10-Q 1 intermetro-10q033111.htm intermetro-10q033111.htm


  UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-Q
 

 
 
x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended March 31, 2011
 
o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 000-51384
 
InterMetro Communications, Inc.
(Exact Name of Registrant as Specified in its Charter)
 
Nevada
              
88-0476779
(State of Incorporation)
 
(IRS Employer Identification No.)
 
2685 Park Center Drive, Building A,
Simi Valley, California 93065
(Address of Principal Executive Offices) (Zip Code)
 
(805) 433-8000
(Registrant’s Telephone Number,
0Including Area Code)
 
Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the proceeding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes  x   No 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated file, an accelerated file, a non-accelerated filer, or a smaller reporting company.  See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o No  x
 
State the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:
 
As of May 9, 2011 there were 74,207,728 shares outstanding of the registrant’s only class of common stock. 
 

 
TABLE OF CONTENTS
 
Part I. Financial Information
 
     
Item 1.
 
 
2
 
3
 
4
 
5
 
6
     
Item 2.
21
     
Item 3.
31
     
Item 4.
31
     
Part II. Other Information
 
     
Item 1.
32
     
Item 1A.
32
     
Item 2.
32
     
Item 3.
32
     
Item 4.
32
     
Item 5.
32
     
Item 6.
32
     
33

 
PART I - FINANCIAL INFORMATION
 Item 1. Financial Statements
 
INTERMETRO COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, except par value)
 
   
March 31,
2011
   
December 31,
2010
 
   
(unaudited)
       
ASSETS
       
 
 
Cash
  $ 560     $ 428  
Accounts receivable, net of allowance for doubtful accounts of $871 and $850 at March 31, 2011 and December 31, 2010, respectively
    1,988       3,494  
Deposits
    113       105  
Prepayments and other current assets
    402       259  
Total current assets
    3,063       4,286  
Property and equipment, net
    105       109  
Goodwill
    900       900  
Other intangible assets
          9  
Other long-term assets
    4       3  
Total Assets
  $ 4,072     $ 5,307  
                 
LIABILITIES AND STOCKHOLDERS’ DEFICIT
               
                 
Accounts payable net of dispute reserve of $509 and $1,016 at March 31, 2011 and December 31, 2010, respectively
  $ 4,794     $ 9,898  
Accrued expenses
    3,683       3,808  
Deferred revenues and customer deposits
    319       323  
Borrowings under line of credit facilities net of debt discount of $0 and $82 at March 31, 2011 and December 31, 2010, respectively
    2,187       2,110  
Amount due to former ATI shareholder (in default)
    75       75  
Current portion of vendor settlements
    3,177       2,140  
Current portion of secured promissory notes, including $875 from related parties net of debt discount of $10 and $12 at March 31, 2011 and December 31, 2010, respectively
    1,989       1,488  
Liability for warrant put feature
    717       717  
Total current liabilities
    16,941       20,559  
                 
Long-term vendor settlements
    1,546       701  
Long-term secured promissory notes
    384       883  
Total liabilities
    18,871       22,143  
                 
Commitments and contingencies (Note 12 )
               
                 
Stockholders’ Deficit
               
Preferred stock — $0.001 par value; 10,000,000 shares authorized; 25,000 shares issued and outstanding at March 31, 2011 and December 31, 2010
           
Common stock — $0.001 par value; 150,000,000 shares authorized;  74,207,728 and 72,975,423 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively
    74       73  
Additional paid-in capital
    29,154       29,145  
Accumulated deficit
    (44,027 )     (46,054 )
Total stockholders’ deficit
    (14,799 )     (16,836 )
Total Liabilities and Stockholders’ Deficit
  $ 4,072     $ 5,307  
 
The accompanying notes are an integral part of these condensed consolidated financial statements
 
 
INTERMETRO COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, except per share amounts)
(Unaudited)
  
   
Three Months Ended March 31,
 
   
2011
   
2010
 
Net revenues
  $ 6,256     $ 5,919  
Network costs
    4,519       4,077  
Gross profit
    1,737       1,842  
Operating expenses
               
Sales and marketing (includes stock based compensation of $0 and $3 for the three months ended March 31, 2011 and 2010, respectively)
    233       455  
General and administrative (includes stock based compensation of $0 and $4 for the three months ended March 31, 2011 and 2010, respectively)
    998       861  
Total operating expenses
    1,231       1,316  
Operating income
    506       526  
Interest expense, net  (includes stock-based charges of  $84 and $44 for the three months ended March 31, 2011 and 2010, respectively)
    379       462  
Accounts payable write-off
    (186 )     (591 )
Gain on forgiveness of debt
    (1,714 )     (461 )
                 
Net income
  $ 2,027     $ 1,116  
Basic net income per common share
  $ 0.03     $ 0.02  
Diluted net income per common share
  $ 0.02     $ 0.02  
Shares used to calculate basic net income per common share
    73,400       71,402  
Shares used to calculate diluted net income per common share
    87,450       71,402  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 

INTERMETRO COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIT
(Dollars in Thousands)
(Unaudited)
 
   
Preferred Stock
   
Common Stock
   
Additional
   
Accumulated
   
Total
 
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Deficit
   
Stockholders’ Deficit
 
Balance at January 1, 2011
    25,000     $       72,975,423     $ 73     $ 29,145     $ (46,054 )   $ (16,836 )
Warrants exercised
                1,232,305       1       9             10  
Net income for the three months ended March 31, 2011
                                  2,027       2,027  
Balance at March 31, 2011
    25,000     $       74,207,728     $ 74     $ 29,154     $ (44,027 )   $ (14,799 )
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 
 
INTERMETRO COMMUNICATIONS, INC.
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
 
   
Three Months Ended March 31,
 
   
2011
   
2010
 
Cash flows from operating activities:
 
 
   
 
 
Net income
  $ 2,027     $ 1,116  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    16       16  
Stock based compensation
          7  
Amortization of debt discount
    84       44  
Provision for doubtful accounts
    21       21  
Accounts payable write-off
    (186 )     (591 )
Gain on forgiveness of debt
    (1,714 )     (461 )
(Increase) decrease in assets:
               
Accounts receivable
    1,485       (919 )
Other current assets
    (149 )     (241 )
Increase (decrease) in liabilities:
               
Accounts payable
    (1,121 )     980  
Accrued expenses
    (32 )     158  
Vendor settlements
    (295 )      
Deferred revenues and customer deposits
    (4 )     (83 )
Net cash provided by operating activities
    132       47  
                 
Cash flows from investing activities:
               
Purchase of property and equipment
    (5 )     (20 )
                 
Cash flows from financing activities:
               
Principal payments on lines of credit
    (5 )      
Bank overdraft
          118  
Proceeds from exercise of warrants
    10       (65 )
Net cash provided by financing activities
    5       53  
                 
Net increase in cash
    132       80  
Cash at beginning of period
    428       99  
Cash at end of period
  $ 560     $ 179  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 
 
INTERMETRO COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 
1 — Nature of Operations and Summary of Significant Accounting Policies

Company Background - InterMetro Communications, Inc., (hereinafter, “InterMetro” or the “Company”) is a Nevada corporation which, through its wholly owned subsidiary, InterMetro Communications, Inc. (Delaware) (hereinafter, “InterMetro Delaware”), is engaged in the business of providing voice over Internet Protocol (“VoIP”) communications services. The Company owns and operates state-of-the-art VoIP switching equipment and network facilities that are utilized to provide traditional phone companies, wireless phone companies, calling card companies and marketers of calling cards with wholesale voice and data services, and voice-enabled application services. The Company’s customers pay the Company for minutes of utilization or bandwidth utilization on its national voice and data network and the Company’s calling card marketing customers pay per calling card sold. The Company’s headquarters is located in Simi Valley, California.
 
Basis of Presentation -  The accompanying unaudited interim condensed consolidated financial statements and information have been prepared in accordance with accounting principles generally accepted in the United States of America and in accordance with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, these condensed consolidated financial statements contain all normal and recurring adjustments considered necessary to present fairly the financial position, results of operations and cash flows for the periods presented. The results for the three month period ended March 31, 2011 are not necessarily indicative of the results to be expected for the full year. These condensed consolidated statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2010 which are included in the Form 10-K filed by the Company on March 30, 2011.
 
Going Concern - The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company had a working capital deficit of $13,878,000 and had a total stockholders’ deficit of $14,799,000 as of March 31, 2011.  Though the Company was profitable for the three months ended March 31, 2011 and the year ended December 31, 2010, which included $1.9 million and $2.3 million of non-cash gains, respectively,  it had net losses in previous years and will have to generate and sustain significant gross margin to maintain profitability. The Company’s ability to continue as a going concern will require additional financings if its ability to generate cash from operations does not fund required payments on its debt obligations.  Obligations to the Company’s debt holders include interest and principal payments to its secured note holders (see Note 7 to the Consolidated Financial Statements), principal and interest due on its revolving line of credit (see Note 11 to the Consolidated Financial Statements) and settlement payments due (see Note 6 to the Consolidated Financial Statements). The loans under the revolving line of credit are secured by substantially all of the Company’s assets. The Company has other significant matters of importance, including contingencies such as vendor disputes and lawsuits discussed in Note 12 that could have material adverse consequences to the Company such as cessation of its operations.
 
   The Company anticipates it will not have sufficient cash flows to fund its operations through fiscal 2011, or earlier, depending on the results of the negotiations with Moriah Capital, L.P. (“Moriah”) regarding the Company’s indebtedness to Moriah discussed in Note 11. If the Company were to require additional financings in order to fund ongoing operations there can be no assurance that it will be successful in completing the required financings which could ultimately cause the Company to cease its operations.   The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.  There are many claims and obligations that could ultimately cause the Company to cease its operations.  The report from the Company’s independent registered public accounting firm relating to the year ended December 31, 2010 states that there is substantial doubt about the Company’s ability to continue as a going concern.

As discussed in Note 11, the Company entered into agreements with Moriah under which it could borrow up to $2,400,000.  At March 31, 2011, the Company had borrowed $2,000,000. The availability of loan amounts under the agreements expires on June 30, 2011 and all amounts will be due at that time.
 
 
Management believes that the losses in past years were primarily attributable to costs related to building out and supporting a telecommunications infrastructure, and the requirement for continued expansion of the customer base, in order for the Company to become profitable. This resulted in the Company taking on debt and delaying payment to certain vendors.  The Company may be required to obtain other financing during the next twelve months or thereafter as a result of future business developments, including any acquisitions of business assets or any shortfall of cash flows generated by future operations in meeting the Company’s ongoing cash requirements. Such financing alternatives could include selling additional equity or debt securities, obtaining long or short-term credit facilities, or selling operating assets. Management continues to work with its historical vendors in order to secure the continued extension of credit. Management believes that cash flows from operations and additional debt conversions are integral to management’s plan to retire past due obligations and be positioned for growth.  No assurance can be given, however, that the Company will be successful in restructuring its debt on terms favorable to the Company or at all. Should the Company be unsuccessful in this restructuring, material adverse consequences to the Company could occur such as cessation of its operations.  Any sale of additional common stock or convertible equity or debt securities would result in additional dilution to the Company’s stockholders.
  
Principles of Consolidation - The consolidated financial statements include the accounts of InterMetro, InterMetro Delaware, and InterMetro Delaware’s wholly owned subsidiary, Advanced Tel, Inc. (“ATI”). All intercompany balances and transactions have been eliminated in consolidation.
 
Use of Estimates - In the normal course of preparing financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.   

Revenue Recognition - VoIP services are recognized as revenue when services are provided primarily based on usage. Revenues derived from sales of calling cards through retail distribution partners are deferred upon sale of the cards. These deferred revenues are recognized as revenue generally at the time card minutes are expended. The Company has revenue sharing agreements based on successful collections.  The company recognizes revenue from these customers at time of invoicing based on the history of collections with such customers. The Company recognizes revenue in the period that services are delivered and when the following criteria have been met: persuasive evidence of an arrangement exists, the fees are fixed and determinable, no significant Company obligations remain and collection is reasonably assured. Deferred revenue consists of fees received or billed in advance of the delivery of the services or services performed in which collection is not reasonably assured. This revenue is recognized when the services are provided and no significant Company obligations remain. Management of the Company assesses the likelihood of collection based on a number of factors, including past transaction history with the customer and the credit worthiness of the customer. Generally, management of the Company does not request collateral from customers. If management of the Company determines that collection of revenues are not reasonably assured, amounts are deferred and recognized as revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.
 
Accounts Receivable - Accounts receivable consist of trade receivables arising in the normal course of business. The Company does not charge interest on its trade receivables. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company reviews its allowance for doubtful accounts monthly. The Company determines the allowance based upon historical write-off experience, payment history and by reviewing significant past due balances for individual collectibility. If estimated allowances for uncollectible accounts subsequently prove insufficient, additional allowance may be required.  Bad debt expense for each of the three month periods ended March 31, 2011 and 2010 amounted to $21,000.
 
Network Costs - The Company’s network costs consist of telecommunication costs, leasing collocation facilities and certain build-outs, and depreciation of equipment related to the Company’s network infrastructure.  It is not unusual in the Company’s industry to occasionally have disagreements with vendors relating to the amounts billed for services provided between the recipient of those services and the vendor. As a result, the Company currently has disputes with vendors that it believes did not bill certain network charges correctly.  The Company’s policy is to include amounts that it intends to dispute or that it has disputed in a reserve account as an offset to accounts payable if management believes that the facts and circumstances related to the dispute provide probable support that the dispute will be resolved in the Company’s favor.
 
Advertising Costs - The Company expenses advertising costs as incurred. There were no advertising costs included in sales and marketing expenses for the three months ended March 31, 2011 and 2010.
 
 
Depreciation and Amortization - Depreciation and amortization of property and equipment is computed using the straight-line method based on the following estimated useful lives:
 
Telecommunications equipment
2-3 years
Telecommunications software
18 months to 2 years
Computer equipment
2 years
Office equipment and furniture
3 years
Leasehold improvements
Useful life or remaining lease term, which ever is shorter
 
 Maintenance and repairs are charged to expense as incurred; significant betterments are capitalized.
 
Impairment of Long-Lived Assets - The Company assesses impairment of its other long-lived assets in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360, “Property, Plant and Equipment”.  An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered by the Company include:
 
 
·
significant underperformance relative to expected historical or projected future operating results;
 
 
·
significant changes in the manner of use of the acquired assets or the strategy for the Company’s overall business; and
 
 
·
significant negative industry or economic trends.

When management of the Company determines that the carrying value of a long-lived asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, an estimate is made of the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future undiscounted cash flows and eventual disposition is less than the carrying amount of the asset, an impairment loss is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset, based on the fair market value if available, or discounted cash flows if not. To date, the Company has not had an impairment of long-lived assets and is not aware of the existence of any indicators of impairment.
 
Goodwill and Intangible Assets - The Company records goodwill when consideration paid in a business acquisition exceeds the fair value of the net tangible assets and the identified intangible assets acquired. The Company accounts for goodwill and intangible assets in accordance with FASB ASC 350 “Goodwill and Other”. FASB ASC 350 requires that goodwill and intangible assets with indefinite useful lives not be amortized, but instead be tested for impairment at least annually or whenever changes in circumstances indicate that the carrying value of the goodwill may not be recoverable. FASB ASC 350 also requires the Company to amortize intangible assets over their respective finite lives up to their estimated residual values.  At March 31, 2011 and December 31, 2010, management does not believe there is any impairment in the value of Goodwill.

Vendor Disputes - The Company’s policy is to include amounts that it intends to dispute or that it has disputed in a reserve account as an offset to accounts payable if management believes that the facts and circumstances related to the dispute provide probable support that the dispute will be resolved in the Company’s favor.
 
Stock-Based Compensation - The Company has applied FASB ASC 718 “Compensation – Stock Compensation”.   For grants to employees under its 2004 plan and 2007 plan, the Company estimates the fair value of each option award on the date of grant using the Black-Scholes option-pricing model. Expected volatility is based on the historical volatility of a peer group of publicly traded entities.  The expected term of the options granted is derived from the average midpoint between vesting and the contractual term, as described in the SEC’s Staff Accounting Bulletin No. 107, “Share-Based Payment.”  The risk-free rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The Company did not grant any options during the three months ended March 31, 2011 and 2010.
  
 
Concentration of Credit Risk - Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, accounts receivable, accounts payable, accrued expenses, and short term debt. The Company maintains its cash with a major financial institution located in the United States. The balances are insured by the Federal Deposit Insurance Corporation up to $250,000. Periodically throughout the year the Company maintained balances in excess of federally insured limits. The Company encounters a certain amount of risk as a result of a concentration of revenue from a few significant customers and services provided from vendors. Credit is extended to customers based on an evaluation of their financial condition. The Company generally does not require collateral or other security to support accounts receivable. The Company performs ongoing credit evaluations of its customers and records an allowance for potential bad debts based on available information. To date, such losses, if any, have been within management’s expectations.
 
The Company had four customers which accounted for 66% and one customer which accounted for 39% of net revenue for the three months ended March 31, 2011 and 2010, respectively.
 
The Company had an accounts receivable balance from four and three customers that accounted for 50% and 70% of total accounts receivable at March 31, 2011 and December 31, 2010, respectively. 

Income Taxes - The Company accounts for income taxes in accordance with FASB ASC 740, “Income Taxes,” which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using presently enacted tax rates in effect. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
 
Segment and Geographic Information - The Company operates in one principal business segment primarily in the United States. All of the operating results and identified assets are located in the United States.
 
Basic and Diluted Net Income (Loss) per Common Share - Basic net income (loss) per common share excludes dilution for potential common stock issuances and is computed by dividing net loss by the weighted-average number of common shares outstanding for the period. Diluted net income (loss) per share includes dilution for potential common stock issuances when the warrants, options or common stock conversion rights underlying those potential issuances are below the then fair market value of the Company’s common stock and have intrinsic value.  A total of 14,049,891 potential common stock issuances were included in the calculation of diluted net income for the three months ended March 31, 2011.  As none of the Company’s potential stock issuances had intrinsic value at March 31, 2010, they had no effect on the calculation of diluted net income per common share.
 
Recent Accounting Pronouncements - Management does not believe that any recently issued, but not yet effective, accounting standards or pronouncements, if currently adopted, would have a material effect on the Company’s consolidated financial statements.
 
2 — Acquisition and Intangible Assets
 
In March 2006, the Company acquired all of the outstanding stock of Advanced Tel, Inc. (“ATI”), a switchless reseller of wholesale long-distance services, for a combination of shares of its common stock and cash. The Company acquired ATI to increase its customer base, to add minutes and revenue to its network and to access new sales channels. The initial portion of the purchase price included 308,079 shares of the Company’s common stock, a payable of $250,000 to be paid over the six-month period following the closing and a $150,000 two-year unsecured promissory note in an amount tied to ATI’s working capital of $150,000.  These amounts were payable to the former selling shareholder of ATI who was appointed President of ATI at the acquisition closing date. As of March 31, 2011 and December 31, 2010, $75,000 remained unpaid to the former selling shareholder. The fair value of the shares issued was based on the guaranteed price of $4.87 per share.  The number of shares of common stock consideration paid to the selling shareholder of ATI was subject to an adjustment (or the payment of additional cash in lieu thereof at the option of the Company) if the trading price of the Company’s common stock did not reach a minimum price of $4.87 per share during the two years following the closing date.   The selling shareholder of ATI was also entitled to contingent consideration of common shares and cash during the two succeeding years from the acquisition date upon meeting certain performance targets tied to revenue and profitability.  In December 2008, the Company issued 4,089,930 shares of common stock, with a fair value of $611,043, as full payment of the contingent consideration.  During the third quarter of 2009, the President of ATI departed from the Company.  On March 31, 2011, the former President of ATI filed a law suit against the Company (see Note 12 to the Consolidated Financial Statements).

The Company has developed an integration plan for utilizing the Company’s network to carry the ATI customer traffic. The execution of this plan will result in a significant cost savings that was used in the present value of net cash flows analysis that supports the carrying value of ATI Goodwill which was $900,000 at March 31, 2011 and December 31, 2010.


3 — Prepayments and Other Current Assets
 
The following is a summary of the Company’s prepayments and other current assets (in thousands):

                                                                                                                           
 
March 31,
2011
   
December 31,
2010
 
   
(unaudited)
       
Employee advances
  $ 63     $ 63  
Deferred loan costs
          96  
Prepaid expenses
    339       100  
Other current assets
  $ 402     $ 259  
 
4 — Property and Equipment
 
The following is a summary of the Company’s property and equipment (in thousands):
 
                                                                                                                           
 
March 31,
2011
   
December 31,
2010
 
   
(unaudited)
       
Telecommunications equipment
  $ 3,327     $ 3,327  
Computer equipment
    179       174  
Telecommunications software
    107       107  
Leasehold improvements, office equipment and furniture     86       86  
Total property and equipment
    3,699       3,694  
Less: accumulated depreciation and amortization
    (3,594 )     (3,585 )
Property and equipment, net
  $ 105     $ 109  
 
Depreciation expense included in network costs was $9,000 and $7,000 for the three months ended March 31, 2011 and 2010, respectively. Depreciation and amortization expense included in general and administrative expenses was $7,000 and $9,000 for the three months ended March 31, 2011 and 2010, respectively.
 
In May 2004, the Company entered in an agreement with a vendor to provide certain network equipment. Under the terms of this agreement, the Company could obtain certain telecommunications equipment with a total purchase price of approximately $5.2 million to expand its operations. At March 31, 2011, the Company had purchased telecommunications equipment under this agreement totaling $1,439,000.  In January 2010, the Company executed a modification to the purchase agreement that set the total amount due to be $249,500 which was subsequently reduced to $100,000 and is subject to timely payments by the Company. As part of the modification, the vendor was awarded 200,000 warrants with a strike price of $0.01 and a fair value of $1,179.  The amount remaining to be paid is $41,000 at March 31, 2011.

In May 2006, the Company entered into a strategic agreement with Cantata Technology, Inc. (“Cantata”), a VoIP equipment and support services provider. Under the terms of this agreement, the Company obtained VoIP equipment to expand its operations. Payments were scheduled to be based on either the actual underlying traffic utilized by each piece of equipment or fixed cash payments. Through December 31, 2009, the Company had purchased VoIP equipment under this agreement totaling $691,000.  The value of the equipment was based on the present value of future scheduled payments.  At December 31, 2009, the Company had accrued $1,096,000 due to Cantata, which was equal to the undiscounted future scheduled payments.  The difference between the undiscounted future payments and the purchase price was recorded to interest expense.  The Company was previously sued by Cantata for breach of contract and lack of payment and the lawsuit was settled in January 2010 for $500,000. The settlement contains a long-term payment plan and is subject to timely payments by the Company. As of March 31, 2011, the remaining amount due under the settlement agreement was $310,000.
 
 
5 — Accrued Expenses
 
The following is a summary of the Company’s accrued expenses (in thousands):
 
   
March 31,
2011
   
December 31,
2010
 
   
(unaudited)
       
Commissions, network costs and other general accruals
  $ 944     $ 1,136  
Accrued USF and Sales Tax
    783       762  
Deferred payroll and other payroll related liabilities
    552       560  
Interest due on convertible promissory notes and other debt
    1,018       1,000  
Payments due to third party providers
    385       350  
Accrued expenses
  $ 3,682     $ 3,808  
 
6 — Vendor Settlements, Contingent Gains and Gain of Forgiveness of Debt

During the three months ended March 31, 2011, the Company entered into numerous cash payment plan agreements with vendors for amounts less than the liability recorded in accounts payable and accrued expenses.  As a result of these agreements, the Company recorded a gain on forgiveness of debt of $1,714,000 for the three months ended March 31, 2011.  In addition, the Company wrote-off certain accounts payable for Competitive Local Exchange Carriers (“CLEC”) that resulted in a gain of $186,000 for the same period, and is included in accounts payable write-off.  The CLEC accounts payable were written off based on a two year statute of limitations on such accounts payable balances. In the three months ended March 31, 2011, these transactions reduced accounts payable by $3,980,000 and accrued expenses by $93,000.

At March 31, 2011, the balance in vendor settlements payable was $4,723,000 including $2,052,000 of deferred gains subject to timely payments.  The settlements will be paid in periods ranging from one to thirty months with an aggregate monthly payment of approximately $93,000.   The Company will continue to approach vendors to enter into similar agreements as well as continuing to write-off certain CLEC accounts payable under statute of limitations.  As of March 31, 2011 some of these settlement agreements are in default.

During the three months ended March 31, 2010, the Company entered into payment plan agreements that resulted in the Company recorded a gain on forgiveness of debt of $461,000.  In addition, the Company wrote-off certain accounts payable for CLECs that resulted in a gain of $591,000. These transactions reduced accrued expenses by $1,535,000 and reduced accounts payable by $1,270,000. These transactions also resulted in vendor settlements payable of $1,753,000 at March 31, 2010 including $819,000 of gain contingency based on timely payments.

7 — Secured Promissory Notes and Advances
 
2008 Bridge Loan - In November and December 2007, the Company received $600,000 in advance payments, pursuant to the sale of secured notes with individual investors, including $330,000 from related parties.  In 2008 the Company received an additional $1,320,000, including $170,000 from related parties, pursuant to the sale of additional secured notes with individual investors, for a total of $1,920,000.  The secured notes were issued on January 16, 2008 and were scheduled to mature 13 to 18 months after issuance (“2008 Bridge Loan”).  The 2008 Bridge Loan was extended in 2009 to July 15, 2010, and then modified on October 5, 2010 (“2008 Bridge Loan Modification”)  to be paid in quarterly installments, of interest, fees and principal, commencing March 31, 2011 and concluding on July 15, 2012. The March 31, 2011 interest payments have not been made. The 2008 Bridge Loan bears interest at a rate of 13% per annum and contain an origination and documentation fee equal to 3% and 2.5%, respectively, of the original principal amount of the note. The 2008 Bridge Loan is collateralized by substantially all of the assets of the Company.  Since inception, the Company has incurred $866,000 in interest and fees, including $61,000 during the three months ended March 31, 2011.
 
 
In connection with the notes, the Company originally issued two common stock purchase warrants for every dollar received or 3.84 million common stock purchase warrants with an exercise price of $1.00, (the “Initial Warrants” and the “Additional Warrants”, collectively the “2008 Bridge Origination Warrants”).  These 2008 Bridge Origination Warrants contained terms which resulted in 3.84 million shares of common stock being issued in 2009, in accordance with those terms, to extinguish the 2008 Bridge Origination Warrants.  In exchange for the first extension of the due date from July 15, 2009 to July 15, 2010 the holder received a common stock purchase warrant (“Extension Warrants”) for each dollar of principal with an exercise price of $0.50 per share that were set to expire on July 14, 2016.  The 2008 Bridge Loan Modification extends the term of Extension Warrants to July 14, 2018. In exchange for the 2008 Bridge Loan Modification the holder received a common stock purchase warrant (“2010 Extension Warrants”) for each dollar of principal with an exercise price of $0.01 per share that will expire on October 5, 2017.  The value associated with the 2010 Extension Warrants was $11,000 and was recorded as an offset to the principal balance of the secured notes and is being amortized into interest expenses over the term of the notes using the effective interest method.  The warrants were valued using the Black-Scholes formula.

The “Initial Warrants” also contained a put feature which gave the holder the option to put the warrant back to the Company for $0.15 per share and had been carried as a liability in the Company’s financial statements. The put feature was eliminated pursuant to the 2008 Bridge Loan Modification and the $288,000 related liability was reclassified to equity.

2009 Bridge Loan- In November and December 2008, two related party secured note holders advanced an additional $310,000 and in 2009 there were advances of an additional $152,500 from existing note holders, including $65,000 from related parties, paying 13% interest per annum.  On June 12, 2009, the Company entered into a Short Term Loan and Security Agreement (“2009 Bridge Loan”) with the advance lenders.  Per the 2009 Bridge Loan, the maturity date of the loans was extended from June 30, 2009 to February 28, 2010, and then subsequently modified on October 5, 2010 (“2009 Bridge Loan Modification”)  to be paid in quarterly installments, of interest, fees and principal, commencing November 30, 2010 and concluding February 28, 2012.  On November 30, 2010 the note holders waived their initial installment payment for 60 days and received their first payments as of January 31, 2011. The February 28, 2011 interest payments have not been made.  The 2009 Bridge Loan accrues interest at 13% per annum and contain an origination and documentation fee equal to 3% and 2.5%, respectively, of the original principal amount of the note.   The holder of each note has the right, at any time and from time to time, to convert the entire principal plus accrued interest and origination and documentation fee, or any portion thereof, into shares of common stock by dividing the conversion amount by $0.25.  The 2009 Bridge Loan is collateralized by substantially all of the assets of the Company.   Since inception, the Company has incurred $160,000 in interest and fees, including $15,000 during the three months ended March 31, 2011.
 
As was the case for the 2008 Bridge Loan warrants, the provisions of the 2009 Bridge Loan warrants included terms that resulted in the company providing shares of common stock in lieu of exercise under certain conditions, which conditions occurred on June 12, 2009 and resulted in the issuance of 1,387,500 shares of common stock to extinguish the 2009 Bridge Original Warrants.  In exchange for the 2009 Bridge Loan Modification the holder received a common stock purchase warrant (“2010 Extension Warrants”) for each dollar of principal with an exercise price of $0.01 per share that expire on October 5, 2017.  The value associated with the 2010 Extension Warrants was $3,000 and was recorded as an offset to the principal balance of the secured notes and is being amortized into interest expenses over the term of the notes using the effective interest method.  The warrants were valued using the Black-Scholes formula.

The total expense recorded by the Company for amortization of the debt discount related to all warrants was $2,000 and $3,000 for the three months ended March 31, 2011 and 2010, respectively.  The net amount of the notes was $2,373,000 and $2,371,000 as of March 31, 2011 and December 31, 2010, respectively.  The Company did not make certain scheduled interest payments on both the 2008 and 2009 Bridge Loans during the three months ended March 31, 2011.   It has not received a notice of cure or default from any of the note holders in response to the non-payments.

8 — Long-Term Debt
 
The Company’s long-term debt consists of the following:
 
   
March 31,
2011
   
December 31,
2010
 
   
(unaudited)
       
Vendor settlements
  $ 4,723     $ 2,841  
Secured promissory notes
    2,373       2,371  
Less: Current portion of long-term debt
    (5,166 )     (3,628 )
Long-term debt
  $ 1,930     $ 1,584  
 
 
As of March 31, 2011 a summary of future maturities of long-term debt are as follows:

2011
  $ 5,166  
2012
    1,125  
2013
    763  
2014
    42  
    $ 7,096  

9 — Common and Preferred Stock
 
Preferred Stock - On May 31, 2007, the Company filed Amended and Restated Articles of Incorporation authorizing 10,000,000 shares of preferred stock, par value $0.001 per share, none of which are issued and outstanding.  On November 19, 2009, the Company filed its Certificate of Designation (“C.D.”) and designated a Series A Preferred stock by resolution of the board of directors.  The C.D. authorized the sale of 250,000 shares of Series A preferred stock at $1.00 per share, with additional rights, preferences, restrictions and privileges as filed with the Nevada Secretary of State.

In November, 2009, the Company issued 25,000 shares of Series A Preferred stock at $1.00 per share to a stockholder and secured note holder

Common Stock - As of March 31, 2011, the total number of authorized shares of common stock, par value $0.001 per share, was 150,000,000 of which 74,207,728 shares were issued and outstanding.
 
Private Placement of Securities – During the three months ended March 31, 2011, the Company issued 1,232,305 shares of its common stock pursuant to the exercise of warrants.  The Company received proceeds of $9,858 in connection with the issuance.
 
10 — Stock Options and Warrants
 
2004 Stock Option Plan - Effective January 1, 2004, the Company’s Board of Directors adopted the 2004 Stock Option Plan for Directors, Officers, and Employees of and Consultants to InterMetro Communications, Inc. (the “2004 Plan”).  A total of 5,730,222 shares of the Company’s common stock had been reserved for issuance under the 2004 Plan. Upon shareholder ratification of the 2004 Plan pursuant to the definitive Information Statement on Schedule 14C filed with the Securities and Exchange Commission on March 6, 2007, the Company froze any further grants of stock options under the 2004 Plan. Any shares reserved for issuance under the 2004 Plan that are not needed for outstanding options granted under that plan will be cancelled and returned to treasury shares.
 
As of March 31, 2011, the Company has granted a total of 5,714,819 stock options under the 2004 Plan to the officers, directors, and employees, and consultants of the Company, of which 308,077 expired in September 2007and an additional 523,734 expired during the year ended December 31, 2008.  In the three months ended March 31, 2008, the Company issued 1,143,165 shares of common stock on the cashless exercise of 1,232,320 stock purchase options.  The remaining 3,650,688 are fully vested at March 31, 2011 and were originally granted with exercise prices ranging from $0.04 to $0.97 per share.  On November 15, 2010, in order to provide continued economic incentive to option holders, most of whose options were issued at prices that were “out of the money”, the Board of Directors authorized a re-pricing of all the stock options under the 2004 Plan to $0.01, the closing price of the Company’s common stock on that day. The incremental compensation cost computed using the Black-Scholes option pricing model was $14,000 which was charged to expense on that date.

Omnibus Stock and Incentive Plan – Effective January 19, 2007, our Board of Directors approved the 2007 Omnibus Stock and Incentive Plan (the “2007 Plan”) for directors, officers, employees, and consultants. Our shareholders ratified the 2007 Plan pursuant to the Schedule 14C Information Statement filed with the Securities and Exchange Commission which was declared effective on May 10, 2007.   Any employee or director of, or consultant for, us or any of the Company’s subsidiaries or other affiliates will be eligible to receive awards under the 2007 Plan. The Company has reserved 12,552,181 shares of common stock for awards under the 2007 Plan. The 2007 Plan specifically prohibits the re-pricing of any stock options awarded under this plan.
 
 
In November 2007, InterMetro granted 2,350,000 stock options to purchase shares of common stock under the 2007 Plan at an average exercise price of $0.25 per share to employees and directors. 1,095,000 of the shares granted were immediately vested at date of grant.  In October 2008, InterMetro granted 600,000 stock options to purchase shares of common stock under the 2007 Plan at an average exercise price of $0.25 per share to employees and directors. 30% vested at date of grant with the remaining vesting 1/12 per subsequent quarter over the succeeding 3 years expiring 5 years from date of grant.  No options to purchase shares of common stock were granted under the 2007 plan in the three months ended March 31, 2011.  As of March 31, 2011 none of the Company’s outstanding stock options under the 2007 Plan have been exercised.
 
The following presents a summary of activity under the Company’s 2004 and 2007 Plans for the three months ended March 31, 2011 (unaudited):
 
   
Number
of
Shares
   
Price
per
Share
   
Weighted
Average
Exercise
Price
   
Weighted
Average
Remaining
Contractual Term
   
Aggregate
Intrinsic
Value
 
Options outstanding at December 31, 2010
    6,600,688     $     $ 0.12       5.16     $ 182,534  
Granted
                                 
Exercised
                                 
Forfeited/expired
                                 
                                         
Options outstanding at March 31, 2011
    6,600,688     $       $ 0.12       4.91     $ 109,521  
                                         
Options vested and expected to vest in the future at March 31, 2011
    6,600,688     $       $ 0.12       4.91     $ 109,521  
                                         
Options exercisable at March 31, 2011
    6,530,688     $       $ 0.12       4.89     $ 109,521  
 
The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last day of the three month period ended March 31, 2011 and the exercises price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 31, 2011. This amount changes based on the fair market value of the Company’s stock.  As of March 31, 2011 there remain 9,602,181 shares available for grant.
 
Additional information with respect to the outstanding options at March 31, 2011 is as follows:
     
Options Outstanding
         
Options Exercisable
 
Exercise Prices
   
Number
of Shares
   
Average
Remaining
Contractual
Life
(in Years)
   
Weighted
Average
Exercise
Price
   
Number
of Shares
   
Weighted
Average
Exercise Price
 
 
   
 
   
 
   
 
   
 
   
 
 
$ 0.01       1,478,748       2.75     $ 0.01       1,478,748     $ 0.01  
  0.01       154,039       3.00       0.01       154,039       0.01  
  0.01       431,307       3.25       0.01       431,307       0.01  
  0.01       123,231       3.75       0.01       123,231       0.01  
  0.01       277,269       4.50       0.01       277,269       0.01  
  0.25       2,950,000       6.50       0.25       2,880,000       0.25  
  0.01       338,884       4.50       0.01       338,884       0.01  
  0.01       643,880       4.75       0.01       643,880       0.01  
  0.01       110,907       4.75       0.01       110,907       0.01  
  0.01       92,423       5.00       0.01       92,423       0.01  
          6,600,688                       6,530,688          
 
 
As of March 31, 2011, there was no unrecognized compensation cost related to unvested share based compensation arrangements granted under the 2004 and 2007 option plans.
 
Warrants – Historically, the Company has issued warrants to providers of equipment financing.  For a detailed description of the warrants issued in connection with equipment financing arrangements, see Note 4.

On April 30, 2008, the Company negotiated a revolving line of credit, which, as amended in September 2008, November 2008, May 2009, January 2010, September 2010 and December 2010, allows the company to borrow up to $2.4 million.  Warrants to purchase 12,500,000 shares of the Company’s common stock with exercise prices ranging from $0.01 to $0.05 per share were granted in connection with securing and amending this credit facility.  See Note 11 for a detail of the warrants issued in connection with this credit facility.

The Company has issued warrants to its secured note holders in connection with the execution of the loan agreements and subsequent amendments.  Warrants to purchase and aggregate of 4,302,500 and 1,920,000 shares of the Company’s common stock with exercise prices ranging from $0.01 to $0.50 were outstanding with these note holders as of March 31, 2011 and 2010, respectively.  See Note 7 for further details of these warrants.

In February 2011 a shareholder exercised warrants to purchase 1,232,305 shares of the Company’s common stock for $9,858.
 
 11 — Credit Facilities
 
ATI Bank Lines of Credit – ATI has two $100,000 lines of credit.  The line of credit with Bank of America has an interest rate of 7.13% per annum.  The line of credit with Wells Fargo Bank has an interest rate of 6.75 % per annum.   The lines of credit are personally guaranteed by the former stockholder of ATI. On March 31, 2011 the former stockholder of ATI filed lawsuit against the Company (see Note 12 to the Consolidated Financial Statements).  Borrowings under these lines of credit amounted to approximately $187,000 at March 31, 2011.

Revolving Credit Facility - The Company entered into agreements (the “Agreements”), effective as of April 30, 2008 (the “Closing Date”), with Moriah Capital, L.P. (“Moriah”), pursuant to which the Company could borrow up to $2,400,000 per Amendments No. 1, No. 2 and No. 3 to the Agreements, was increased to $2,575,000 per an over-advance in Amendment No. 4. (the “Amendments), $25,000 of the over-advance was due and payable on July 31, 2009 and was paid in November, 2009 with the additional $50,000 over-advance paid during the year ended December 31, 2010.  The Company also paid $500,000 in principal during 2010.
 
Pursuant to the Agreements, the Company was permitted to borrow an amount not to exceed 80% of its eligible accounts (as defined in the Agreements), net of all discounts, allowances and credits given or claimed. Pursuant to the Amendments, from September 10, 2008 through November 4, 2008 this borrowing base increased to 110% of eligible accounts, from November 5, 2008 through December 15, 2008 increased to 135% of eligible accounts, from December 16, 2008 to January 15, 2009 decreased to 120% of eligible accounts, from January 16, 2009 through May 1, 2009 decreased to 110% of the eligible accounts, from May 1, 2009 to July 31, 2009 increased to 120% of eligible accounts, from August 1, 2009 to September 30, 2009 decreased to 100% and thereafter decreased to 85%.  The Company's obligations under the loans are secured by all of the assets of the Company, including but not limited to accounts receivable; provided, however, that Moriah’s lien on the collateral other than accounts receivable (as such terms are defined in the Agreements) are subject to the prior lien of the holders of the Company’s outstanding secured notes.  The Agreements include covenants that the Company must maintain including financial covenants pertaining to cash flow coverage of interest and fixed charges, limitations on the ratio of debt to cash flow and a minimum ratio of current assets to current liabilities. The Company is not in compliance with one of the financial covenants as of March 31, 2011.  Amendment No. 8 extended the term to June 30, 2011.
 
Annual interest on the credit facility is equal to the greater of (i) the sum of (A) the Prime Rate as reported in the “Money Rates” column of The Wall Street Journal, adjusted as and when such Prime Rate changes plus (B) 4% or (ii) 15%, and is payable in arrears prior to the maturity date, on the first business day of each calendar month, and in full on June 30, 2011.  (See Note 1.)
 
 
In accordance with the agreement, the outstanding amount of the loan at any given time may be converted into shares of the Company's common stock at the option of the lender. The conversion price was $1.00, subject to adjustments and limitations as provided in the Agreements.
 
The Company has also agreed to register the resale of shares of the Company's common stock issuable under the Agreements and the shares issuable upon conversion of the convertible note if the Company files a registration statement for its own account or for the account of any holder of the Company’s common stock.

As part of the original transaction, Moriah received warrant #1 to purchase 2,000,000 shares of the Company’s common stock with an exercise price of $1.00 which expire on April 30, 2015.  As part of the Amendments No.1 and No. 2, Moriah received warrants to purchase an additional 1,000,000 and 3,000,000 shares, respectively, of the Company’s common stock under the same terms as the original 2,000,000 warrants.   The Company accounts for the issuance of detachable stock purchase warrants in accordance with FASB ASC 470-20 “Debt With Conversion and Other Options”, whereby it separately measures the fair value of the debt and the detachable warrants, and in the case of detachable warrants with put features to the Company for cash, it also values the put feature as a separate component of the detachable warrant, and allocates the proceeds from the debt on a pro-rata basis to each. The resulting discount from the fair value of the debt allocated to the warrant and put feature for cash, which are accounted for as paid-in capital and a liability, respectively, is amortized over the estimated life of the debt.   The warrants were valued using the Black-Scholes option-pricing model using the assumptions noted in the table below.  The value associated with the 6,000,000 warrants was $928,000 and was recorded as an offset to the principal balance of the revolving credit facility and was amortized on a straight-line basis through April 2009.  As discussed below, the put option liability was $250,000 and the $678,000 difference was credited to Additional Paid in Capital.

Pursuant to Amendment No. 4 dated May 22, 2009, effective as of April 30, 2009, Moriah received 1,000,000 seven year warrants with an exercise price of $0.01. The warrants were valued using the Black-Scholes option-pricing model using assumptions in the table below.  The value associated with the 1,000,000 warrants was $45,000 and was recorded as an offset to the principal balance of the revolving credit facility and was amortized on a straight-line basis through January 2010.  The warrant put option liability was increased to $437,500 and the $187,500 increase in the liability was recorded as an offset to the principal balance of the revolving credit facility and was amortized on a straight-line basis through January 2010.  In addition, Amendment No. 4 reduced the exercise price per share of the previous 6,000,000 warrants from $1.00 to $0.25.  As a result of re-pricing, incremental cost of $19,000 was recorded as debt discount and was fully amortized as of December 31, 2010.

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

Pursuant to Amendment No. 6 entered into September 29, 2010 and effective April 30, 2010, the Company agreed to make regular principal reductions that would permanently reduce the maximum amount borrowed to $1,450,000 by December 31, 2010. As previously amended, the Company had issued to Moriah Warrants #1 to #6 to purchase a total of 9,000,000 shares of the Company's common stock, 6,000,000 of which have an exercise price of $0.05 and 3,000,000 of which have an exercise price of $0.01 and which collectively expire on various dates between April 30, 2015 and February 28, 2017.   The Company had also previously granted Moriah an option, as part of the Agreement, pursuant to which Moriah could sell the 2,000,000 shares subject to Warrant #1 back to the Company for $437,500.  The Company, as part of Amendment No. 6, has now issued to Moriah an additional warrant (Warrant #8) to purchase 1,500,000 shares of common stock with an exercise price of $0.01 and a term of seven years, which, in combination with the aforementioned Warrant #1 (exercisable for a total of 3,500,000 shares) may now be sold back to the Company for $437,500 between July 1, 2011 and July 30, 2011.  In addition, as part of Amendment No. 6, the Company issued to Moriah a warrant (Warrant #7) to purchase 2,000,000 shares of the Company's common stock with an exercise price of $0.01 and a term of seven years and also granted Moriah an option to sell this warrant (Warrant #7) back to the Company for $280,000 between July 1, 2011 and July 30, 2011.  The warrants issued pursuant to Amendment No. 6 have been valued using the Black-Scholes option-pricing model.  The value associated with the 3,500,000 warrants is $20,400 and was amortized on a straight-line basis over the extended term of the agreement, of which $6,000 was amortized during the three months ended March 31, 2011.
 
 
Pursuant to Amendment No. 7 entered into in March 2011 and effective December 31, 2010, the maximum amount that could be borrowed at December 31, 2010 is $2,400,000.  The Company has made payments on the line of credit that have reduced the outstanding advances to $2,000,000 at March 31, 2011.  Also pursuant to Amendment No. 7, the term of all warrants issued to Moriah was extended by two years.  The extension of the warrants has been valued using the Black-Scholes option-pricing model. The value associated with the extension was $14,000 and was charged to interest expense.

Pursuant to Amendment No. 8 entered into in May 2011 and effective March 30, 2011, the term of the agreement was extended to June 30, 2011 and the Company incurred loan costs of $30,000 that will be amortized over the extended term of the agreement.

The expense recognized by the Company in the three months ended March 31, 2011 and 2010 from the amortization of the debt discount was $82,000 and $41,000, respectively.  The Company calculated the fair value of the warrants using the following assumptions:

   
December 31,
2010
   
March 31,
2010
 
Risk-free interest rate
  0.7% to 2.7 %       1.63 %
Expected lives (in years)  
 
3.2 to 4.4 years
   
3.5 years
 
Dividend yield
    0 %     0 %
Expected volatility
    86.0 %     86.0 %
Forfeiture rate
    0 %     0 %
 
Pursuant to various Agreements and Amendments pursuant to which Moriah may sell certain warrants back to the Company for $437,500 at any time during the 30 day period commencing on the earlier of the prepayment in full of all loans or January 31, 2010. As noted above, as part of Amendment No. 6 the Company granted Moriah an additional option pursuant to which Moriah can sell warrants back to the company for $280,000.  The Company has determined that the put options associated with the warrants causes the instrument to contain a net cash settlement feature. In accordance with FASB ASC 480 “Distinguishing Liabilities from Equity,” the put option requires liability treatment.  As a result, the put warrant liability was recorded at the warrant purchase price of $717,500 as of March 31, 2011.  The debt discount associated with the $280,000 liability for warrant put feature was amortized over the extended term of the agreement, of which $76,000 was amortized during the three months ended March 31, 2011.

Pursuant to Amendment No. 6, the Company incurred deferred loan costs of $242,500 that were amortized over the extended term of the agreement.  Interest expense recognized for the three months ended March 31, 2011 for the amortization of deferred loan costs was $66,000.

Also pursuant to Amendment No. 7, the Company incurred additional loan costs of $30,000. The full amount of the costs was amortized in the three month period ended March 31, 2011.
 
12 — Commitments and Contingencies
 
Facility Lease – The Company leases its facilities under a non-cancelable operating lease that expires on March 31, 2012 at an annual expense of approximately $168,000.  Rent expense for the Company’s facilities for the three months ended March 31, 2011 and 2010 was $48,000 and $69,000, respectively.
 
Vendor Agreements – The Company has entered into agreements with its network partners and other vendors for various services which are, in general, for periods of twelve months and provide for month to month renewal periods.
 
 
Vendor Disputes – It is not unusual in the Company’s industry to occasionally have disagreements with vendors relating to the amounts billed for services provided between the recipient of those services and the vendor, or in some cases, to receive invoices from companies that the Company does not consider a vendor. The Company currently has disputes with vendors and other companies that it believes did not bill certain charges correctly or should not have billed any charges at all. The Company’s policy is to include amounts that it intends to dispute or that it has disputed in a reserve account as an offset to accounts payable if management believes that the facts and circumstances related to the dispute provide probable support that the dispute will be resolved in the Company’s favor.  As of March 31, 2011, there were approximately $509,000 of disputed payables. The Company is in discussion with the significant vendors, or companies that have sent invoices, regarding these charges and it may take additional action as deemed necessary against these vendors in the future as part of the dispute resolution process. Management does not believe that any settlements would have a material adverse effect on the Company’s financial position or results of operations. Management reviews available information and determines the need for recording an estimate of the potential exposure when the amount is probable, reasonable and estimable based on FASB ASC 450 “Contingencies.”

A Local Exchange Carrier – In April 2008, the Company entered into a settlement agreement with a significant provider of network services to the Company (“Vendor”).  The settlement agreement included a payment arrangement for past due amounts of approximately $3.0 million with full repayment due prior to December 31, 2008.  The settlement agreement also provided a separate credit to the Company of approximately $1.4 million for past disputes.   The Company received a notice of default, dated August 12, 2009, threatening, among other things, a rescission of the $1.4 million credit.   Effective March 31, 2011, the Company entered into a settlement agreement (“the Agreement”) with the Vendor which superseded and replaced the April 2008 settlement between the parties.  The Agreement resolves all outstanding disputes between the parties and includes definitive resolution of the credits previously due to the Company, unconditionally.  As a result of the settlement the Company recorded a non-recurring gain during the three months ended March 31, 2011.  The settlement contains a long-term payment plan and is subject to timely payment by the Company.   

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

The Company has received several notices from state and local regulatory and taxing authorities for its possible failure to file certain documents pertaining to the Company’s wholly-owned subsidiary ATI.  The amounts at issue with these potential filings are de minimis.

Legal Proceedings

A Network Service Provider – On October 12, 2010, the Company was served a complaint filed by a network service provider (“NSP”) against the Company asserting various causes of action.  The NSP claims that the Company owes various charges totaling $505,583. The Company denies that it owes this amount and is vigorously disputing a significant portion of the asserted amount owed. The Company believes it has adequately reserved for amounts, if any, owed.

On March 31, 2011, the Company was notified that a former employee and the former president of Advanced Tel, Inc, (“ATI”) the Company’s wholly owned subsidiary, had filed suit against the Company asserting, among other things, that the Company owed said former employee certain amounts related to the agreement entered into by the parties (“Purchase Agreement”) when the Company purchased ATI in 2006.  The Company denies that it owes these amounts and is vigorously asserting its position.
 
Universal Service Administrative Company – The Universal Service Administrative Company (USAC) administers the Universal Service Fund (USF).  In 2009 and 2010 the Company did not make all of the payments claimed by the USAC in a timely manner and USAC transferred these unpaid amounts to the Federal Communications Commission (FCC) for collection.  The FCC has transferred some of these unpaid amounts to the Department of the Treasury which worked with the Company to establish long term payment plans.   Should any of the remaining unpaid amounts with the FCC transfer from the FCC to Treasury, additional fees, surcharges and penalties will be added to the amount due.  As of March 31, 2011, the Company has recorded an aggregate $1.2 million in connection with the USF.  The Company continues to work with the FCC and the Department of the Treasury to resolve these amounts in long term payment programs.  Failure to finalize any significant proposed payment plan would likely have a material adverse effect on the Company.
 
Consulting Agreement – Commencing in December 2006, the Company entered into a three-year consulting agreement with an affiliate of a stockholder and debt holder pursuant to which the Company received services related to strategic planning, investor relations, acquisitions, and corporate governance.  The Company was obligated to pay $13,000 a month for these services, subject to annual increases.  In June 2008, the parties orally agreed to cancel the agreement and any future obligation.  Included in accounts payable is $182,000 at March 31, 2011 and December 31, 2010 for unpaid amounts.
 
 
13 — Income Taxes
 
At March 31, 2011, the Company had net operating loss carryforwards to offset future taxable income, if any, of approximately $44 million for Federal and State taxes. The Federal net operating loss carryforwards begin to expire in 2021. The State net operating loss carryforwards began to expire in 2008.
 
The following is a summary of the Company’s deferred tax assets and liabilities (in thousands):
 
   
March 31,
2011
   
December 31,
2010
 
   
(unaudited)
       
Current assets and liabilities:
 
 
   
 
 
Current assets and liabilities:
 
 
   
 
 
Deferred revenue
  $ (89 )   $ (88 )
Bad Debt
    349       340  
Accrued expenses
    1,472       1,523  
      1,732       1,775  
Valuation allowance
    (1,732     (1,775 )
                 
Net current deferred tax asset
  $     $  
                 
Non-current assets and liabilities:
               
Depreciation and amortization
  $ (15 )   $ (23 )
Net operating loss carryforward
    17,610       18,421  
      17,595       18,398  
Valuation allowance
    (17,595 )     (18,398 )
Net non-current deferred tax asset
  $     $  

The reconciliation between the statutory income tax rate and the effective rate is as follows:  
 
   
For the Three Months Ended
March 31,
 
   
2011
   
2010
 
   
(unaudited)
 
Federal statutory tax rate
    (34 )%     (34 )%
State and local taxes
    (6 )     (6 )
Valuation reserve for income taxes                                  
    40       40  
Effective tax rate
    %     %
 
 
Management has concluded that it is more likely than not that the Company will not have sufficient taxable income of an appropriate character within the carryforward period permitted by current law to allow for the utilization of certain of the deductible amounts generating the deferred tax assets; therefore, a full valuation allowance has been established to reduce the net deferred tax assets to zero at March 31, 2011 and December 31, 2010.
 
The Company has applied the provision of FASB ASC 740, “Income Taxes” which clarifies the accounting for uncertainty in tax positions.  FASB ASC 740 requires the recognition of the impact of a tax position in the financial statements if that position is more likely than not of being sustained on a tax return upon examination by the relevant taxing authority, based on the technical merits of the position.  At March 31, 2011 and December 31, 2010, the Company had no unrecognized tax benefits.
 
The Company recognizes interest and penalties related to income tax matters in interest expense and operating expenses, respectively.  As of March 31, 2011 and December 31, 2010, the Company has no accrued interest and penalties related to uncertain tax positions.
 
The Company is subject to taxation in the United States of America (“U.S.”) and files tax returns in the U.S. federal jurisdiction and California (or various) state jurisdiction (s). The Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years before 2006. The Company currently is not under examination by any tax authority.

14 — Cash Flow Disclosures
 
The table following presents a summary of the Company’s supplemental cash flow information (in thousands):
 
   
Three Months Ended
March 31,
 
   
2011
 
2010
 
   
(unaudited)
 
Cash paid:
 
 
   
 
 
Interest
  $ 118     $ 150  
                 
Non-cash information:                                                                                 
               
                 
Stock and warrants issued for debt
  $     $ 18  
                 
Fair value of debt discount
  $     $ 20  
                 

15 — Consulting Fee
 
Effective September 1, 2009, the Company entered into a consulting agreement with one of its board members to provide consulting services.  The Company was obligated to pay $6,250 per month plus out of pocket expenses for these services for the period September 1, 2009 to October 31, 2009, then $10,000 per month plus out of pocket expense and $15,000 beginning in February 2011.
 
The Company incurred consulting fees under this agreement in the amount of $40,000 and 30,240 for the three months ended March 31, 2011 and 2010, respectively.


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Cautionary Statements
 
This Report contains financial projections and other “forward-looking statements,” as that term is used in federal securities laws, about our financial condition, results of operations and business. These statements include, among others: statements concerning the potential for revenues and expenses and other matters that are not historical facts. These statements may be made expressly in this Report. You can find many of these statements by looking for words such as “believes,” “expects,” “anticipates,” “estimates,” or similar expressions used in this Report. These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. The most important factors that could prevent us from achieving our stated goals include, but are not limited to, the risks and uncertainties discussed in the “Business” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections, as applicable, of our Annual Report on Form 10-K for the year ended December 31, 2010 (the “2010 10-K”) as well as the following:


 
(a)
our success in renegotiating and settling the terms of our indebtedness and other liabilities;
 
 
(b)
Our ability to raise additional financing to the extent necessary to continue to operate our business;
 
 
(c)
volatility or decline of our stock price;
 
 
(d)
potential fluctuation in quarterly results;
 
 
(e)
our failure to earn revenues or profits;
 
 
(f)
inadequate capital and barriers to raising capital or to obtaining the financing needed to implement our business plans;
 
 
(g)
changes in demand for our products and services;
 
 
(h)
rapid and significant changes in markets;
 
 
(i)
litigation with or legal claims and allegations by outside parties;
 
 
(j)
insufficient revenues to cover operating costs;
 
 
(k)
the possibility we may be unable to manage our growth;
 
 
(l)
extensive competition;
 
 
(m)
loss of members of our senior management;
 
 
(n)
our dependence on local exchange carriers;
 
 
(o)
our need to effectively integrate businesses we acquire;
 
 
(p)
risks related to acceptance, changes in, and failure and security of, technology; and
 
 
(q)
regulatory interpretations and changes.
 
 
We caution you not to place undue reliance on forward looking statements, which speak only as of the date of this Report. The cautionary statements contained or referred to in this section should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on behalf of us may issue. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this Report or to reflect the occurrence of unanticipated events.
 
The following discussion should be read in conjunction with our condensed consolidated financial statements and notes to those statements.
 
Background
 
InterMetro Communications, Inc., (hereinafter, “we,” “us,”  “InterMetro” or the “Company”) is a Nevada corporation which through its wholly owned subsidiary, InterMetro Communications, Inc. (Delaware) (hereinafter, “InterMetro Delaware”), is engaged in the business of providing voice over Internet Protocol (“VoIP”) communications services.
 
General
 
We have built a national, private, proprietary voice-over Internet Protocol, or VoIP, network infrastructure offering an alternative to traditional long distance network providers. We use our network infrastructure to deliver voice calling services to traditional long distance carriers, broadband phone companies, VoIP service providers, wireless providers, other communications companies and end users. Our VoIP network utilizes proprietary software, configurations and processes, advanced Internet Protocol, or IP, switching equipment and fiber-optic lines to deliver carrier-quality VoIP services that can be substituted transparently for traditional long distance services. We believe VoIP technology is generally more cost efficient than the circuit-based technologies predominantly used in existing long distance networks and is easier to integrate with enhanced IP communications services such as web-enabled phone call dialing, unified messaging and video conferencing services.
 
We focus on providing the national transport component of voice services over our private VoIP infrastructure. This entails connecting phone calls of carriers or end users, such as wireless subscribers, residential customers and broadband phone users, in one metropolitan market to carriers or end users in a second metropolitan market by carrying them over our VoIP infrastructure. We compress and dynamically route the phone calls on our network allowing us to carry up to approximately eight times the number of calls carried by a traditional long distance company over an equivalent amount of bandwidth. In addition, we believe our VoIP equipment costs significantly less than traditional long distance equipment and is less expensive to operate and maintain. Our proprietary network configuration enables us to quickly, without modifying the existing network, add equipment that increases our geographic coverage and calling capacity.
 
We enhanced our network’s functionality by implementing Signaling System 7, or SS-7, technology. SS-7 allows access to customers of the local telephone companies, as well as customers of wireless carriers. SS-7 is the established industry standard for reliable call completion, and it also provides interoperability between our VoIP infrastructure and traditional telephone company networks.  While we expect to continue to add to capacity, as of March 31, 2011 and 2010, the SS-7 network expansion was a fully operating and revenue generating component of our VoIP infrastructure.  A key aspect of our current business strategy is to focus on sales to increase these voice minutes.
 
Overview
 
History.  InterMetro began business as a VoIP on December 29, 2006 and began generating revenue at that time. Since then, we have increased our revenue to approximately $28.0 million for the year ended December 31, 2010.

Trends in Our Industry and Business
 
A number of trends in our industry and business could have a significant effect on our operations and our financial results. These trends include:
 
Increased competition for end users of voice services. We believe there are an increasing number of companies competing for the end users of voice services that have traditionally been serviced by the large incumbent carriers. The competition has come from wireless carriers, competitive local exchange carriers, or CLECs, and interexchange carriers, or IXCs, and more recently from broadband VoIP providers, including cable companies and DSL companies offering broadband VoIP services over their own IP networks. All of these companies provide national calling capabilities as part of their service offerings, however, most of them do not operate complete national network infrastructures. These companies previously purchased national transport services exclusively from traditional carriers, but are increasingly purchasing transport services from us.
 
 
Merger and acquisition activities of traditional long distance carriers. Recently, the three largest operators of traditional long distance service networks were acquired by or have merged with several of the largest local wireline and wireless telecommunications companies. AT&T Corp. was acquired by SBC Communications Inc., MCI, Inc. was acquired by Verizon Communications, Inc. and Sprint Corporation and Nextel Communications, Inc. engaged in a merger transaction. While we believe it is too early to tell what effects these transactions will have on the market for national voice transport services, we may be negatively affected by these events if these companies increase their end user bases, which could potentially decrease the amount of services purchased by our carrier customers. In addition, these companies have greater financial and personnel resources and greater name recognition. However, we could potentially benefit from the continued consolidation in the industry, which has resulted in fewer competitors.
 
Regulation. Our business has developed in an environment largely free from regulation. However, the Federal Communications Commission (“FCC”) and many state regulatory agencies have begun to examine how VoIP services could be regulated, and a number of initiatives could have an impact on our business. These regulatory initiatives include, but are not limited to, proposed reforms for universal service, the intercarrier compensation system, FCC rulemaking regarding emergency calling services related to broadband IP devices, and the assertion of state regulatory authority over us. Complying with regulatory developments may impact our business by increasing our operating expenses, including legal fees, requiring us to make significant capital expenditures or increasing the taxes and regulatory fees applicable to our services. One of the benefits of our implementation of SS-7 technology is to enable us to purchase facilities from incumbent local exchange carriers under switched access tariffs. By purchasing these traditional access services, we help mitigate the risk of potential new regulation related to VoIP.
 
Our Business Model
 
Historically, we have been successful in implementing our business plan through the expansion of our VoIP infrastructure. Since our inception, we have grown our customer base to include over 200 customers, including several large publicly-traded telecommunications companies and retail distribution partners. In connection with the addition of customers and the provision of related voice services, we have expanded our national VoIP infrastructure.
 
Revenue. We generate revenue primarily from the sale of voice minutes that are transported across our VoIP infrastructure. In addition, ATI, as a reseller, generates revenues from the sale of voice minutes that are currently transported across other telecom service providers’ networks. However, we have migrated a significant amount of these revenues on to our VoIP infrastructure and continue to migrate ATI’s revenues. We negotiate rates per minute with our carrier customers on a case-by-case basis. The voice minutes that we sell through our retail distribution partners are typically priced at per minute rates, are packaged as calling cards and are competitive with traditional calling cards and prepaid services. Our carrier customer services agreements and our retail distribution partner agreements are typically one year in length with automatic renewals. We generally bill our customers on a weekly or monthly basis with either a prepaid balance required at the beginning of the week or month of service delivery or with net terms determined by the customers’ creditworthiness. Factors that affect our ability to increase revenue include:
 
 
·
Changes in the average rate per minute that we charge our customers.
  
Our voice services are sold on a price per minute basis. The rate per minute for each customer varies based on several factors, including volume of voice services purchased, a customer’s creditworthiness, and, increasingly, use of our SS-7 based services, which are priced higher than our other voice transport services.
 
 
·
Increasing the net number of customers utilizing our VoIP services.
 
Our ability to increase revenue is primarily based on the number of carrier customers and retail distribution partners that we are able to attract and retain, as revenue is generated on a recurring basis from our customer base. We expect increases in our customer base primarily through the expansion of our direct sales force and our marketing programs. Our customer retention efforts are primarily based on providing high quality voice services and superior customer service. We expect that the addition of SS-7 based services to our network will significantly increase the universe of potential customers for our services because many customers will only connect to a voice service provider through SS-7 based interconnections.
 
 
 
·
Increasing the average revenue we generate per customer.
 
We increase the revenue generated from existing customers by expanding the number of geographic markets connected to our VoIP infrastructure. Also, we are typically one of several providers of voice transport services for our larger customers, and can gain a greater share of a customer’s revenue by consistently providing high quality voice service.
 
 
·
Acquisitions.
 
We expect to expand our revenue base through the acquisition of other voice service providers. We plan to continue to acquire businesses whose primary cost component is voice services or whose technologies expand or enhance our VoIP service offerings.
 
We expect that our revenue will increase in the future primarily through the addition of new customers gained from our direct sales and marketing activities and from acquisitions.
 
Network Costs. Our network, or operating, costs are primarily comprised of fixed cost and usage based network components. In addition, ATI incurs usage based costs from its underlying telecom service providers. We generally pay our fixed network component providers at the beginning or end of the month in which the service is provided and we pay for usage based components on a weekly or monthly basis after the delivery of services. Some of our vendors require a prepayment or a deposit based on recurring monthly expenditures or anticipated usage volumes. Our fixed network costs include:
 
 
·
SS-7 based interconnection costs.
 
During the first nine months of 2006, we added a significant amount of capacity, measured by the number of simultaneous phone calls our VoIP infrastructure can connect in a geographic market, by connecting directly to local phone companies through SS-7 based interconnections purchased on a monthly recurring fixed cost basis. As we expand our network capacity and expand our network to new geographic markets, SS-7 based interconnection capacity will be the primary component of our fixed network costs. Until we are able to increase revenues based on our SS-7 services, these fixed costs significantly reduce the gross profit earned on our revenue.

 
·
Other fixed costs.
 
Other significant fixed costs components of our VoIP infrastructure include private fiber-optic circuits and private managed IP bandwidth that interconnect our geographic markets, monthly leasing costs for the collocation space used to house our networking equipment in various geographic markets, local loop circuits that are purchased to connect our VoIP infrastructure to our customers and usage based vendors within each geographic market. Other fixed network costs include depreciation expense on our network equipment and monthly subscription fees paid to various network administrative services.
 
The usage-based cost components of our network include:
 
 
·
Off-net costs.
 
In order to provide services to our customers in geographic areas where we do not have existing or sufficient VoIP infrastructure capacity, we purchase transport services from traditional long distance providers and resellers, as well as from other VoIP infrastructure companies. We refer to these costs as “off-net” costs. Off-net costs are billed on a per minute basis with rates that vary significantly based on the particular geographic area to which a call is being connected.
 
 
·
SS-7 based interconnections with local carriers.
 
The SS-7 based interconnection services that are purchased from the local exchange carriers, include a usage based, per minute cost component. The rates per minute for this usage based component are significantly lower than the per minute rates for off-net services. The usage based costs for SS-7 services continue to be the largest cost component of our network as we grow revenue utilizing SS-7 technology.
 
 
Our fixed-cost network components generally do not experience significant price fluctuations. Factors that affect these network components include:
 
 
·
Efficient utilization of fixed-cost network components.
 
Our customers utilize our services in identifiable fixed daily and weekly patterns. Customer usage patterns are characterized by relatively short periods of high volume usage, leaving a significant amount of time during each day where the network components remain idle.
 
Our ability to attract customers with different traffic patterns, such as customers who cater to residential calling services, which typically spike during evening hours, with customers who sell enterprise services primarily for use during business hours, increases the overall utilization of our fixed-cost network components. This decreases our overall cost of operations as a percentage of revenues.

 
·
Strategic purchase of fixed-cost network components.
 
Our ability to purchase the appropriate amount of fixed-cost network capacity to (1) adequately accommodate periods of higher call volume from existing customers, (2) anticipate future revenue growth attributed to new customers, and (3) expand services for new and existing customers in new geographic markets is a key factor in managing the percentage of fixed costs we incur as a percentage of revenue.
 
From time to time, we also make strategic decisions to add capacity with newly deployed technologies, such as the SS-7 based services, which require purchasing a large amount of network capacity in many geographic markets prior to the initiation of customer revenue.
 
We expect that both our fixed-cost and usage-based network costs will increase in the future primarily due to the expansion of our VoIP infrastructure and use of off-net providers related to the expected growth in our revenues.
 
Our usage-based network components costs are affected by:
 
 
·
Fluctuations in per minute rates of off-net service providers.
 
Increasing the volume of services we purchase from our vendors typically lowers our average off-net rate per minute, based on volume discounts. Another factor in the determination of our average rate per minute is the mix of voice services we use by carrier type, with large fluctuations based on the carrier type of the end user which can be local exchange carriers, wireless providers or other voice service providers.
 
 
·
Sales mix of our VoIP infrastructure capacity versus off-net services.
 
Our ability to sell services connecting our on-net geographic markets, rather than off-net areas, affects the volume of usage based off-net services we purchase as a percentage of revenue.
 
 
·
Acquisitions of telecommunications businesses.
 
Longer term, we expect to continue to make acquisitions of telecommunications companies. As we complete these acquisitions and add an acquired company’s traffic and revenue to our operations, we may incur increased usage-based network costs. These increased costs will come from traffic that remains with the acquired company’s pre-existing carrier and from any of the acquired company’s traffic that we migrate to our SS-7 services or our off-net carriers. We may also experience decreases in usage based charges for traffic of the acquired company that we migrate to our network. The migration of traffic onto our network requires network construction to the acquired company’s customer base, which may take several months or longer to complete.
 
 
Sales and Marketing Expense . Sales and marketing expenses include salaries, sales commissions, benefits, travel and related expenses for our direct sales force, marketing and sales support functions. Our sales and marketing expenses also include payments to our agents that source carrier customers and retail distribution partners. Agents are primarily paid commissions based on a percentage of the revenues that their customer relationships generate. In addition, from time to time we may cover a portion or all of the expenses related to printing physical cards and related posters and other marketing collateral. All marketing costs associated with increasing our retail consumer user base are expensed in the period in which they are incurred. We expect that our sales and marketing expenses will increase in the future primarily due to increases in our direct sales force.
 
General and Administrative Expense . General and administrative expenses include salaries, benefits and expenses for our executive, finance, legal and human resources personnel. In addition, general and administrative expenses include fees for professional services, occupancy costs and our insurance costs, and depreciation expense on our non-network depreciable assets. Our general and administrative expenses also include stock-based compensation on option grants to our employees and options and warrant grants to non-employees for goods and services received.
 
Results of Operations for the Three Months Ended March 31, 2011 and 2010
 
The following table sets forth, for the periods indicated, the results of our operations expressed as a percentage of revenue:

   
Three Months Ended
March 31,
 
   
2011
   
2010
 
Net revenues
    100 %     100 %
Network costs
    72       69  
Gross profit
    28       31  
Operating expenses:
               
Sales and marketing
    4       8  
General and administrative
    16       15  
Total operating expenses
    20       23  
Operating income
    8       8  
Gain on forgiveness of debt
    30       18  
Interest expense
    6       8  
                 
Net income
    32 %     18 %
 
Net Revenues. Net revenues increased $337,000, or 5.7%, to $6.2 million for the three months ended March 31, 2011 from $5.9 million for the three months ended March 31, 2010. Though we have continued to increase new customers, this has been offset by the loss of certain low-margin customers, primarily attributable to ATI, combined with decreased revenues from existing customers.  Specifically, while the addition of new customers contributed approximately $1.0 million to revenue in the three months ended March 31, 2011 and existing customers contributed  an additional $2.7 million in increasing revenues, these $3.7 million in revenue gains were offset by an approximate $3.4 million decrease in revenue attributable to the loss of customers or decreased revenue from existing customers.

 Network Costs. Network costs increased $442,000, or 10.8%, to $4.5 million for the three months ended March 31, 2011 from $4.1 million for the three months ended March 31, 2010.  Included within total network costs, variable network costs increased by $631,000 to $4.2million (67.2% of revenues) for the three months ended March 31, 2011 from $3.6 million (60.4% of revenues) for the three months ended March 31, 2010. Fixed network costs decreased by $189,000 to $313,000 for the three months ended March 31, 2011 from $502,000 for the three months ended March 31, 2010, with the decrease coming primarily from the elimination of underutilized network components that were in operation during three months ended March 31, 2010.  There were no significant fixed network expenses added during the three months ended March 31, 2011.  Gross margin decreased to 27.8% for the three months ended March 31, 2011 from a gross margin of 31.1% for the three months ended March 31, 2010. The increase in variable cost as a percentage of revenues and the decrease in gross margin were related primarily to changes in traffic patterns during the three months ended March 31, 2011.  Depreciation expense included within network costs for the three months ended March 31, 2011 was $9,000 as compared to $7,000 for the three months ended March 31, 2010.
 
Sales and Marketing. Sales and marketing expenses decreased $222,000, or 48.8% to $233,000 for the three months ended March 31, 2011 from $455,000 for the three months ended March 31, 2010. Sales and marketing expenses as a percentage of net revenues were 3.7% and 7.7% for the three months ended March 31, 2011 and 2010, respectively.  The decrease is primarily attributable to the decrease in ATI revenues from which agent commissions are paid.  In addition, a change in product mix resulted in a decrease in certain high percentage commissions.
 
 
General and Administrative. General and administrative expenses increased $137,000 or 15.9% to $998,000 for the three months ended March 31, 2011 from $861,000 million for the three months ended March 31, 2010. General and administrative expenses as a percentage of net revenues were 16.0% and 14.5% for the three months ended March 31, 2011 and 2010, respectively. After a reduction in workforce and salary reductions during 2009, the Company has begun to hire and the resulting increase in compensation cost is the most significant factor in the increase in general and administrative expenses for the three months ended March 31, 2011.
 
Accounts Payable Write Off and Gain on Forgiveness of Debt   During the three months ended March 31, 2011, the Company entered into numerous cash payment plan agreements with vendors for amounts less than the liability recorded in accounts payable.  As a result of these agreements, the Company recorded a gain on forgiveness of debt of $1,714,000 for the three months ended March 31, 2011.  In addition, the Company wrote-off certain accounts payable for Competitive Local Exchange Carriers (“CLEC”) that resulted in a gain of $186,000 for the same period, and is included in accounts payable write-off.  The CLEC accounts payable were written off based on a two year statute of limitations on such accounts payable balances. During the three months ended March 31, 2010, the Company entered into payment plan agreements that resulted in the Company recorded a gain on forgiveness of debt of $461,000.  In addition, the Company wrote-off certain accounts payable for CLECs that resulted in a gain of $591,000.

Interest Expense, net. Interest expense, net decreased $83,000, or 18.0%, to $379,000 for the three months ended March 31, 2011 from $462,000 for the three months ended March 31, 2010. The most significant factor in the reduction of interest expense was certain vendor settlements that ended the assessment of late payment charges.  Interest expense for the three months ended March 31, 2011 includes $82,000 from the amortization of debt discount related to the Moriah credit facility as compared to $41,000 in the March 31, 2010 quarter.  Interest expense related to the secured promissory notes was $78,000 for the three months ended March 31, 2011 and 2010. 
 
Liquidity and Capital Resources
 
At March 31, 2011, we had $561,000 in cash as compared to cash of $428,000 at December 31, 2010.  The Company’s working capital position, defined as current assets less current liabilities, has historically been negative and was negative $13.9 million at March 31, 2011 and negative $16.3 million at December 31, 2010.  Working capital increased primarily due to settlements with vendors that resulted in payment plans for lesser amounts over extended terms. (see Note 6 to the Consolidated Financial Statements.)

Significant changes in cash flows from March 31, 2011 as compared to March 31, 2010:
 
Net cash provided by operating activities was $132,000 for the three months ended March 31, 2011 as compared to $47,000 for the three months ended March 31, 2010. The most significant change that contributed to cash from operating activities was net income for the three months ended March 31, 2011 of approximately $2.0 million. This was offset by non-cash gain on debt forgiveness of $1.7 million.

Net cash used in investing activities was $5,000 and $20,000 for the three months ended March 31, 2011and 2010, respectively, attributable to the purchase of equipment.
 
Net cash provided by financing activities for the three months ended March 31, 2011 was $5,000 as compared to cash provided by financing activities of $53,000 for the three months ended March 31, 2010. Net cash provided by financing activities for the three months ended March 31, 2011 consisted of $10,000 proceeds from the exercise of warrants offset by $5,000 of principal payments on a credit line.   Net cash provided by financing activities for the three months ended March 31, 2010 included a $118,000 bank overdraft as a source of funds and principal payments on a note for equipment of $65,000 as a use of funds.
 
The Company had a working capital deficit of $13,878,000 and had a total stockholders’ deficit of $14,799,000 as of March 31, 2011.  Though the Company was profitable for the three months ended March 31, 2011 and the year ended December 31, 2010, which included $1.9 million and $2.3 million of non-cash gains, respectively,  it had net losses in previous years and will have to generate and sustain significant gross margin to maintain profitability. The Company’s ability to continue as a going concern will require additional financings if its ability to generate cash from operations does not fund required payments on its debt obligations.  Obligations to the Company’s debt holders include interest and principal payments to its secured note holders (see Note 7 to the Consolidated Financial Statements), principal and interest due on its revolving line of credit (see Note 11 to the Consolidated Financial Statements) and settlement payments due (see Note 6 to the Consolidated Financial Statements). The loans under the revolving line of credit are secured by substantially all of the Company’s assets. The Company has other significant matters of importance, including contingencies such as vendor disputes and lawsuits discussed in Note 12 that could have material adverse consequences to the Company such as cessation of its operations.
 
 
   The Company anticipates it will not have sufficient cash flows to fund its operations through fiscal 2011, or earlier, depending on the results of the negotiations with Moriah Capital, L.P. (“Moriah”) regarding the Company’s indebtedness to Moriah discussed in Note 11. If the Company were to require additional financings in order to fund ongoing operations there can be no assurance that it will be successful in completing the required financings which could ultimately cause the Company to cease its operations.   The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.  There are many claims and obligations that could ultimately cause the Company to cease its operations.  The report from the Company’s independent registered public accounting firm relating to the year ended December 31, 2010 states that there is substantial doubt about the Company’s ability to continue as a going concern.

As discussed in Note 11, the Company entered into agreements with Moriah under which it could borrow up to $2,400,000.  At March 31, 2011, the Company had borrowed $2,000,000. The availability of loan amounts under the agreements expires on June 30, 2011 and all amounts will be due at that time.

Management believes that the losses in past years were primarily attributable to costs related to building out and supporting a telecommunications infrastructure, and the requirement for continued expansion of the customer base, in order for the Company to become profitable. This resulted in the Company taking on debt and delaying payment to certain vendors.  The Company may be required to obtain other financing during the next twelve months or thereafter as a result of future business developments, including any acquisitions of business assets or any shortfall of cash flows generated by future operations in meeting the Company’s ongoing cash requirements. Such financing alternatives could include selling additional equity or debt securities, obtaining long or short-term credit facilities, or selling operating assets. Management continues to work with its historical vendors in order to secure the continued extension of credit. Management believes that cash flows from operations and additional debt conversions are integral to management’s plan to retire past due obligations and be positioned for growth.  No assurance can be given, however, that the Company will be successful in restructuring its debt on terms favorable to the Company or at all. Should the Company be unsuccessful in this restructuring, material adverse consequences to the Company could occur such as cessation of operations.  Any sale of additional common stock or convertible equity or debt securities would result in additional dilution to the Company’s stockholders.
 
Credit Facilities
 
Revolving Credit Facility – In April 2008, the Company entered into a convertible revolving credit agreement with Moriah pursuant to which the Company may access funds up to $1.5 million.  In September 2008, the Company entered into Amendment No. 1 to the agreement which increased the access to $2.0 million, in November 2008 the Company entered into Amendment No 2 to the agreement which increased the access to $2.4 million and in May 2009 the Company entered into Amendment No. 4 to the agreement which increased the access to $2.55 million.  The availability of loan amounts at December 31, 2009 under the revolving credit agreement was to expire on April 30, 2009. The Company entered into Amendment No. 5 to the agreement as of January 31, 2010 that extended the expiration to April 30, 2010.  The Company entered into Amendment No. 6 on September 29, 2010, effective April 30, 2010, that extended the expiration to March, 30, 2011and Amendment No. 7 as of December 31, 2010 that lowered the amount of the principal reduction payments required as of December, 31, 2010.  As of March 31, 2011, the Company is permitted to borrow an amount not to exceed 85% of its eligible accounts receivable. As of March 31, 2011, the Company had borrowed $2.0 million. The Company's obligations are secured by all of the assets of the Company.  Annual interest on the loans is equal to the greater of (i) the sum of (A) the Prime Rate (B) 4% or (ii) 15%, and shall be payable in arrears prior to the maturity date, on the first business day of each calendar month, and in full on June 30, 2011. (See Note 11 to the Consolidated Financial Statements for detailed discussion.)

Critical Accounting Policies and the Use of Estimates
 
Our financial statements are prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.
 
 
We believe that the following accounting policies involve the greatest degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.
 
Revenue Recognition.
 
We recognize our VoIP services revenues when services are provided, primarily on usage. Revenues derived from sales of calling cards through related distribution partners are deferred upon the sale of the cards. These deferred revenues are recognized as revenues generally when all usage of the cards occurs. The Company has revenue sharing agreements based on successful collections.  The Company recognizes revenue from these customers at time of invoicing based on the history of collections with such customers. We recognize revenue in the period that services are delivered and when the following criteria have been met: persuasive evidence of an arrangement exists, the fees are fixed and determinable, no significant performance obligations remain for us and collection of the related receivable is reasonably assured. Our deferred revenues consist of fees received or billed in advance of the delivery of the services or services performed in which cash receipt is not reasonably assured. This revenue is recognized when the services are provided and no significant performance obligations remain or when cash is received for previously performed services. We assess the likelihood of collection based on a number of factors, including past transaction history with the customer and the credit worthiness of the customer. Generally, we do not request collateral from our customers. If we determine that collection of revenues are not reasonably assured, we defer the recognition of revenue until the time collection becomes reasonably assured, which is generally upon receipt of cash.
 
Stock-Based Compensation.

The Company has adopted FASB ASC 718 “Compensation – Stock Compensation”.   The Company is applying the “modified prospective transition method” under which it continues to account for nonvested equity awards outstanding at the date of adoption of FASB ASC 718 in the same manner as they had been accounted for prior to adoption, that is, it would continue to apply APB 25 in future periods to equity awards outstanding at the date it adopted FASB ASC 718, unless the options are modified or amended.
 
For grants to employees under the 2004 plan and 2007 plan in the year ended December 31, 2008, the Company estimated the fair value of each option award on the date of grant using the Black-Scholes option-pricing model using the assumptions noted in the following table.  Expected volatility is based on the historical volatility of a peer group of publicly traded entities.  The expected term of the options granted is derived from the average midpoint between vesting and the contractual term, as described in the SEC’s Staff Accounting Bulletin No. 107, “Share-Based Payment.”  The risk-free rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
 
Accounts Receivable and the Allowance for Doubtful Accounts
 
Accounts receivable consist of trade receivables arising in the normal course of business. We do not charge interest on our trade receivables. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We review our allowance for doubtful accounts monthly. We determine the allowance based upon historical write-off experience, payment history and by reviewing significant past due balances for individual collectibility. If estimated allowances for uncollectible accounts subsequently prove insufficient, additional allowance may be required.
 
Impairment of Long-Lived Assets
 
We assess impairment of our other long-lived assets in accordance with the provisions of FASB ASC 360, “Property, Plant and Equipment”. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered by us include:
 
 
·   Significant underperformance relative to expected historical or projected future operating results;
 
 
·   Significant changes in the manner of use of the acquired assets or the strategy for our overall business; and
 
 
·   Significant negative industry or economic trends.
 
 
When we determine that the carrying value of a long-lived asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, an estimate is made of the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future undiscounted cash flows and eventual disposition is less than the carrying amount of the asset, an impairment loss is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset, based on the fair market value if available, or discounted cash flows if not. To date, we have not had an impairment of long-lived assets and are not aware of the existence of any indicators of impairment.
 
Goodwill
We record goodwill when consideration paid in a business acquisition exceeds the fair value of the net tangible assets and the identified intangible assets acquired. The Company accounts for goodwill and intangible assets in accordance with FASB ASC 350 “Goodwill and Other”. FASB ASC 350 requires that goodwill and intangible assets with indefinite useful lives not be amortized, but instead be tested for impairment at least annually or whenever changes in circumstances indicate that the carrying value of the goodwill may not be recoverable. FASB ASC 350 also requires the Company to amortize intangible assets over their respective finite lives up to their estimated residual values.  At March 31, 2011, management does not believe there is any impairment in the value of goodwill.
 
Accounting for Income Taxes
 
We account for income taxes using the asset and liability method in accordance with FASB ASC 740 “Income Taxes”, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of the assets and liabilities. We periodically review the likelihood that we will realize the value of our deferred tax assets and liabilities to determine if a valuation allowance is necessary. We have concluded that it is more likely than not that we will not have sufficient taxable income of an appropriate character within the carryforward period permitted by current law to allow for the utilization of certain of the deductible amounts generating deferred tax assets; therefore, a full valuation allowance has been established to reduce the deferred tax assets to zero at March 31, 2011 and 2010. In addition, we operate within multiple domestic taxing jurisdictions and are subject to audit in those jurisdictions. These audits can involve complex issues, which may require an extended period of time for resolution. Although we believe that our financial statements reflect a reasonable assessment of our income tax liability, it is possible that the ultimate resolution of these issues could significantly differ from our original estimates.
 
Net Operating Loss Carryforwards
 
As of March 31, 2011 and December 31, 2010, our net operating loss carryforwards for federal tax purposes were approximately $44.0 million and $46.1 million, respectively.  These net operating losses occurred subsequent to our business combination in December 2006.
 
Contingencies and Litigation
 
We evaluate contingent liabilities including threatened or pending litigation in accordance with FASB ASC 450 “Contingencies” and record accruals when the outcome of these matters is deemed probable and the liability is reasonably estimable. We make these assessments based on the facts and circumstances and in some instances based in part on the advice of outside legal counsel.
 
It is not unusual in our industry to occasionally have disagreements with vendors relating to the amounts billed for services provided. We currently have disputes with vendors that we believe did not bill certain charges correctly. While we have paid the undisputed amounts billed for these non-recurring charges based on rate information provided by these vendors, as of March 31, 2011, there is approximately $500,000 of unresolved charges in dispute. We are in discussion with these vendors regarding these charges and may take additional action as deemed necessary against these vendors in the future as part of the dispute resolution process.

Contractual Obligations
 
We have no capital lease obligations at March 31, 2011. The operating lease for our corporate offices expires March 31, 2012 with a monthly lease payment of $14,000.  There are no significant provisions in our agreements with our network partners that are likely to create, increase, or accelerate obligations due thereunder other than changes in usage fees that are directly proportional to the volume of activity in the normal course of our business operations.
 
 
The following table reflects a summary of our contractual obligations at March 31, 2011:  
 
   
Payments Due by Period
(Dollars in Thousands)
 
Contractual Obligations
 
Total
 
Less Than
1 Year
 
1-3 Years
 
3-5 Years
 
More Than
5 Years
 
                       
Capital lease obligations
    $     $     $              
Operating lease obligations
      168       168                    
Total
    $ 168     $ 168     $     $     $  
 
Recent Accounting Pronouncements
 
For a discussion of the impact of recently issued accounting pronouncements, see the subsection entitled "Recent Accounting Pronouncements" contained in Note 1 of the Notes to Condensed Consolidated Financial Statements under "Item 1. Financial Statements".

Item 3.  Quantitative and Qualitative Disclosures About Market Risk 

The registrant is a smaller reporting company and, therefore, is not required to provide the information under this item.

Item 4. Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures

As required by Rules 13a-15(b) and 15d-15(b) under the Exchange Act, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer.

The Company maintains a set of disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms. Disclosure controls are also designed with the objective of ensuring that this information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
Based upon their evaluation as of the end of the period covered by this report, the Company’s Chief Executive Officer and Chief Financial Officer were not able to conclude that, the Company’s disclosure controls and procedures are effective to ensure that information required to be included in the Company’s periodic Securities and Exchange Commission filings is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and forms.  Therefore, under Section 404 of the Sarbanne’s-Oxley Act of 2002, the Company must conclude that these controls and procedures are not effective.
 
Changes in Internal Control Over Financial Reporting
 
There were no changes in our internal control over financial reporting during the three months ended March 31, 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 
PART II - OTHER INFORMATION
 
Item 1. Legal Proceedings
 
See Note 12 to the Condensed Consolidated Financial Statements.

Item 1A. Risk Factors

See Risk Factors in the Form 10-K filed by the Company on March 30, 2011

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
None.

Item 3. Defaults Upon Senior Securities

None.
 
Item 4. Removed and Reserved
  
Item 5. Other Information
 
Effective March 30, 2011, the Company entered into Amendment No. 8 to the loan and security agreement with Moriah Capital, L.P. that extended the term of the agreement to June 30, 2011. 

Item 6. Exhibits
 
 
 
In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
INTERMETRO COMMUNICATIONS, INC.
     
Dated: May 16, 2011
By: 
/s/ Charles Rice                                
Charles Rice, Chairman of the Board,
   
Chief Executive Officer, and President
     
     
Dated: May 16, 2011
By:
/s/ David Olert                                  
David Olert
   
Chief Financial Officer and Director