize or reclassify our common stock without the majority consent of Hale.  Additionally, we cannot effect such a transaction without obtaining the foregoing requisite consent if such transaction would trigger the most favored nation provision in the Hale Securities Purchase Agreement described above or if such transaction would otherwise involve the issuance of any equity securities or the incurrence of debt at a price that is less than the price paid in connection with the transaction consummated pursuant under the Hale Securities Purchase Agreement.
 
Post-Closing Adjustment Shares.The Company is required to make payment on certain identified contingent liabilities up to an aggregate amount of $369,539, then it will issue additional shares of common stock to Hale, such that the total percentage ownership of its fully diluted common stock immediately after the payment of such liabilities will equal the same percentage ownership that Hale would have had if the contingent payable had been paid prior to the closing under the Hale Securities Purchase Agreement.  To date $214,052 of these contingent liabilities have been incurred as expenses.  Accordingly, in April of 2011 we issued to Hale an additional 225,576 shares of our common stock under the terms of the Hale Securities Purchase Agreement and are currently in the process of issuing the remaining shares.  During the third quarter 2012, the remaining shares in the amount of 300,004 shares of common stock will be issued to Hale as final settlement of the contingent liabilities.
 
Registration Rights Agreement
 
In connection with the Hale Securities Purchase Agreement, we entered into a registration rights agreement with Hale pursuant to which we  agreed to file a registration statement with the SEC for the resale of the shares issued and issuable to Hale under the Hale Securities Purchase Agreement.  We filed that registration statement on September 30, 2010.  The registration rights agreement contains penalty provisions in the event that we failed to secure the effectiveness of that registration statement by November 29, 2010, fail to file other registration statements we are required to file under the terms of the registration rights agreement in a timely manner or if we fail to maintain the effectiveness of any registration statement we are required to file under the terms of the registration rights agreement until the shares issued to Hale are sold or can be sold under Rule 144 without restriction or limitation (including volume restrictions) and without the requirement that our company be in compliance with Rule 144 (c)(1).  In the event of any such failure, and in addition to other remedies available to Hale, we agreed to pay Hale as liquidated damages and amount equal to 1% of the purchase price for the share to be registered in such registration statement.  Such payments are due on the date we fail to comply with our obligation and every 30th day thereafter (pro-rated for periods totaling less than 30 days) until such failure is cured.  The registration statement covering the resale of the shares issued to Hale has not been declared effective. Hale and the Company have agreed to amend the term “Initial Effectiveness Deadline” set forth in Section 1(o) of the Registration Rights Agreement to read in its entirety as follows: “Initial Effectiveness Deadline” means December 31, 2012.
 
 
Impact of Debenture Repurchase and Senior Secured Note Private Placement
 
In connection with the Hale Securities Purchase Agreement we received gross proceeds of $10.5 million.  We incurred expenses of $1.5 million in connection with the transaction contemplated by the Hale Securities Purchase Agreement, resulting in net proceeds of approximately $9.0 million.  We used $7.5 million of these proceeds to repurchase our outstanding debentures and allotted the remaining $1.5 million for working capital purposes, including advertising and distribution programs for its Digital Phone Service products
 
Merriman Curhan Ford acted as our financial advisor in the transaction and we paid them a fee of $682,500 in connection with the transaction.  We also issued Merriman Curhan Ford warrants to purchase 31,152 shares of our common stock.  The warrants are exercisable at $2.889 per share for a period of 5 years.
 
Rights Offering
 
Under the terms of the Hale Securities Purchase Agreement, we agreed to conduct a rights offering pursuant to which we would distribute at no charge to holders of our common stock non-transferable subscription rights to purchase up to an aggregate 1,038,414 share our common stock at a subscription price of $2.889 per share.  Under the terms of the 2010 Notes, we agreed to use the gross proceeds of the rights offering to redeem an aggregate of up to $3.0 million of principle amount of such notes.  To the extent the gross proceeds of the rights offering were less than $3.0 million, we and Hale agreed that Hale would exchange the principle amount to be redeemed (up to $3 million) for shares of our common stock at an exchange price equal to the subscription price of the subscription rights.  We paid Hale an aggregate of $60,000 in consideration for the foregoing.  In addition, we agreed to pay Hale upon completion of the rights offering an amount of cash equal to the accrued and unpaid interest in respect of the principal amount of the senior secured notes redeemed or exchanged for shares of common stock in connection with the rights offering.  As discussed below the Company has cancelled the rights offering and related obligations.
 
In August 2011, the independent directors of the Company approved, and the Company and Hale entered into a settlement agreement, pursuant to which (1) Hale released the Company from any obligation to conduct the rights offering, and (2) the Company released Hale from its "backstop" obligation to convert up to $3.0 million of the 2010 Notes into common stock.  As a result of the amendment, the original principal amount of the 2010 notes outstanding remained at approximately $10.5 million, plus interest that was accrued to principal through June 30, 2012.  In addition, under the settlement agreement, Hale granted the Company the right to defer cash payment of the interest on up to $3.0 million of principal (plus associated “PIK Interest”) through June 30, 2012 and to have any such amounts added to principal.  The Company's scheduled payment obligations under the 2010 Notes, assuming that it pays all of the interest current, will average approximately $431,000 per month through June 30, 2013 and will average approximately $400,000 per month for the remaining twelve months until maturity. 

Recent Developments

Our overriding objective is to grow revenue while achieving operating profitability and generating cash from operations.  In 2011 and the first half of 2012 we addressed this objective through the growth in our core voice businesses.
 
We experienced growth in revenue and gross profit for our AccessLine division in 2011 and the first half of 2012. Our increased revenue during 2011 and the first half of 2012 was due, in part, to greater efficiency in our advertising and also through our success in selling our SIP Trunking Service through direct and agent channels. Our Digital Phone Service and SIP Trunking Service continues to grow month over month. We manage our gross profit percentage through our continued progress in optimizing our network configuration. Additionally, we carefully monitor our discretionary operating expenses and staffing levels. 
 
 
Results of Operations
 
Second Quarter of Fiscal 2012 Compared to Second Quarter of Fiscal 2011
 
Revenues, Cost of Revenues and Gross Profit
 
               
Increase/(Decrease)
 
   
2012
   
2011
   
Dollars
   
Percent
 
Three Months Ended June 30:
                       
Revenues
 
$
7,861,644
   
$
6,994,902
   
$
866,742
     
12.5
%
Cost of revenues
   
3,311,487
     
2,991,432
     
320,055
     
10.7
%
    Gross profit
   
4,550,157
     
4,003,470
     
546,687
     
13.7
%
    Gross profit percentage
   
57.9
%
   
57.2
%
               
                                 
Six Months Ended June 30:
                               
Revenues
 
$
15,681,668
   
$
13,929,303
   
$
1,752,365
     
12.6
%
Cost of revenues
   
6,479,434
     
5,861,829
     
617,605
     
10.5
%
    Gross profit
   
9,202,234
     
8,067,474
     
1,134,760
     
14.1
%
    Gross profit percentage
   
58.7
%
   
57.9
%
               

Net revenues for the three months ended June 30, 2012 were $7.9 million, an increase of $0.9 million, or 12.5% over the same period in 2011.  Net revenues for the six months ended June 30, 2012 were $15.7 million, an increase of $1.8 million, or 12.6% over the same period in 2011.  Net revenues increased for the three and six months ended June 30, 2012 as a result of increased sales in Digital Phone Service, SIP Trunking Service and Voice Volume Service offset by the a decline in Individual Services and Legacy business.
 
Cost of revenues for the three months ended June 30, 2012 were $3.3 million, an increase of less than $0.3 million, or 10.7%, over the same period in 2011. Cost of revenues for the six months ended June 30, 2012 were $6.5 million, an increase of $0.6 million, or 10.5% over the same period in 2011.  Cost of revenues increased proportionately to our growth in revenues.

Gross profit for the three months ended June 30, 2012 was $4.6million, an increase of $0.5 million, or 13.8%, over the same period in 2011.  Gross profit for the six months ended June 30, 2012 was $9.2 million, an increase $1.1 million, or 14.1% over the same period in 2011.  Gross profit percentage was 58.7% for the six months ended June 30, 2012 as compared to 57.9% in the same period in 2011.
 
  Selling and Marketing Expenses
 
Selling and marketing expenses for the three months ended June 30, 2012 were $1.6 million, a decrease of $0.1 million or 5.9%, over the same period in 2011.  Selling and marketing expenses for the six months ended June 30, 2012 and 2011 were $3.4 million and $3.5 million, respectively.  We anticipate that selling and marketing expenses for fiscal year 2012 will be higher than those incurred in fiscal year 2011 as we look to increase our advertising expense in our effort to increase market share and to promote our Digital Phone Service, SIP Trunking Service, and Individualized Services product lines.
 
 
General and Administrative Expenses
 
General and administrative expenses for the three months ended June 30, 2012 were $1.8 million, a decrease of less than $0.1 million or 1.2%, over the same period in 2011.  General and administrative expenses in both the six months ended June 30, 2012 and 2011 were $3.7 million.  
 
Research, Development and Engineering Expenses
 
Research, development and engineering expenses for the both the three months ended June 30, 2012 and June 30, 2011 were $0.5 million.  Research, development and engineering expenses for the both the six months ended June 30, 2012 and June 30, 2011 were $1.0 million.  
 
Depreciation Expense
 
Depreciation expense for the three months ended June 30, 2012 and June 30, 2011 was $0.2 million.  Depreciation for the six months ended June 30, 2012 and June 30, 2011 was $0.3 million.

Amortization of Purchased Intangibles
 
We recorded $1.1 million of amortization expense in both the six months ended June 30, 2012 and 2011, related to the amortization of intangible assets acquired in the AccessLine acquisition.
 
Interest Expense
 
Interest expense was $0.6 and $0.9 million for the three months ended June 30, 2012 and 2011 respectively.  Interest expense was $1.3 and $1.8 million for the six months ended June 30, 2012 and 2011 respectively.  Interest expense includes stated interest, amortization of note discounts, amortization of deferred financing costs, and interest on capital leases.

On June 30, 2010, we entered into a securities purchase agreement with holders of our outstanding debentures in the principal amount of $29.6 million.  Under the terms of the agreement, we repurchased and cancelled all of our outstanding debentures in exchange for payment of $7.5 million in cash. Additionally, the holders of our debentures exchanged all outstanding warrants they held for shares of our common stock and we issued to such holders an additional number of shares of our common stock, such that the holders collectively beneficially owned approximately 221,333 shares of our common stock immediately following the completion of the transactions contemplated by the agreement.
 
 Concurrently with the repurchase of our debentures, we entered into the Hale Securities Purchase Agreement, pursuant to which we issued $10.5 million in principal of 2010 Notes.  Interest accrues on the 2010 Notes at a rate equal to the prime rate as published in the Wall Street Journal as of the first business day of each interest period plus 4.75% per annum and is payable at the end of each month, with the first payment due on July 31, 2010.  Through June 30, 2011, we had the option to defer the monthly interest payments otherwise due and have the amount of interest deferred added to the principal balance of the 2010 Notes. The Company elected to defer interest on the 2010 Notes at all available times during 2010 and 2011.  In connection with the August 2011 amendment to the 2010 Notes, through June 30, 2012, the Company has the option to defer the monthly interest payments otherwise due on $3.0 million of the 2010.  Notes and have any such amount of deferred interest added to the principal balance of the 2010 Notes.
 
 
Provision for Income Taxes
 
No provision for income taxes has been recorded because we have experienced net losses from inception through June 30, 2012. As of December 31, 2011, we had net operating loss carry forwards (“NOL’s”), net of section 382 limitations, of approximately $8.5 million, some of which, if not utilized, will begin expiring in the current year. Our ability to utilize the NOL carry forwards is dependent upon generating taxable income.  We have recorded a corresponding valuation allowance to offset the deferred tax assets as it is more likely than not that the deferred tax assets will not be realized.
 
Net Loss

Our net loss for the three months ended June 30, 2012 was $802,181, compared with a net loss of $1,655,802 for the three months ended June 30, 2011, a reduction in quarterly net loss of $853,621 over the comparable period a year ago.  Our net loss for the six months ended June 30, 2012 was $1,660,738, compared with a net loss of $3,266,878 for the six months ended June 30, 2011, a reduction in year to date losses of $1,606,140 over the comparable period a year ago.
 
Liquidity and Capital Resources
 
We had an accumulated deficit of $37.0 million as of June 30, 2012, and incurred a net loss of $0.8 million for the six months ended June 30, 2012.  At June 30, 2012, we had cash of $2.3 million, accounts receivable of $1.8 million and a working capital deficit of $5.3 million. However, current liabilities include certain items that will likely settle without future cash payments or otherwise not require significant expenditures by the Company including: deferred revenue of $1.1 million (primarily deferred up front customer activation fees), deferred rent of $0.1 million and accrued vacation of $0.5 million. The aforementioned items represent $1.7 million of total current liabilities as of June 30, 2012. We do not anticipate being in a positive working capital position in the near future.  However, based on our projected 2012 results and, if necessary, our ability to reduce certain variable operating expenses, we believe that our existing capital, together with anticipated cash flows from operations, will be sufficient to finance our operations through at least July 1, 2013.

If our cash reserves prove insufficient to sustain operations, we plan to raise additional capital by selling shares of capital stock or other equity or debt securities.  However, there are no commitments or arrangements for future financings in place at this time, and we can give no assurance that such capital will be available on favorable terms or at all.  We may need additional financing thereafter until we can achieve profitability.  If we cannot, we may be forced to curtail our operations or possibly be forced to evaluate a sale or other strategic alternative.  Any future financing may involve substantial dilution to existing investors.

In addition, if our cash flows from operations are not sufficient to make interest payments owed on the 2010 Notes in cash in 2012 or we are unable to make the payments due on the 2010 Notes in 2012 through maturity in 2014, we would be in default under such notes.  If this were to occur, we would need to evaluate other equity financing opportunities, the proceeds of which could be used to make interest payment and/or repay the 2010 Notes.  If we do not pay the 2010 Notes in accordance with their terms, the holder of such notes would be entitled to additional default interest of 4%, which will accrue on the outstanding principal balance.  In addition, we may be required to redeem all or any portion of the 2010 Notes at a price equal to 125% of the sum of the principal amount that such holder requests that we redeem plus accrued but unpaid interest on such principal amount plus any accrued or unpaid late charges with respect to such principal and interest.  In addition, the holder would have the right to foreclose on all of our assets pursuant to the terms of the security agreement we entered into with such holders and they would have the right to take possession of our assets and operate our business.  Further, a monthly penalty calculated as one percent of the aggregate Hale shares purchase price under the Hale Securities Purchase Agreement could be imposed if the Company is unable to register the Hale shares.  

We have been unable to register any portion of the Hale shares and at this time we anticipate that a significant number of the Hales shares will remain unregistered as of December 31, 2012.  As such, we may need to seek a waiver from Hale or incur the aforementioned penalties.  While we have successfully obtained waivers in the past we can give no assurance that additional waivers will be available.

Cash generated by continuing operations during the six months ended June 30, 2012 was $2.1 million. This was primarily the result of cash generated from operations of $2.1 million as the net loss from continuing operations of $1.7 million was more than offset by the following non-cash charges: amortization of note discounts of $0.8 million; amortization of intangible assets of $1.1 million; depreciation expense of $1.0 million (which includes depreciation expense of $0.3 million in cost of sales); non-cash interest of $0.1 million and stock compensation expense of $0.2 million. The remaining $0.6 million of cash was provided by the changes in working capital.
 
 
Net cash used by investing activities during the six months ended June 30, 2012 was $0.2 million, which consisted primarily of purchases of property and equipment.
 
Net cash used by financing activities was $1.5 million during the six months ended June 30, 2012, $0.3 million of which was related to payments on our capital leases and $1.2 million was related to payment on the 2010 notes.
 

We do not currently have any unused credit arrangement or open credit facility available to us.  The 2010 notes are secured by a lien on all of our assets, and the terms of those notes restrict our ability to borrow funds, pledge our assets as security for any such borrowing or raise additional capital by selling shares of capital stock or other equity or debt securities, without the consent of the holders of the 2010 notes.
 
If our cash reserves prove insufficient to sustain operations, we plan to raise additional capital by selling shares of capital stock or other equity or debt securities.  However, there are no commitments or arrangements for future financings in place at this time, and we can give no assurance that such capital will be available on favorable terms or at all.  We may need additional financing thereafter until we can achieve profitability.  If we cannot, we may be forced to curtail our operations or possibly be forced to evaluate a sale or other strategic alternative.   Any future financing may involve substantial dilution to existing investors.

Commitments and Contingencies
 
Leases

We have non-cancelable operating and capital leases for corporate facilities and equipment.
 
Future minimum rental payments required under non-cancelable operating and capital leases are as follows:

   
Operating Leases
   
Capital Leases
 
                 
2012
   
795,164
     
352,229
 
2013
   
467,936
     
535,681
 
2014
   
       215,016
     
     476,383
 
2015
   
96,554
     
115,660
 
2016
           
26,766
 
2017
           
8,922
 
Total minimum lease payments
 
$
1,574,670
     
1,515,641
 
Less amount representing interest
           
(161,125
)
Present value of minimum lease payments
           
1,354,517
 
Less current portion
           
(533,632
)
           
$
820,885
 
 
 
The 2010 Notes

In connection with the Recapitalization, on July 2, 2010, we issued $10.5 million in principal amount of 2010 Notes.  The following summarizes the terms of the 2010 Notes:

Term.  The 2010 Notes are due and payable on July 2, 2014.

Interest.  Interest accrues at a rate equal to the prime rate as published in The Wall Street Journal as of the first business day of each interest period plus 4.75% per annum and is payable at the end of each month, with the first payment due on July 2, 2010.  Through June 30, 2011, we had the option to defer the monthly interest payments otherwise due and have the amount of interest deferred added to the principal balance of the 2010 Notes. In connection with the August 2011 amendment to the 2010 Notes, through June 30, 2012, the Company has the option to defer the monthly interest payments otherwise due on $3.0 million of the 2010 Notes and have any such amount of deferred interest added to the principal balance of the 2010 Notes.

Principal Payment.  In July 2011 and continuing for 11 months thereafter, principal payments of $200,000 per month are due on the last day of each month.  Thereafter, we are required to pay principal in a monthly amount equal to the sum of (a) $383,702and (b) the quotient determined by dividing the (i) aggregate amount of interest added to the principal amount by (ii) 24.  Any remaining principal amount, if not paid earlier, is due and payable on July 2, 2014.

August 2011 Amendment.  We had the right to redeem up to $3.0 million of the 2010 Notes prior to maturity in connection with the rights offering. In August 2011, the Company and Hale amended the Hale Securities Purchase Agreement to (i) cancel the Company's obligation to conduct the rights offering, and (2) cancel Hale's obligation to convert up to $3.0 million of the 2010 Notes into common stock.  As a result of the amendment, the original principal amount of the 2010 Notes outstanding remained at approximately $10.5 million, plus interest that was accrued to principal through June 30, 2012.  The Company's scheduled payment obligations under the 2010 Notes will average approximately $431,000 per month through June 30, 2013 and average approximately $400,000 per month for the remaining twelve months until maturity.
 
No Conversion Rights.  The 2010 Notes are not convertible.

Security.  The 2010 Notes are secured by all our assets under the terms of a pledge and security agreement and we and our subsidiaries entered into with Hale.  Each of our subsidiaries also entered into guarantees in favor of Hale, pursuant to which each subsidiary guaranteed the complete payment and performance by us of our obligation under the 2010 Notes and related agreements.

Covenants.  The 2010 Notes impose certain covenants on us, including: restrictions against incurring additional indebtedness, creating any liens on our property, entering into a change in control transaction, redeeming or paying dividends on shares of our outstanding common stock, entering into certain related party transactions, changing the nature of our business, making or investing in a joint venture, disposing of any of our assets outside of the ordinary course of business, effecting any subsequent offering of debt or equity, amending our articles of incorporation or bylaws, and limiting our ability to enter into lease arrangements.

Events of Default.  The 2010 Notes define certain events of default, including; failure to make a payment obligation under the 2010 Notes, failure to pay other indebtedness when due if the amount exceeds $250,000, bankruptcy, entry of a judgment against us in excess of $250,000 which is not discharged or covered by insurance, failure to observe other covenants of the 2010 Notes or related agreements (subject to applicable cure periods), breach of representation or warranty, failure of Hale’s security documents to be binding and enforceable, and casualty loss of any of our assets that would have a material adverse effect on our business, and failure to meet 80% of quarterly financial targets from our annual operating budget, including cash, revenue and EBITDA.  In the event of default, additional default interest of 4% will accrue on the outstanding balance.  In addition, in the event of default, we may be required to redeem all or any portion of the 2010 Notes at a price equal to 125% of the sum of the principal amount that such holder requests that we redeem plus accrued but unpaid interest on such principal amount plus any accrued and unpaid late charges with respect to such principal and interest.

Change of Control.  We are required to obtain the consent of the holders of the 2010 Notes representing at least a majority of the aggregate principal amount of the 2010 Notes then outstanding in order to enter into a change of control transaction.  If such consent is obtained the holders of the 2010 Notes may require us to redeem all or any portion of such notes at a price equal to 125% of the sum of the principal amount that such holder requests that we redeem plus accrued but unpaid interest on such principal amount plus any accrued and unpaid late charges with respect to such principal and interest.
 
 
Minimum Third Party Network Service Provider Commitments
 
We have a contract with a third party network service provider that facilitates interconnectivity with a number of third party network service providers.  The contract contains a minimum usage guarantee of $0.2 million per monthly billing cycle and expires in July 2012.  The cancellation terms are a 90 day written notice prior to the then current term expiring.
 
 
Critical Accounting Policies Involving Management Estimates and Assumptions
 
Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements.  The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and equity and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant estimates include those related to the allowance for doubtful accounts; valuation of inventories; valuation of goodwill, intangible assets and property and equipment; valuation of stock based compensation expense, the valuation of warrants and conversion features; and other contingencies.  We evaluate our estimates on an ongoing basis.  We base our estimates on historical experience and on various other assumptions that are believed 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.  Actual results could differ from those estimates under different assumptions or conditions.
 
There have been no material changes to our critical accounting policies, estimates, or judgments from those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.  The following is a discussion of certain of the accounting policies that require management to make estimates and assumptions where the impact of those estimates and assumptions may have a substantial impact on our financial position and results of operations.

 Internally Developed Software:
 
The Company capitalizes payroll and related costs that are directly attributable to the design, coding, and testing of the Company's software developed for internal use.   Internally developed software costs, which are included in property and equipment, are amortized on a straight-line basis over an estimated useful life of two years.  

Goodwill:
 
Goodwill is not amortized but is regularly reviewed for potential impairment.  The identification and measurement of goodwill impairment involves the estimation of the fair value of our reporting units.  The estimates of fair value of reporting units are based on the best information available as of the date of the assessment, which primarily incorporate management assumptions about expected future cash flows.  Future cash flows can be affected by changes in industry or market conditions or the rate and extent to which anticipated synergies or cost savings are realized with newly acquired entities.

Impairment of Long-Lived Assets:
 
Purchased intangible assets with finite lives are amortized using the straight-line method over the estimated economic lives of the assets, which range from five to ten years.  Purchased intangible assets determined to have indefinite useful lives are not amortized.  Long-lived assets, including intangible assets with finite lives, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.  Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition.  Measurement of an impairment loss for long-lived assets that management expects to hold and use is based on the fair value of the asset.  Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
 
 
Revenue Recognition:
 
Revenues from continuing operations are derived primarily from monthly recurring fees, which are recognized over the month the service is provided, activation fees, which are deferred and recognized over the estimated life of the customer relationship, and fees from usage, which are recognized as the service is provided.
 
Income Taxes:
 
We account for income taxes using the asset and liability method, which recognizes deferred tax assets and liabilities determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income.  Valuation allowances are established to reduce deferred tax assets when, based on available objective evidence, it is more likely than not that the benefit of such assets will not be realized.  In addition, FASB guidance requires us to recognize in the consolidated financial statements only those tax positions determined to be more likely than not of being sustained.
 
Derivative Financial Instruments
 
We do not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks.
 
We review the terms of convertible debt and equity instruments the Company issues to determine whether there are embedded derivative instruments, including the embedded conversion option, that are required to be bifurcated and accounted for separately as a derivative financial instrument.  In circumstances where the convertible instrument contains more than one embedded derivative instrument, including the conversion option, that is required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument.  Also, in connection with the sale of convertible debt and equity instruments, we may issue freestanding warrants that may, depending on their terms, be accounted for as derivative instrument liabilities, rather than as equity.
 
Bifurcated embedded derivatives are initially recorded at fair value and are then revalued at each reporting date with changes in the fair value reported as non-operating income or expense.  When the convertible debt or equity instruments contain embedded derivative instruments that are to be bifurcated and accounted for as liabilities, the total proceeds allocated to the convertible host instruments are first allocated to the fair value of all the bifurcated derivative instruments.  The remaining proceeds, if any, are then allocated to the convertible instruments themselves, usually resulting in those instruments being recorded at a discount from their face amount.
 
The discount from the face value of the convertible debt, together with the stated interest on the instrument, is amortized over the life of the instrument through periodic charges to income, using the effective interest method.
 
Stock Based Compensation:
 
We measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award.  That cost is recognized in the Consolidated Statement of Operations over the period during which the employee is required to provide service in exchange for the award – the requisite service period.  No compensation cost is recognized for equity instruments for which employees do not render the requisite service.  The grant-date fair value of employee share options and similar instruments is estimated using option-pricing models adjusted for the unique characteristics of those instruments.
 
Recent Accounting Pronouncements
 
See “Note 2 – Basis of Presentation” of the Notes to the Condensed Consolidated Financial Statements included in "Item 1. Financial Statements” of Part I of this report.
 
Off-Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated under the Securities Act.
 
 
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Under the rules and regulations of the Securities and Exchange Commission, as a smaller reporting company we are not required to provide the information required by this Item.
 
Item 4. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
Our disclosure controls and procedures are designed to provide reasonable assurances that material information related to our company is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Our Chief Executive Officer and Chief Financial Officer have determined that as of June 30 2012, our disclosure controls were effective at that "reasonable assurance" level.
 
Changes In Internal Controls over Financial Reporting.
 
No changes were made in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
PART II – OTHER INFORMATION
 
Item 1. LEGAL PROCEEDINGS
 
From time to time and in the course of business, we may become involved in various legal proceedings seeking monetary damages and other relief.  The amount of the ultimate liability, if any, from such claims cannot be determined.  However, in the opinion of our management, there are no legal claims currently pending or threatened against us that would be likely to have a material adverse effect on our financial position, results of operations or cash flows.

On November 11, 2011, the Company was named as a defendant in a lawsuit, Klausner Technologies, Inc. v. AccessLine Communications Corporation (Case number 6;11-cv-586), filed in the Federal District Court for the Eastern District of Texas.  The case alleges patent infringement and seeks unspecified damages and other relief.  As this matter is in an early stage, and discovery has not yet commenced the Company is not in a position to estimate potential liability or other ramifications, if any, that may result.
 
Item 1A. RISK FACTORS
 
In addition to the other information set forth in this report, you should carefully consider the risk factors discussed in "Part I. Item 1A—Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. The risks and uncertainties described in such risk factors and elsewhere in this report have the potential to materially affect our business, financial condition, results of operations, cash flows, projected results and future prospects. As of the date of this report, we do not believe that there have been any material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
 
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
None.
 
 
None.
 
Item 4. (REMOVED AND RESERVED)
 
 
Item 5. OTHER INFORMATION
 
None.
 
Item 6. EXHIBITS
 
See the exhibit index immediately following the signature page of this report.
 
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
TELANETIX, INC.
 
 
/s/ Paul C. Bogonis
Date: August 10, 2012
Paul C. Bogonis, Chief Financial Officer
 
(Duly Authorized Officer and Principal Financial Officer)
 
 
 

 
 
 
Exhibit No.
 
Description
10.1
 
Letter Agreement dated July 11, 2011, between Telanetix, Inc. and Paul C. Bogonis (incorporated herein by reference to the registrant's Form 8-K filed on July 14, 2011)
 
10.2
 
Confidential Settlement Agreement dated July 8, 2011, between Telanetix, Inc. and J. Paul Quinn (incorporated herein by reference to the registrant's Form 8-K filed on July 14, 2011)
 
10.3
 
Letter Agreement dated November 9, 2011 between Telanetix, Inc. and Rob Cain
 
10.4
 
Letter Agreement dated February 4, 2011 between Telanetix, Inc. and Rob Cain (incorporated herein by reference to registrant’s Form 8-K filed on February 4, 2011)
 
31.1
 
 
31.2
 
 
32.1
 
 
32.2
 
 
101.INS*
 
XBRL Instance Document
 
101.SCH*
 
XBRL Taxonomy Extension Schema Document
 
101.CAL*
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
101.DEF*
 
XBRL Taxonomy Extension Definition Linkbase Document
 
101.LAB*
 
XBRL Taxonomy Extension Label Linkbase Document
 
*
Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
 

PINX:TNIX Quarterly Report 10-Q Filling

PINX:TNIX Stock - Get Quarterly Report SEC Filing of PINX:TNIX stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

PINX:TNIX Quarterly Report 10-Q Filing - 6/30/2012
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