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Item 2.
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Management's Discussion and Analysis of Financial Condition and Results of Operations.
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This Quarterly Report
on Form 10-Q contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they
never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking
statements. The statements contained herein that are not purely historical are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate,"
"believe," "can," "continue," "could," "estimate," "expect," "intend,"
"may," "will," "plan," "project," "seek," "should," "target,"
"will," "would," and similar expressions or variations intended to identify forward-looking statements. These
statements are based on the beliefs and assumptions of our management based on information currently available to management. Such
forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and
the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements.
Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed
in the section titled "Risk Factors" included in our Annual Report on Form 10-K filed on March 30, 2012. The forward-looking
statements set forth herein speak only as of the date of this report. Except as required by law, we undertake no obligation to
update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
We
provide a range of software products for mobile video entertainment, personalization and mobile social applications. Our comprehensive
software platforms include applications that allow users to: (i) create, download and share mobile video entertainment content
in the form of video ringtones for mobile phones, (ii) create social picture ringtone and ringback content, in the form of animated
slideshows sourced from friends’ social networks, (iii) create ReMixed video clips from artists and branded content, and
(iv) utilize Fan Loyalty mobile applications for contestant based reality TV shows. Our applications and services have been launched
with ten carriers in eight markets. The billing integrations that we have with these operators are of significant strategic value
to our operations. In addition, we have deals in place with two of the four largest handset makers in the world. We believe that
social network information and updates will be shared regularly when friends regularly communicate by voice and by text. Our video
ringtone solutions and other mobile social and video applications, which encompass a suite of mobile and PC-based tools, enable
users to create, download and share video and other social content with ease as part of the normal communication process, and provide
our business partners with a consumer-friendly and easy-to-integrate monetization platform. While our current portfolio of applications
and services represents
what we believe to be
cutting edge mobile
technology that can work across many operating systems, we recognize that the pace at which the mobile landscape is changing has
increased and the two most dominant operating systems are Google’s Android and Apple’s iOS. Moving forward, we intend
to develop additional applications and services for these two key operating systems, as well as other dominant smartphone operating
systems that may emerge. We believe that we can leverage our existing distribution and relationships to promote apps and services
for these two
operating systems
.
We
are a development stage company. From inception through March 31, 2012, we have raised
approximately $34.8 million
.
These amounts have been used to finance our operations, as until now, we have not yet generated any significant revenues. From
inception through March 31, 2012, we recorded losses of $43.2 million and net cash outflow from operations of $30.5 million. Our
average monthly cash burn rate from operations for the three month period ended March 31, 2012, was approximately $0.4 million.
For the three month period ended March 31, 2012, the operational cash burn included expenses incurred in connection with merger
and acquisition activities, in the total amount of approximately $0.45 million.
In
February 2012, we raised
approximately
$3.6 million through warrant
exercises. Pursuant to agreements with warrant holders
, we issued new warrants to purchase an aggregate of 2,660,922 shares
of common stock at an
exercise price
of $1.76 per share (the “Reload
Warrants”)
, with
the
potential
of
raising
up to
an
additional $5.0 million.
The shares of common stock issuable upon the exercise of these
warrants are pending registration approval by the Securities Exchange Commission, pursuant to a Form S-3 Registration Statement
filed on March 30, 2012.
On
March 12, 2012, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with VIP Merger
Sub, Inc., a Delaware corporation, which will be our wholly-owned subsidiary (“Merger Sub”), and
Innovate/Protect, Inc., a Delaware corporation and an intellectual property firm founded in 2011 whose wholly-owned
subsidiary, I/P Engine, holds eight patents that were acquired from Lycos Inc. (“Innovate/Protect”), pursuant to
which Innovate/Protect will merge with and into Merger Sub, with Merger Sub being the surviving corporation (the
“Surviving Corporation”) through an exchange of capital stock of Innovate/Protect for our capital stock (the
“Merger”).
Under
the terms of the Merger Agreement, upon completion of the Merger, (i) each share of then-outstanding common stock of Innovate/Protect,
par value $0.0001 per share (other than shares held by us, Innovate/Protect or any of our and their subsidiaries, which will be
cancelled at the completion of the Merger) will be automatically converted into the right to receive the number of shares of our
common stock, par value $0.01 per share
multiplied by
the Common
Stock Exchange Ratio (as defined below) and (ii) each share of then-outstanding Series A Convertible Preferred Stock of Innovate/Protect,
par value $0.0001 per share (other than shares held by us, Innovate/Protect or any of our and their subsidiaries, which will be
cancelled at the completion of the Merger) will be automatically converted into the right to receive the same number of shares
of our Series A Convertible Preferred Stock, which as of March 31, 2012, 6,818 shares shall be initially convertible into an aggregate
of 20,573,998 shares of our common stock (or at a current conversion rate of 3,017.6). The preferred stock to be issued, will have
the powers, designations, preferences and other rights as will be set forth in a Certificate of Designations, Preferences and Rights
of Series A Convertible Preferred Stock to be filed by us prior to closing. The Common Stock Exchange Ratio initially is 3.0176,
which is subject to adjustment in the event of a reverse stock split to provide the holders of shares of Innovate/Protect capital
stock with the same economic benefit as contemplated by the Merger Agreement prior to any such reverse stock split. In addition,
at the effective time of the Merger, we will issue to the holders of Innovate/Protect capital stock and the holder of Innovate/Protect’s
issued and outstanding warrant (on a pro rata as-converted basis) an aggregate of 15,959,838 warrants to purchase an aggregate
of 15,959,838 shares of our common stock with an exercise price of $1.76 per share, each subject to equitable adjustment in the
event of a reverse stock split. The issued and outstanding warrant to purchase Innovate/Protect common stock shall be exchanged
for 250,000 shares of our common stock and 850,000 warrants to purchase 850,000 shares of our common stock with an exercise price
of $1.76 per share, each subject to equitable adjustment in the event of a reverse stock split. In addition, the aggregate number
of shares of our common stock and the aggregate number of warrants (and the aggregate number of shares of our common stock that
may be purchased upon exercise thereof) to be issued in exchange for the issued and outstanding warrant of Innovate/Protect shall
each be ratably adjusted to give effect to any partial exercise of such warrant prior to the effective time of the Merger.
In
addition, at the effective time of the Merger, each outstanding and unexercised option to purchase Innovate/Protect common stock,
whether vested or unvested will be converted into and become an option to purchase our common stock and we will assume such Innovate/Protect
stock option in accordance with the terms of the Innovate/Protect 2011 Equity Incentive Plan. After the effective time of the Merger,
(a) each Innovate/Protect stock option assumed by us may be exercised solely for shares of our common stock and (b) the number
of shares of our common stock and the exercise price subject to each Innovate/Protect stock option assumed by us shall be determined
by the Common Stock Exchange Ratio.
Immediately
following the completion of the Merger, the former stockholders of Innovate/Protect are expected to own approximately 56.05% of
the outstanding common stock of the combined company, and our current stockholders are expected to own approximately 43.95% of
the outstanding common stock of the combined company. On a fully diluted basis, the former stockholders of Innovate/Protect are
expected to own approximately 67.55% of the outstanding common stock of the combined company, and our current stockholders are
expected to own approximately 32.45% of the outstanding common stock of the combined company.
We
have expended significant effort and management attention on the proposed transaction. There is no assurance that the transaction
contemplated by the Merger Agreement will be consummated. If the transaction is not consummated for any reason, our business and
operations, as well as the market price of our stock and warrants may be adversely affected. For accounting purposes, based on
our preliminary assessment, Innovate/Protect was identified as the “Acquirer”, as it is defined in FASB Topic ASC 805.
As a result, in the post-combination consolidated financial statements, Innovate/Protect’s assets and liabilities will be
presented at its pre-combination amounts, and our assets and liabilities will be recognized and measured in accordance with the
guidance for business combinations in ASC 805. On April 6, 2012, we filed a Form S-4 Registration Statement with the Securities
Exchange Commission regarding the proposed Merger with Innovate/Protect, although the Registration Statement is pending approval
by the SEC. The Merger requires approval by the stockholders of both companies. We currently estimate that the Merger will be consummated
in the third quarter of 2012.
As
of March 31, 2012, we had approximately $3.6 million in cash and cash equivalents. We believe that current cash levels, after taking
into effect the
Merger
with
Innovate/Protect
,
will be sufficient to support our activity into the fourth quarter of 2012. The continuation of our business, as a going concern
is dependent upon the successful consummation of our Merger with Innovate/Protect, or additional merger or acquisition, financing,
and upon the further development of our products. In addition a significant portion of
our
issued
and outstanding
warrants are currently “in the money”
and
the shares of common stock underlying such warrants
will become
freely tradable upon exercise
after registration, with
the
potential of
up to
$5 million of incoming
funds for
us
. A Form S-3 Registration Statement
was filed on March 30, 2012 and is pending approval by the Securities Exchange Commission.
Provided that our stock price
remains at or near its current level, we
expect that the exercise of these
instruments will generate substantial additional f
unds
for our operations.
There can be no assurance, however, that any such opportunities will materialize. All of our audited consolidated financial statements
since inception have contained a “going concern” reference by our auditors, expressing substantial doubt about our
ability to continue as a going concern.
Our
financial statements were prepared using principles applicable to a going concern, which contemplate the realizations of assets
and liquidation of liabilities in the normal course of business for the foreseeable future, and do not include any adjustments
to reflect the possible effects on the recoverability and classification of assets, or the amounts and classification of liabilities
that may result if we are not able to continue as a going concern.
On April
26, 2012, the NYSE Amex notified us that it had resolved the continued listing deficiency referenced in the NYSE Amex's letter
dated May 24, 2011, which stated that we were not in compliance with Section 1003(a) (iv) of the NYSE Amex's continued
listing standards. The NYSE Amex's conclusion was based on a review of available information, including our filings with the Securities
and Exchange Commission. Our continued listing eligibility will be assessed on an ongoing basis.
Our Strategy
Our
goal is to become a leading global provider and licensor of mobile video and mobile social applications, services and software,
including mobile personalization, and interactive services via our different software platforms and maximize the benefits of our
intellectual property. To achieve this goal, we plan to:
Grow
our business
. On March 12, 2012, we announced the entry into a Merger Agreement with Innovate/Protect. The objectives of the
Merger are to maximize the economic benefits of our intellectual property assets, add significant talent in technological innovation,
and be positioned to enhance its opportunities for revenue generation through the monetization of the combined company’s
assets. Innovate/Protect is the owner of certain patent assets acquired from Lycos, one of the largest search engine websites of
its kind in the mid-late 1990s, including technologies that remain critical to current search platforms. We believe that the Merger,
if consummated, will potentially enhance our technology, our portfolio of intellectual property, and as a result, open new business
opportunities for our company.
Maintain and grow
our product technology and monetization of intellectual property
. Our technical team is made up of highly regarded industry
professionals that continually ensure that our product is on the cutting-edge in terms of ease of use, functionality and look and
feel. Our applications and services have millions of downloads and registered users, however there is no guarantee that we can
maintain this leadership position. Separately, the mobile video and mobile social networking industries are in their infancy and
in order to create a user base with scale and ultimately substantial revenue we will need to spend additional capital resources.
In addition to product leadership we continue to grow our portfolio of intellectual property through internal development. We plan
to continue to allocate technical resources to remain ahead of our competition and provide users with a product that is easy-to-use
and cutting-edge. We have filed 24 patent applications for our platform (three of which have been issued to date) and we continue
to create new intellectual property. We believe that, if consummated, the Merger will add significant talent in technological innovation,
and position the combined company for potential enhanced opportunities and revenue generation through the monetization of the combined
company’s assets.
Continue to maintain
a base of strategically important intellectual property.
If consummated, the Merger will substantially increase our intellectual
property portfolio, we believe that there are additional intellectual property assets that we will be able to partner with, license
or acquire. Our success depends on not just the monetization of the existing portfolio of patents, but expanding it further.
Create additional
applications and services.
We intend to develop, license or acquire additional applications and services to distribute through
our carrier, handset and application store partners. While we have gained significant user adoption for our products and services
we believe that to achieve substantial revenue we will need to create new products in particular for Apple’s iOS devices.
Apple is currently the dominant operating system for the monetization of mobile applications followed by Android. We have already
deployed 4 applications for Apple’s iOS and generated over 1 million downloads on Android alone for our Facetones product.
To be competitive we will continue to focus on the two most dominant smartphone platforms.
Grow our subscription
services through mobile carrier partnerships
. We have built our products so as to be easily integrated with mobile carriers
and content aggregators. We believe the mobile carrier channel is one of the most cost effective channels to grow our user base
and to monetize our products. Our subscription services are currently live in Belgium, India, Malaysia, Singapore, the United Kingdom
and the United Arab Emirates and in limited release in the United States.
Generate revenue
via software licensing partnerships.
We have licensed our software to 2 of the 4 largest handset makers in the world, ZTE and
Nokia. We believe that the market for pre-loaded software for mobile devices is a fast growing market that provides broad reach
and sustainable recurring revenue.
Enhance our
viral and social tools.
We believe that there is substantial opportunity to increase the social and viral nature of our products,
which will be critical for our growth. We will continue to add features to the product platforms to enhance their viral and social
aspects and which enable users to connect with their existing social networks on platforms such as Facebook™, Twitter™
and LinkedIn™.
Build a strong revenue
base of recurring revenue.
We will focus on recurring revenue stream generated by operator partners and advertising. We believe
that our products and services are well suited for monetization through these avenues. While the mobile advertising market is promising,
it is still in its infancy and our success is dependent on the growth of the market as a whole. Our aim is to penetrate this market
through our established partnerships; however we recognize that the realization of this model on a significant scale will continue
to require investment over a sustained period of time.
Find new forms of
distribution.
While we are currently focused on the mobile carrier distribution channel, we believe there are other avenues
that could be successful distribution channels for us. Specifically, we believe broadcasters and content owners could greatly benefit
by promoting our service to their customers by monetizing either their content or leveraging their relationship with advertisers
via ads.
Business
Overview
Our
video ringtone platform was our primary product of focus from inception through the launch of our Facetones product in the third
quarter of 2011. We continue to develop business for this product. We believe that our comprehensive video ringtone service represents
the next stage in the evolution of the ringtone market from standard audio ringtones to high-quality video ringtones, with social
networking capability and integration with web systems. Our solution, which encompasses a suite of mobile and PC-based tools, enables
users to create, download and share video ringtones with ease. Furthermore, our solution, provides our business partners with a
consumer-friendly and easy-to-integrate monetization platform. This platform combines a downloadable mobile application which works
on multiple operating systems and over 400 mobile handsets, a WAP site, which is a simplified website accessible by a user on a
mobile phone, and a website, together with a robust content integration, management and distribution system. As part of providing
a complete end-to-end video ringtone platform, we have amassed a library of over 12,000 video ringtones that we provide for our
users in various territories. Certain portions of this library are geographically restricted. We also have developed substantial
tools for users to create their own video ringtones and for mobile carriers and other partners to include their own content and
deliver it exclusively to their customers. Our VringForward™ video ringtone technology allows users to enjoy a rich social
experience by sharing video ringtones from our library or which they created.
Until
the end of 2009, our video ringtone service was offered to consumers for free. At that point, we moved to a paid service model
together with mobile carriers and other partners around the world. The revenue model for our video ringtone service offered through
the carriers is generally a subscription-based model where users pay a monthly fee for access to our service and additional fees
for premium content. Our free version is still available in markets where we have not entered into commercial arrangements with
carriers or other partners. We have built our video ringtone platform with a flexible back-end and front-end that is easy to integrate
with the back-end systems of mobile carriers and easy to co-brand with mobile carriers. To date, we have filed 24 patent applications
for our platform, three of which have been issued in the United States and we have received one notice of allowance in Europe to
date, and we continue to create new intellectual property.
As of May 15, 2012,
we have commercial video ringtone services with the following eight carriers and partners.
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Celcom AxiataBerhad, or Celcom, a mobile carrier in Malaysia, with 11.0 million subscribers. Celcom
is one of the largest mobile telecommunications operators in Malaysia with the widest national 2G and 3G coverage in the country,
with 25 thousand subscribers to our paid service. Celcom is a Vodafone partner and is part of the Axiata Group of Companies, one
of the world’s largest telecommunications companies with more than 160 million customers across 10 Asian markets (launched
in October 2011);
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Maxis Mobile Services SDN BHD, or Maxis, a mobile carrier in Malaysia with 11.4 million subscribers,
of which there are 139 thousand subscribers to our paid service and an additional 7 thousand subscribers on a free trial basis
(launched in September 2009);
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Emirates Telecommunications Corporation, or Etisalat, a mobile carrier with 7.3 million subscribers
in the United Arab Emirates and which has more than 94.0 million subscribers worldwide, where we have launched our products and
services and have 23 thousand subscribers to our paid service, (launched in January 2010);
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Everything Everywhere Limited (EEL), a mobile carrier with almost 30.0 million subscribers in the
United Kingdom. Our video ringtone platform launched was with Orange UK, a large mobile communications company and subsidiary of
EEL, with 16.0 million subscribers and we have 33 thousand subscribers to our paid service (launched in February 2011);
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Starhub, a mobile carrier with 2.0 million subscribers in Singapore (initially launched in February
2011 and re-launched in the first quarter 2012);
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RTL in Belgium, part of the Bertelsman RTL Television network, has offered together with us, a subscription
service on all three Belgian mobile operators (with a combined subscriber base of 1 million) that includes RTL content (launched
in June 2010 with limited subscribers due to regulatory limitations introduced on mobile services);
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Hungama, a content and mobile services aggregator in India. The service with Hungama is being offered
to customers of 15 different mobile carriers in India. Our paid service was on temporary hold as a result of regional legalities
in India, however we re-launched the service in March 2012 in partnership with Hungama and Tata DOCOMO; and
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Emirates Integrated Telecommunications Company (du Networks), a mobile carrier with 5.0 million
subscribers in the United Arab Emirates, where we have launched our products and services in February 2012.
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We
are currently in discussions with several other mobile carriers and we will be pursuing additional agreements with mobile carriers
over the next 12 to 24 months. As of May 15, 2012, our partners have an aggregate of approximately 700 million subscribers, of
which 227 thousand are paid subscribers to our service, and another 9 thousand subscribers have enrolled on a free-trial basis.
Our
new Facetones™ social ringtone platform generates social visual ringtone content automatically by aggregating and displaying
a user’s friends’ pictures from social networks and then displaying as a video ringtone, as well as a video ringback
tone. These ringtones do not replace, but rather enhance, standard ringtone and ringback tones with relevant, current social content
that is visually displayed. The Facetones™ product is available for devices running Android, iOS, and Nokia’s
Symbian S3. We are currently working together with mobile handset makers to develop this application for other operating systems.
Facetones™
is experiencing growth both in consumer downloads and in the number of commercial deals with major partners already announced.
The product is being made available to consumers in several different configurations and with a variety of distribution and monetization
methods. As of May 5, 2012, the Facetones™ free ad-supported version had more than a million downloads and is generating
more than 3.8 million requests in mobile ad inventory on a weekly basis.
Facetones™
is offered directly to consumers via leading mobile application stores and download sites where both for purchase versions (at
prices ranging from $1 to $5), as well as ad-supported free versions are available. Facetones is available in application stores
integrated into popular handsets such as the Google Android Market and Apple App Store. We have announced placement deals for the
app with GetJar, the world’s largest independent app store, Mobango and AppBrain. In August 2011, we launched Facetones™
in Japan for Android users through the DOCOMO market, a mobile internet portal operated by NTT DOCOMO, INC., the largest mobile
phone operator in Japan, with more than 50 million users. In October 2011, Verizon, the largest mobile operator in the
United States, announced the launch of Facetones™ as a subscription service for Verizon subscribers for $0.99 a month. We
continue to pursue business for Facetones™ together with handset manufacturers. In December 2011, we launched Facetones™
for Symbian in cooperation with Nokia. In January 2012, we launched Facetones™ for iPhone which generates, as of the end
of February 2012, close to a thousand daily downloads without any promotion. In March 2012, we shifted from providing an ad-based
free-of-charge for iPhone to a one-time fee ads-free app.
In
addition to our direct to consumer and carrier marketed versions of the Facetones™ application, we believe that licensing
our software to handset makers will provide a growing and significant revenue stream during 2012 and beyond. In November 2011,
we announced an agreement with ZTE Corporation, the largest handset maker in China and fourth-largest globally, to preload the
Facetones™ application on Android handsets manufactured by ZTE. ZTE will pay us a royalty for each device that our software
is pre-loaded on. These ZTE handsets will be sold via mobile phone operators and through various OEM contracts to brand name handset
manufacturers. In addition, we have entered into a development contract with Nokia, the world’s largest handset maker, to
supply Facetones for Nokia’s S3 devices, subsequent to delivering this version of our application it was recently launched
on the Nokia Ovi Store.
Early
in 2011, we launched our new Video ReMix platform that allows users to download an application for iOS (iPhone, iPad, iPod) or
Android phones and create their own music video by tapping on a variety of music beats and video files. Essentially, the user is
able to “Remix” this music video content and add his own user generated video to the mix and then view this content
or share it with friends via Facebook® or other social networks. This application turns the smartphone or tablet into a virtual
video ReMix sound/video board where this “mixing” is accomplished by simple tapping on the touch screen interface.
The Video ReMix applications are branded with an artist or sponsor and then monetized via advertising, sponsorship, a-la carte
sales or in app store purchases.
The
initial Video ReMix application was developed with Nappy Boy Enterprises, the music production company of the artist T-Pain. Booty
Symphony was released in an ad-supported free Android version as well as paid versions for iOS and Android. Our newest application
on our Video ReMix platform was delivered in the second quarter of 2011 to partner Corso Communications and its client Heineken.
This sponsored version highlighted music and video of the group Dirty Vegas, and was used by Heineken “brand ambassadors”
at the Coachella Music festival. We later created an additional version of this application for Heineken in the third quarter of
2011. We continue to seek new business for this platform with other recording artists and sponsored by additional major brands.
Our
Fan Loyalty platform was launched in mid-2011 by co-branding our Fan-Loyalty application with Star Academy 8, the largest music
competition in the Middle East and Nokia, the world’s largest handset maker. This platform enables users to obtain video
content from the show as well as from behind the scenes, retrieve information regarding the show and vote for their favorite contestants.
The free app was launched in partnership with Rotana, a diversified media company and the world's largest producer of music and
music television in the Middle East, and sponsored by Nokia. The application featured exclusive content and fully integrated live
voting capabilities for the blockbuster "Star Academy" reality music show, which reached over 300 million viewers and
was available in over 10 countries in the region. In the first quarter of 2012, we entered into an agreement with Endemol, a producer
of entertainment and reality TV programming, to work together on additional sponsored versions of this application.
The
Fan Loyalty application for Star Academy was made available exclusively for download on the Ovi Store, and had more than 200 thousand
downloads during the season. We are in discussions with several other entertainment groups regarding potential deals for this Fan
Loyalty platform.
As of March 31, 2012, we had 24 full time
employees and 4 part-time employees.
Revenue
We
recognize revenue from monthly subscription from carriers, development projects and content sales when all the conditions for revenue
recognition are met: (i) persuasive evidence of an arrangement exists, (ii) collection of the fee is probable, (iii) the
sales price is fixed and determinable and (iv) delivery has occurred or services have been rendered. Our subscription service
arrangements are evidenced by a written document signed by both parties. Our revenues from monthly subscription fees, content purchases
and advertisement revenues are recognized when we have received confirmation that the amount is due to us, which provides proof
that the services have been rendered, and making collection probable. We recognize revenue from non-refundable up-front fees relating
to set-up and billing integration across the period of the contract for the subscription service as these fees are part of hosting
solution that we provide to the carrier. The hosting is provided on our servers for the entire period of the arrangement with this
carrier, and the revenues relating to the monthly subscription, set-up fees and billing integration have been recognized over the
period in the agreement.
Cost
of revenue
Cost
of revenue consists primarily of third party expenses directly related to providing our service in launched markets. In addition,
these costs include royalty fees for content sales and amortization of prepaid content licenses. Cost of revenue does not include
expenses related to product development, integration, and support. These costs are included in research and development and marketing
expenses.
Research and development expenses
Research
and development expenses consist primarily of salary expenses of our development and quality assurance engineers in our research
and development facility in Israel, outsourcing of certain development activities, preparation of patent filings, labor cost incurred
in connection with customer integration, server and support functions for our development environment.
Marketing
expenses
Marketing
expenses include the salary of all business development and marketing personnel, travel expenses relating to business development
activity and trade shows, as well as public relations, advertising, ongoing customer relations and customer acquisition expenses.
As we increase our sales, certain commissions to agents will affect marketing expenses.
General
and administrative expenses
General
and administrative expenses primarily include the salary of our finance and administrative personnel, rental costs, legal and accounting
fees, insurance, telephone and other office expenses including depreciation and amortization.
Non-operating
income (expenses)
Non-operating
income (expenses) includes transaction gains (losses) from foreign exchange rate differences, interest on deposits, bank charges,
as well as fair value adjustments of derivative liabilities on account of the Preferential Reload Warrants, Special Bridge Warrants
and the Conversion Warrants, which are highly influenced by our stock price at the period end (revaluation date). Finally, in the
first quarter of 2012, non-operating income included non-recurring expense related to the issuance of the Reload Warrants (see
also Notes 3 and 5 to the financial statements).
Income
taxes
Our
effective tax rate differs from the statutory federal rate primarily due to differences between income and expense recognition
prescribed by income tax regulations and generally accepted accounting principles. We utilize different methods and useful lives
for depreciating and amortizing property and equipment and different methods and timing for certain expenses. Furthermore, permanent
differences arise from certain income and expense items recorded for financial reporting purposes but not recognizable for income
tax purposes. In addition, our income tax expense has been adjusted for the effect of foreign income from our wholly owned subsidiary.
At March 31, 2012, our deferred tax assets generated from our U.S. activities were entirely offset by a valuation allowance because
realization depends on generating future taxable income, which, in our estimation, is not more likely than not to be generated.
The deferred tax assets and liabilities generated from our subsidiary's operations are not offset by an allowance, as in our estimation,
they are more likely than not to be realized.
Our
subsidiary generates net taxable income from services it provides to us. The subsidiary charges us for research, development, certain
management and other services provided to us, plus a profit margin on such costs, which is currently 8%. On December 5, 2011, the
Knesset (Israel’s Parliament) approved the Law to Change the Tax Burden (Legislative Amendments) - 2011. According to the
new law, the corporate tax rate will be 25% starting in 2012. However, the subsidiary is a "Beneficiary Enterprise" as
defined in amendment No. 60 to the Israeli Law for the Encouragement of Capital Investment, 1959, which means that income
arising from its approved research and development activities is subject to zero percent tax for a period of two years and a reduced
tax rate for the subsequent five years. The subsidiary elected to receive the zero percent tax benefits for the fiscal years of
2007-2008. In January 2011, new legislation amending the Investment Law was enacted. According to the amendment, the uniform tax
rate applicable to a “Beneficiary Enterprise” in the zone where the production facilities of the subsidiary are located
would be 15% in 2011 and 2012, 12.5% in 2013 and 2014, and 12% in 2015 and thereafter. Under the transitory provisions of the newly
legislated amendment, the subsidiary irrevocably implemented the new law while waiving benefits provided under the current law.
Results of Operations
Three months ended March 31, 2012, compared to
the three months ended March 31, 2011 and the development stage period (cumulative from inception through March 31,
2012)
The following analysis
compares the results of our operations for the three month period ended March 31, 2012, to the results of operations for the three
month period ended March 31, 2011 and the results of our operations from inception through March 31, 2012.
Revenue
|
|
|
|
|
|
Cumulative
|
|
|
|
|
|
|
|
from inception
|
|
|
|
|
Three month period ended March 31,
|
|
|
to March 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
2012
|
|
|
|
|
($ - in thousands)
|
|
|
($ - in thousands)
|
|
|
Revenue
|
|
|
106
|
|
|
|
147
|
|
|
|
(41
|
)
|
|
|
1,055
|
|
During the three month
period ended March 31, 2012, we recorded total revenues of $106 thousand, which represents decrease of $41 thousand (or 28%) compared
to revenues recorded in the three month period ended March 31, 2011. The decrease, compared to the first quarter of 2011,
was mainly due to a decrease in revenue recorded in connection with one time set up fees in Singapore and Armenia. Additional decrease
in revenues was due to Video ReMix platform revenue recorded in the first quarter of 2011, in the total amount of $23 thousand,
which did not occur in 2012. In addition, i
n the first quarter of 2012, the number of subscribers
in Maxis was reduced due to system updates of recycled numbers from the regulated carrier database, as a result revenue decreased
by $40 thousand (or 50%), compared to the first quarter of 2011. The decrease was offset by revenue from new subscription agreement
in Malaysia ($16 thousand recorded in the first quarter of 2012) and an increase in revenue in the UK (an increase of $17 thousand,
compared to the first quarter of 2011). Overall, we do not expect the abovementioned decrease in subscribers in Maxis to have a
material effect on our future revenue.
During the three month
period ended March 31, 2011, we recorded revenues of $147 thousand, which represents an increase of $117 thousand (or 390%)
from revenues recorded for the three month period ended March 31, 2010. The recognized revenue in the first quarter of 2011
was mainly from our revenue-sharing agreements in Malaysia ($77 thousand recorded, an increase of $67 thousand compared to the
first quarter of 2010). In addition, we recognized revenue for one time set up fees in Singapore ($9 thousand in the first quarter
of 2011 and Armenia ($9 thousand in the first quarter of 2011). Revenue for our Video ReMix platform commenced this quarter, with
the recognition of $23 thousand in March 2011. The revenue in the first quarter of 2010 was mainly comprised of our then new revenue-sharing
agreements in Malaysia, the United Arab Emirates and Armenia, whereby we recognized approximately $10 thousand for each one of
these customers.
From inception through
March 31, 2012, we recorded revenues of $1,055 thousand, which includes $726 thousand from revenue share subscription services,
$118 thousand from one-time setup fees, $91 thousand from Facetones™, $80 thousand from Fan Loyalty application formats,
$30 thousand from Video ReMix platform and $10 thousand from applications sold.
We expect to
continue to generate a substantial portion of our future revenues from: (i) Facetones™ preloads through the agreement with
ZTE as well as the development of additional business from handset makers, (ii) Facetones™ app, and Fan Loyalty application
platforms, (iii) revenue-sharing agreements in India, Malaysia, Singapore, United Arab Emirates and UK, (iv) new revenue-sharing
agreements for subscription-based services in new territories, (v) one-time service fees for customized production and development
of the Facetones and Fan Loyalty application platforms, (vi) monetization of our intellectual property.
Cost of Revenue
|
|
|
Three month period ended March 31,
|
|
|
Cumulative
from inception
to March 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
2012
|
|
|
|
|
($ - in thousands)
|
|
|
($ - in thousands)
|
|
|
Cost of revenue
|
|
|
31
|
|
|
|
25
|
|
|
|
6
|
|
|
|
397
|
|
During the three month
period ended March 31, 2012, our cost of revenue was $31 thousand, which represents an increase of $6 thousand (or 24%) compared
to our cost of revenue for the three month period ended March 31, 2011. During the three month period ended March 31, 2011
and 2010, our cost of revenue was $25 thousand and $34 thousand, respectively, which represents a decrease of $9 thousand (or 26%)
compared to cost of revenue for the three month period ended March 31, 2010. Our cost of revenue is mainly comprised of cost
of services related to the provision of content to end-users and cost of hosted servers needed to support our service in markets
where we have launched our product. The change in cost of revenue, between the presented periods was mainly related to changes
in content amortization expenses.
We expect that cost
of revenue will increase over time, as we diversify the portfolio of our products. As some of these costs are fixed irrespective
of our revenues, we expect our gross margin to increase, as our revenues increase.
Research and Development
|
|
|
Three month period ended March 31,
|
|
|
Cumulative
from inception
to March 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
2012
|
|
|
|
|
($ - in thousands)
|
|
|
($ - in thousands)
|
|
|
Research and development
|
|
|
512
|
|
|
|
519
|
|
|
|
(7
|
)
|
|
|
13,883
|
|
Research and development
expenses decreased from $519 thousand to $512 thousand (or 1%) during the three month period ended March 31, 2012, compared
to the three month period ended March 31, 2011. In the first quarter of 2012, our research and development expenses mainly
consisted of workforce and consulting related costs ($371 thousand, compared to $374 thousand in the first quarter of 2011), as
well as share based compensation costs ($35 thousand, compared to $82 thousand in the first quarter of 2011). The decrease was
mainly due to a decrease in shares based compensation expense, offset by higher patent expenses (an increase of $36 thousand in
the first quarter of 2012), following our decision to enhance and diversify our intellectual property portfolio.
Research and development
expenses decreased from $587 thousand to $519 thousand (12%) during the three month period ended March 31, 2011, compared
to the three month period ended March 31, 2010. The decrease is mainly due to a separation agreement we entered into with
our former Chief Technology Officer. This was offset by an increase in share based compensation expense in connection with 2011
and 2010 grants.
From
inception through March 31, 2012, research and development expenses amounted to approximately $13.9 million. Of this amount, approximately
$9.0 million was attributed to salaries and related expenses, $0.6 million to share based payments, $2.2 million was attributed
to sub-contracting and consulting services, $0.9 million was attributed to operating expenses, $0.3 million was attributed to overhead
and $0.9 million was attributed to patent expenses.
We
anticipate that our research and development costs will remain constant until after the consummation of the proposed Merger with
Innovate/Protect. Following the completion of the proposed Merger, those costs may increase, should we seek to develop additional
technology and intellectual property to diversify and enhance our business.
Marketing
|
|
|
Three month period ended March 31,
|
|
|
Cumulative
from inception
to March 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
2012
|
|
|
|
|
($ - in thousands)
|
|
|
($ - in thousands)
|
|
|
Marketing
|
|
|
759
|
|
|
|
621
|
|
|
|
138
|
|
|
|
11,970
|
|
During
the three month period ended March 31, 2012, marketing expenses increased by $138 thousand (or 22%), to $759 thousand, from $621
thousand in the three month period ended March 31, 2011.
The increase in our marketing expenses
in the first quarter of 2012, was mainly due to an increase of $254 thousand in non-cash share-based compensation expenses, related
to new grants in 2012 and the effect of the separation agreement signed between us and our former CEO (an increase of $0.16 million).
This increase was offset by a decrease of $81 thousand in payroll expenses related to reclassification of 50% of the cost of our
President and newly appointed CEO in the United States, as of March 2012, to general and administrative expenses.
The increase in our
marketing expenses for the three month period ended March 31, 2011, was in part due to the hiring, in April 2010, of our President
in the United States, whose efforts are focused on marketing and business development. In addition, the increase relates to the
2011 and 2010 options grants for marketing employees, thereby increasing the respective compensation expense. Furthermore, we had
an increase in public relations and advertising costs in connection with new commercial launches in 2011.
From inception through
March 31, 2012, marketing expenses amounted to approximately $12 million. Of this amount, approximately $5.2 million was attributed
to salaries, $1.4 million was attributed to share based payments and related expenses, $2.2 million was attributed to travel and
trade shows, $1.6 million was attributed to sub-contracting and consulting services, $1.4 million was attributed to public relations
services and customer acquisition expenses and $0.2 million was attributed to overhead expenses.
A significant portion
of our marketing activity relates to the launching of services with our global partners and building a pipeline for further agreements.
In addition, we conduct direct-to-consumer marketing activities in countries where we have launched our services to build on the
efforts of our partners. While we do not expect to invest heavily in direct-to-consumer marketing activities in the future, we
do expect an increase in marketing expenses as we continue launching our service in different global markets. In certain markets,
our marketing efforts may include hiring local personnel to introduce us to the market and purchasing rights to certain local content.
As our market reach grows, we expect our marketing expenses to continue to increase our visibility to potential partners.
General and Administrative
|
|
|
Three month period ended March 31,
|
|
|
Cumulative
from inception
to March 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
2012
|
|
|
|
|
($ - in thousands)
|
|
|
($ - in thousands)
|
|
|
General and administrative
|
|
|
1,460
|
|
|
|
665
|
|
|
|
795
|
|
|
|
9,729
|
|
During the three month
period ended March 31, 2012, general and administrative expenses increased by $795 thousand (or 120%), to $1,460 thousand, from
$665 thousand during the three month period ended March 31, 2011. General and administrative expenses increased mostly due
to the increase in various professional fees in connection with increased merger and acquisition activity (an increase of approximately
$0.4 million, compared to the first quarter of 2011). In addition, there was an increase due to non-cash share based compensation
expenses due to new option grants in 2012 and the effect of the separation agreement signed between us and our former CEO (an increase
of $0.16 million). Finally, an additional increase in expense in the first quarter of 2012, compared to the first quarter of 2011,
was due an increase in payroll expenses of $76 thousand, related mainly to reclassification of 50% of the cost of our President
and new CEO in the United States to general and administrative expenses.
During the three month
period ended March 31, 2011, general and administrative expenses increased $471 thousand (or 242%), to $665 thousand, from
$194 thousand in the three month period ended March 31, 2010. The increase is mostly due to increase in various professional
fees in connection with becoming a public company. In addition, there was an increase due to additional insurance costs for our
directors' and officers' liability insurance and an increase in share based compensation expenses due to new option grants in 2011
and 2010.
From inception through
March 31, 2012, general and administrative expenses totaled approximately $9.7 million. Of this amount, approximately $2.4 million
was attributed to salaries and related expenses, $2.1 million was attributed to share based payments, $1.8 million was attributed
to various office expenses, $2.8 million was attributed to professional fees and $0.6 million was attributed to depreciation and
amortization.
We expect that
our general and administrative expenses will remain high, as we expect to incur significant costs in connection with future merger,
acquisition and financing activities. These costs will be reflected in increased accounting, legal and insurance costs. We also
expect that our compensation costs will increase significantly due to the recording of expense related to management share based
compensation.
Non-operating Expense (Income), Net
|
|
|
Three month period ended March 31,
|
|
|
Cumulative
from inception
to March 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
2012
|
|
|
|
|
($ - in thousands)
|
|
|
($ - in thousands)
|
|
|
Non-operating income (expense), net
|
|
|
(2,968
|
)
|
|
|
592
|
|
|
|
(3,560
|
)
|
|
|
(8,127
|
)
|
During the three month
period ended March 31, 2012, non-operating income (expense) changed by $3.6 million (or -603%), to an expense of $3.0 million,
from an income of $0.6 million, in the three month period ended March 31, 2011.
In the three month
period ended March 31, 2012, we recorded non-operating expense in the amount of $3.0 million, which was mainly comprised of an
expense of $2.6 million recorded in connection with issuance of the Reload Warrants accounted for as an inducement to convert convertible
debt (see Notes 3 and 5 to the accompanying financial statements), as well as an additional expense of $0.4 million, recorded due
to adjustment of fair value of the Preferential Reload Warrants, Special Bridge Warrants and the Conversion Warrants.
In the three month
period ended March 31, 2011, we recorded non-operating income in the amount of $0.6 million, which was mainly comprised of
an income of $0.7 million recorded due to decrease in the fair value of the Special Bridge Warrants and the Conversion Warrants
and an expense on $0.1 million in connection with interest on venture loan.
The non-operating expense in the first quarter
of 2010 was mainly comprised of $0.5 million in connection with the bridge financing and an interest expense of $0.1 million relating
to the bridge notes and the venture loan.
From inception through
March 31, 2012, non-operating income (expense) totaled approximately $8.1 million. This amount mainly included: income from interest
on deposits of $0.2 million, interest expense on venture loan of $1.6 million, $0.1 million of debt extinguishment expense related
to the Series B Convertible Preferred Stock, $0.2 million of debt extinguishment expenses as a result of the loan modification
agreement with SVB/Gold Hill, $1.0 million of additional interest expense as a result of the conversion of the convertible loan,
$0.3 million of warrant amortization and $1.1 million of additional interest expense from the Bridge Notes, $1.3 million as additional
interest expense for warrants granted to lead investors of the Bridge Financing, $1.0 million income in connection with the settlement
of the venture loan and $1.3 million expense recorded in connection with amortization of discount on convertible notes, and non-operating
income of $0.1 million for the adjustment of the fair value of the Preferential Reload, Special Bridge and the Conversion Warrants.
Finally, additional non-operating expense of approximately $2.6 million was recorded due to issuance of the Reload Warrants, accounted
for as an inducement to convert convertible debt.
Taxes on Income
|
|
|
Three month period ended March 31,
|
|
|
Cumulative
from inception
to March 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
2011
|
|
|
|
|
($ - in thousands)
|
|
|
($ - in thousands)
|
|
|
Income tax expense (benefit)
|
|
|
20
|
|
|
|
18
|
|
|
|
2
|
|
|
|
139
|
|
During the three month
period ended March 31, 2012, we recorded an income tax expense in the total amount of $20 thousand, which reflects an increase
of $2 thousand compared to tax expense of $18 thousand recorded in the three month period ended March 31, 2011. In addition,
income tax expense recorded during the three month period ended March 31, 2011, reflect a decrease of $2 thousand compared to tax
expense of $20 thousand recorded in the three month period ended March 31, 2010.
Taxes on income are
mainly due to taxable profits generated by our subsidiary, as a result of the intercompany cost plus agreement between us and the
subsidiary, whereby the subsidiary performs development and other services for us and is reimbursed for its expenses plus 8%. For
financial statements purposes, these profits are eliminated upon consolidation. The profits of the subsidiary benefitted from a
tax holiday in the 2007-2008 tax years and a taxable loss in 2009, 2010 and 2011. We expect a taxable income in our subsidiary,
in 2012, under the terms of the intercompany agreement. In addition, during the three month period ended March 31, 2012, 2011 and
2010, we recorded income tax expense of $7 thousand, $12 thousand and $0 thousand, respectively, in connection with tax withheld
at source by our partner in Malaysia, which we do not expect to be reclaimed.
From inception through
March 31, 2012, income tax expense totaled $139 thousand. We expect tax expense to increase as our business grows and as our subsidiary
continues to generate taxable income under the intercompany cost plus agreement.
Off-Balance Sheet Arrangements
We have no obligations,
assets or liabilities which would be considered off-balance sheet arrangements. We do not participate in transactions that create
relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, which would
have been established for the purpose of facilitating off-balance sheet arrangements.
Liquidity and Capital Resources
As of March 31, 2012,
we had a cash balance of $3.6 million and $2.7 million in net working capital. The increase of $2.4 million in our cash balance
from December 31, 2011, was mainly due to $3.65 million received from exercise of approximately 90% of the then outstanding Special
Bridge and Conversion Warrants, offset by net cash used by us in our business operations ($0.8 million) and funds used in connection
with the Merger (approximately $0.4 million). As of March 31, 2012, our total stockholders' equity was $1.0 million, mainly due
to the exercise of the abovementioned warrants, offset by continued operating deficits from inception to date.
The Company believes that its current cash levels will be sufficient to support its activity into the first quarter of 2013. Based
on current operating plans, additional resources that may be required for the continuation of our operations approximates $0.9
million and $4.4 million, for the twelve month periods ending March 31, 2013 and March 31, 2014, respectively.
After
taking into effect the Merger with
Innovate/Protect
, additional resources that may
be required for the continuation of our combined operations approximates $4.3 million and $11.8 million, for the twelve month periods
ending March 31, 2013 and March 31, 2014, respectively. These estimates include a projected $0.7 million cash outflow for merger
and integration costs relating to the Innovate/Protect combination, specifically for legal, accounting and exchange fees, as well
as an expected increase in D&O insurance.
In
addition a significant portion of
our
issued
and outstanding
warrants are currently “in the money” and
the shares
of common stock underlying such warrants
will become
freely tradable
upon exercise
after registration, with
the
potential of
up to
$5 million of incoming funds for us. A Form S-3
Registration Statement was filed on March 30, 2012 and is pending approval by the Securities Exchange Commission.
Provided
that our stock price remains at or near its current level, we
expect that
the exercise of these instruments will generate substantial additional
funds
for our operations. There can be no assurance, however, that any such opportunities will materialize.
The
continuation of our business, as a going concern is dependent upon the successful consummation of the proposed Merger with
Innovate/Protect, or similar merger or acquisition, financing, and upon the further development of our products. There can be
no assurance, however, that any such opportunities will materialize. We anticipate that we will continue to issue equity
and/or debt securities as a source of liquidity, when needed, until we generate positive cash flow to support our operations.
We cannot give any assurance that the necessary capital will be raised or that, if funds are raised, it will be on favorable
terms. Any future sales of securities to finance our operations may require stockholder approval and will dilute existing
stockholders' ownership. We cannot guarantee when or if we will ever generate positive cash flow.
Cash flows
|
|
|
Three month period ended March 31,
|
|
|
Cumulative
from inception
to March 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
2012
|
|
|
|
|
($ - in thousands)
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(1,215
|
)
|
|
|
(1,517
|
)
|
|
|
302
|
|
|
|
(30,518
|
)
|
|
Net cash provided by (used in) investing activities
|
|
|
(5
|
)
|
|
|
14
|
|
|
|
(19
|
)
|
|
|
(611
|
)
|
|
Net cash provided by financing activities
|
|
|
3,652
|
|
|
|
(345
|
)
|
|
|
3,997
|
|
|
|
34,812
|
|
Operating activities
During the three month
period ended March 31, 2012, net cash used in operating activities totaled $1.2 million. During the three month period ended March 31,
2011, net cash used in operating activities totaled $1.5 million. The decrease of $0.3 million in cash used in operating activities
was mainly due to increased collection of receivables ($0.3 million the first quarter of 2012, compared to $0.1 million in the
first quarter of 2011), as well as reduction in workforce related costs. The operating activities included merger and acquisition
related expenses (increase of $0.45 million compared to the first quarter of 2011).
During the three month
period ended March 31, 2011, net cash used in operating activities totaled $1.5 million. During the quarter ended March 31,
2010, net cash used in operating activities totaled $1.7 million. The decrease of $0.2 million used in operating activities was
mainly due to reduction in workforce related costs in connection with the cost reduction plan implemented in the first quarter
of 2011.
We expect our net cash
used in operating activities to increase due to costs related to merger and acquisition activity, as well as due to possible future
financing activity. As we move towards greater revenue generation, we expect that these amounts will be offset by revenue. Since
we receive most of our revenues directly from carriers whose payment schedules are generally net 90 days or longer, and our suppliers'
payment schedules are generally net 30 days, we do not expect the increase in revenue will initially increase our net cash from
operating activities.
Investing activities
During the three month
period ended March 31, 2012, net cash used in investing activities totaled $5 thousand. During the three month period ended March 31,
2011, net cash provided by investing activities totaled $14 thousand. This change of $19 thousand in cash provided by investing
activities was primarily due to the release of a short term deposit, which was offset by the purchase of fixed assets in the first
quarter of 2011. Fixed asset purchases in the three month period ended March 31, 2012, amounted to $5 thousand compared to $7 thousand
for the three month period ended March 31, 2011.
We expect that net
cash used in investing activities will increase as we intend to continue to upgrade our computers and software in 2012. Moreover,
as our service continues to grow, we will need to increase our server capacity to meet the needs of our customers.
Financing activities
During
the three month period ended March 31, 2012, net cash provided by financing activities totaled $3.65 million, which relates to
the exercise of warrants in February 2012. Pursuant to agreements with warrant holders
, we
issued
Reload Warrants
at
an
exercise price
of $1.76 per share
, with
the
potential for raising
up to
an additional $5.0 million.
We expect to continue
to see a net cash inflow from financing activities, as a result of possible inflows from the exercise of warrants and options granted
to employees management and consultants.
Future operations
In March 2012, we entered
into the Merger Agreement with Innovate/Protect. We believe that the Merger, if consummated, will maximize the economic benefits
of our intellectual property portfolio, add significant talent in technological innovation, and potentially enhance our opportunities
for revenue generation through the monetization of the combined company’s assets. Innovate/Protect is the owner of certain
patent assets acquired from Lycos, one of the largest search engine websites of its kind in the mid-late 1990s, including technologies
that remain critical to current search platforms. The completion of the Merger is subject to a number of conditions and there can
be no assurance that the conditions to the completion of the Merger will be satisfied and the Merger will be consummated.
In
the fourth quarter of 2011, we announced an agreement with ZTE Corporation, the largest handset maker in China and fourth-largest
globally, to preload the Facetones™ application on Android handsets, which is scheduled to
commence late in the second
quarter or third quarter of 2012. As
part of the commercial terms of the agreement, these
handsets will be sold via mobile phone operators and through various OEM contracts. Similar arrangement are being pursued with
other handset manufacturers, although there can be no assurance that any such opportunities may arise.
We
are currently in discussions with several potential strategic partners and mobile carriers and we will be pursuing additional agreements
over the next 12 to 24 months. In addition, we are continuing to explore further opportunities for strategic business alliances,
however, there can be no assurance that any such opportunities may arise, or that any such opportunities will be consummated.
Together
with the executive team from Innovate/Protect we anticipate the creation of additional products and services that will be distributed
through our existing operator and handset relationships.
Critical Accounting Estimates
While our significant
accounting policies are more fully described in the notes to our audited consolidated financial statements for the years ended
December 31, 2011, we believe the following accounting policies to be the most critical in understanding the judgments and
estimates we use in preparing our consolidated financial statements.
Accounting for Stock-based Compensation
We account for stock-based
awards under ASC 718, "Compensation—Stock Compensation" (formerly SFAS 123R, "Share-Based Payment"),
which requires measurement of compensation cost for stock-based awards at fair value on the date of grant and the recognition of
compensation over the service period in which the awards are expected to vest. In addition, for options granted to consultants,
FASB ASC 505-50, "
Equity-Based Payments to Non Employees
" is applied. Under this pronouncement, the measurement
date of the option occurs on the earlier of counterparty performance or performance commitment. The grant is revalued at every
reporting date until the measurement date. The estimation of stock-based awards that will ultimately vest requires judgment, and
to the extent actual results differ from our estimates, such amounts will be recorded as a cumulative adjustment in the period
estimates are revised. We consider various factors when estimating expected forfeitures, including historical experience. Actual
results may differ substantially from these estimates.
We determine the fair
value of stock options granted to employees, directors and consultants using the Black-Scholes-Merton, the Lattice (for out-of-money
option grants) and the Monte-Carlo (for grants that include market conditions) valuation models, those require significant assumptions
regarding the expected stock price volatility, the risk-free interest rate and the dividend yield, and the estimated period of
time option grants will be outstanding before they are ultimately exercised. Due to insufficient history, we estimate our expected
stock volatility based on historical stock volatility from comparable companies.
In
January 2012,
our board of directors
approved an acceleration of
option vesting for all option holders, should
we will
be subject
to a change of control in a merger and/or acquisition transaction. In addition, in March 2012, the
board of director
approved participation of all outstanding options, except for those grants pursuant to separation arrangements, in future dividends,
if any, as well as the acceleration of vesting of certain outstanding options, according certain market conditions. In addition,
upon a subsequent change of control, defined as a more than 50% change in shareholder ownership excluding the transaction
Innovate/Protect
,
75% of the then unvested options held by each grantee shall automatically vest. Moreover, all outstanding options granted to members
of the
board of directors
shall fully vest if a
member
of the board of directors
ceases to be a director at any time during the
six-month period immediately following a change of control. As of March 31, 2012, the Company expects to account for no dividends
payouts, acceleration of vesting triggered by the Merger with
Innovate/Protect
will be accounted for upon the consummation of the
proposed Merger
;
moreover, it assumes that the estimated effect of acceleration pursuant to meeting the abovementioned market conditions will be
immaterial, due to low probability of occurrence, please refer to Note 5 to the accompanying financial statements.
These option pricing
models utilize various inputs and assumptions, which are highly subjective. Had we used different assumptions, our results may
have been significantly different. For further information on judgments and assessments used, please refer to Note 11 in our consolidated
financial statements for the year ended December 31, 2011.
Valuation
of Financial Instruments
On
December 29, 2009, we consummated a bridge financing pursuant to which we issued 5% subordinated convertible promissory
notes, ("Bridge Notes"), in the aggregate amount of $2.98 million in a private placement, as well as warrants to
purchase 795,200 shares of common stock (the "Special Bridge Warrants", and collectively with the Bridge Notes, the
"Bridge Financing"). Proceeds from the Bridge Financing were first allocated to the Special Bridge Warrants, which
were classified as a derivative liability and recorded at fair value, with the residual amount allocated to the Bridge
Notes.
On
December 1, 2011, we entered into financing agreements which triggered anti-dilution provisions in certain of our outstanding warrants.
As a result, the exercise price was reduced to $0.94 and the number of Special Bridge Warrants outstanding was adjusted to 2,528,615.
Between February 6 and February 14, 2012, we entered into agreements with holders of the Special Bridge Warrants, pursuant to which
such holders exercised 2,274,235 Special Bridge Warrants (see also to Notes 3 and 5 to the accompanying financial statements).
As of March 31, 2012, the Special Bridge Warrants were revalued using the Black-Scholes-Merton and the Monte-Carlo models. As the
terms of these warrants include a special down-round protection clause, i.e. in a new issuance of common stock at a lower price
than the current exercise price, the current exercise price will be lowered to the new issuance price and the number of warrants
granted will increase so that the total exercisable value remains as under the original terms. As of March 31, 2012, we estimated
30% probability of such protection being activated in September 2012. We have estimated the value of the down-round protection
using a Monte-Carlo simulation. The following assumptions were used: 82.95% expected volatility, a risk-free interest rate of 0.50%,
estimated life of 2.75 years and no dividend yield.
Upon
the consummation of the IPO, the Bridge Notes automatically converted into 864,332 shares of common stock and 1,728,664 warrants
(the "Conversion Warrants"). The Conversion Warrants have down-round protection clauses, i.e. in a new issuance of common
shares at a lower price than the current exercise price, the current exercise price will be adjusted to the new issuance price.
On December 1, 2011, we entered into financing agreements which triggered anti-dilution provisions in certain of our outstanding
warrants. As a result, the exercise price was reduced to $0.94. Between February 6 and February 14, 2012, we entered into agreements
with
holders of the Special Bridge Warrants and Conversion Warrants
,
pursuant to which such holders exercised 1,554,758 Conversion Warrants (see also to Notes 3 and 5 to the accompanying financial
statements). As of March 31, 2012, the Conversion Warrants were revalued using the Black-Scholes-Merton and the Monte-Carlo models.
As the terms of these warrants include a special down-round protection clause, i.e. in a new issuance of common stock at a lower
price than the current exercise price, the current exercise price will be lowered to the new issuance price and the number of warrants
granted will increase so that the total exercisable value remains as under the original terms. As of March 31, 2012, we estimated
30% probability of such protection being activated in September, 2012. We have estimated the value of the down-round protection
using a Monte-Carlo simulation. The following assumptions were used: 79.26% expected volatility, a risk-free interest rate of 0.60%,
estimated life of 3.23 years and no dividend yield.
Between
February 6 and February 14, 2012, we entered into agreements with
holders of the Special Bridge Warrants and Conversion
Warrants
, pursuant to which
such holders
exercised 2,274,235 Special Bridge
Warrants
and
1,554,758 Conversion Warrants to purchase an aggregate of 3,828,993 shares of our common stock for aggregate proceeds of
approximately
$3.6 million. In addition, we issued
Reload
Warrants
to purchase an aggregate of 2,660,922
shares of common stock at an exercise price of $1.76 per share in consideration for the immediate exercise of the warrants. 1,392,972
of the Reload Warrants bear down-round protection clauses; as a result, they will be classified as a long term derivative liability
and recorded at fair value (“Preferential Reload Warrants”). At the issuance date fair value, in the total amount of
$1,476 thousand was calculated using the Black-Scholes-Merton and the Monte-Carlo models (see also to Notes 3 and 5 to the accompanying
financial statements), using the following assumptions: 72.89% expected volatility, a risk-free interest rate of 0.79%, estimated
life of 5 years and no dividend yield. The fair value of the common stock was $1.76. We estimated there is a 30% probability that
down-round protection will be activated in September 2012. As of March 31, 2012 fair value of the Preferential Reload Warrants
was calculated using the Black-Scholes-Merton and the Monte-Carlo models, using the following assumptions: 73.13% expected volatility,
a risk-free interest rate of 1.05%, estimated life of 4.86 years and no dividend yield. We estimated there is a 30% probability
that down-round protection will be activated in September 2012.
Had
we made different assumptions about the fair value of the stock price (before it was publicly traded), risk-free interest rate,
volatility, the impact of the down-round provision, or the estimated time that the above-mentioned warrants will be outstanding
before they are ultimately exercised, the recorded expense, our net loss and net loss per share amounts could have been significantly
different.
Accounting for Income Taxes
As part of the process
of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in
which we operate. This process involves management estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax
assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred
tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not more likely than not,
we must establish a valuation allowance. Significant management judgment is required in determining our provision for income taxes,
our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. At March 31,
2012, we have fully offset our U.S. net deferred tax asset with a valuation allowance. Our lack of earnings history and the uncertainty
surrounding our ability to generate U.S. taxable income prior to the expiration of such deferred tax assets were the primary factors
considered by management in establishing the valuation allowance. Also, refer to Note 14 of our consolidated financial statements
for the year ended December 31, 2011.
ASC 740, "Income
Taxes" (formerly FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes—an Interpretation
of FASB Statement 109"), prescribes how a company should recognize, measure, present and disclose in its financial statements
uncertain tax positions that the company has taken or expects to take on a tax return. Additionally, for tax positions to qualify
for deferred tax benefit recognition under ASC 740, the position must have at least a "more likely than not" chance of
being sustained upon challenge by the respective taxing authorities, which criteria is a matter of significant judgment.
Recently Issued Accounting Pronouncements
In
April 2011, the Financial Accounting Standards Board (FASB) issued ASU 2011-04,
Fair
Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and
IFRS.
This ASU amends current fair value measurement and disclosure guidance
to include increased transparency around valuation input and investment categorization. ASU 2011-04 is effective for fiscal years
and interim periods beginning after December 15, 2011, with early adoption not permitted. The adoption of ASU 2011-04 in the first
quarter of 2012 did not have an impact on our financial position, results of operations, or cash flows.
In
June 2011, the FASB issued ASU 2011-05,
Comprehensive Income (Topic 220):
Presentation of Comprehensive Income. ASU 2011-05 allows an entity to present components of net income and other comprehensive
income in one continuous statement, referred to as the statement of comprehensive income, or in two separate, but consecutive statements.
ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in
stockholders’ equity. In December 2011, the FASB issued ASU 2011-12 Comprehensive Income (Topic 220): Deferral of the Effective
Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting
Standards Update No. 2011-05.”ASU 2011-12 deferred the effective date of the specific requirement to present items that are
reclassified out of accumulated other comprehensive income to net income alongside their respective components of net income and
other comprehensive income. While the new guidance changes the presentation of comprehensive income, there are no changes to the
components that are recognized in net income or other comprehensive income under current accounting guidance. ASU 2011-05 is effective
for fiscal years and interim periods beginning after December 15, 2011 and must be applied retrospectively. The adoption of ASU
2011-05 in the first quarter of 2012 did not have an impact on our financial position, results of operations, or cash flows.
In
December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210),
Disclosures
about Offsetting Assets and Liabilities, which require companies to disclose information about financial instruments that have
been offset and related arrangements to enable users of their financial statements to understand the effect of those arrangements
on their financial position. Companies will be required to provide both net (offset amounts) and gross information in the notes
to the financial statements for relevant assets and liabilities that are offset. ASU 2011-11 is effective for fiscal years, and
interim periods within those years, beginning on or after January 1, 2013. We do not expect the adoption of ASU 2011-11 in
the first quarter of 2013 to have an impact on our financial position, results of operations, or cash flows.
