XWELL, Inc. - Quarter Report: 2010 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2010

For the transition period from              to             

Commission file number: 001-34785

VRINGO, INC.

(Exact Name of Registrant as Specified in its Charter)

(646) 525-4319

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x

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

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

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

As of August 12, 2010, 5,098,364 shares of the registrant’s common stock were outstanding.

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VRINGO, INC.

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Part I

FINANCIAL INFORMATION

Vringo, Inc. and Subsidiary

(a Development Stage Company)

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands except share and per share data)

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

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands except share and per share data)

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

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands except share and per share data)

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

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

STATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

(in thousands)

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

STATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

(in thousands)

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

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

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1—General

Vringo, Inc. (the “Parent”) was incorporated in Delaware on January 9, 2006 and commenced operations during the first quarter of 2006. The Parent formed a wholly-owned subsidiary, Vringo (Israel) Ltd. (the “Subsidiary”) in March 2006, primarily for the purpose of providing research and development services, as detailed in the intercompany service agreement. The Parent and the Subsidiary are collectively referred to herein as the Company.

The Company is engaged in developing software for mobile phones. The Company provides a comprehensive platform allowing users to create, download and share video ringtones. The Company’s proprietary ringtone platform includes social networking capability and integration with web systems.

In June 2010, the Company completed an initial public offering (IPO) of 2,392,000 units, each containing one share of common stock and two warrants, at an issuance price of $4.60 per unit. Each warrant in the IPO unit is exercisable for five years after the IPO at an exercise price of $5.06. Gross proceeds of the IPO totaled approximately $11 million of which the Company received approximately $9.3 million in net proceeds after deducting underwriting discounts and other offering costs. The underwriters for the IPO were granted an option to purchase an additional 358,800 units at the same price per unit (the over-allotment option) for 45 days following the closing of the IPO, which has not been exercised by the underwriters. Immediately prior to the closing of the offering, the Company’s outstanding shares of preferred stock were exchanged for shares of common stock and the Company effected a 1 for 6 reverse stock split of its common stock. The Company issued a stock dividend to holders of the preferred stock prior to the split and exchange. All share and per-share information in these unaudited condensed financial statements have been adjusted to give effect to the reverse stock split.

On July 27, 2010, the unit was separated into its components and the shares and warrants began to trade separately. Upon separation of the units into shares and warrants, the units ceased trading.

The Company is in the development stage. Therefore, there is no certainty regarding the Company’s ability to complete the product’s development and success of its marketing. The continuation of the stages of development and the realization of assets related to the planned activities depend on future events, including future financings and achieving operational profitability. The Company has incurred significant losses since its inception and expects that it will continue to operate at a net loss in the foreseeable future. Management believes that the Company’s currently available capital resources are sufficient to meet its cash requirements for at least the next 12 months. There are still significant doubts as to the ability of the Company to continue operating as a “going concern”. These financial statements were prepared using principles applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business for the foreseeable future, and do not include any adjustments to reflect the possible effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result should the Company not be able to continue as a going concern. For the three and six months ended June 30, 2010 and for the cumulative period from inception until June 30, 2010, the Company incurred net losses of $4.6 million, $6.6 million and $26.7 million, respectively. The Company’s stockholders’ equity and working capital as of June 30, 2010 were $2.6 million and $7.5 million respectively.

The high-tech industry in which the Company operates is highly competitive and is characterized by the risks of rapidly changing technologies. Penetration into world markets requires investment of considerable resources and continuous development efforts. The Company’s future success depends upon several factors including the technological quality, price and performance of its product relative to those of its competitors.

As of June 30, 2010, approximately $752 thousand of the Company’s net assets were located outside of the United States.

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 2—Significant Accounting and Reporting Policies

(a) Basis of presentation

The accompanying consolidated financial statements include the accounts of the Parent and the Subsidiary and are presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All significant intercompany balances and transactions have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles. Nevertheless, these financial statements should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2009. The results of operations for the three and six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the entire fiscal year or for any other interim period.

(b) Development stage enterprise

The Company’s principal activities to date have been the research and development of its products and the Company has not generated significant revenues from its planned, principal operations. Accordingly, the Company’s financial statements are presented as those of a development stage enterprise.

(c) Translation into U.S. dollars

The currency of the primary economic environment in which the operations of the Company are conducted is the U.S. dollar (“dollar”). Therefore, the dollar has been determined to be the Company’s functional currency.

Transactions in foreign currency (primarily in New Israeli Shekels or “NIS”) are recorded at the exchange rate as of the transaction date. All exchange gains and losses from remeasurement of monetary balance sheet items denominated in non-dollar currencies are reflected as finance expense in the statement of operations, as they arise.

At June 30, 2010, the exchange rate was U.S.$1 = NIS 3.875 (December 31, 2009—U.S.$1 = NIS 3.775). The average exchange rate for the three and six months ended June 30, 2010 was U.S.$1 = NIS 3.7835 and and US $1 = NIS 3.7589, respectively (three and six months ended June 30, 2009—U.S.$1 = NIS 4.077 and US$ = NIS 4.0678, respectively).

The translation should not be construed as a representation that the foreign currency amounts upon which the translation is based actually represent, or could be converted into, U.S. dollars.

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(d) Use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results may differ from such estimates. Significant items subject to such estimates and assumptions include the useful lives of property and equipment, deferred tax assets, valuation of warrants, valuation of common stock share-based compensation, income tax uncertainties and other contingencies. The current economic environment has increased the degree of uncertainty inherent in those estimates and assumptions.

(e) Accounting for share-based compensation

Share-based compensation is recognized as an expense in the financial statements and such cost is measured at the grant-date fair value of the equity-settled award. The expense is recognized using the straight-line method. The fair value of stock options granted to employees and directors is estimated at the date of grant using the Black-Scholes-Merton option-pricing model, which takes into consideration the share price at the date of grant, the exercise price of the option, the expected life of the option, risk-free interest rates and the expected volatility. The fair value of the March 17, 2010 stock options granted to employees and directors at an exercise price of $0.01 and $5.50 were valued using the Lattice model which takes into consideration the share price at the date of grant, the exercise price of the option, the expected life of the option, risk free interest rates and the expected volatility. The fair value of stock options granted to consultants is estimated at the date of grant using the Black-Scholes-Merton option-pricing model. In cases where no measurement date has been reached as there is no counter-party performance or performance commitment (sufficiently large disincentive for non-performance), the options are revalued. The options are valued using the share price, the exercise price of the option, the expected life of the option, risk-free interest rates and the expected volatility, at the reporting period date.

(f) Net loss per share data

Basic net loss per share is computed by dividing the net loss for the period by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted-average number of shares of common stock plus dilutive potential common stock considered outstanding during the period. However, as the Company generated net losses in all periods presented, potentially dilutive securities, comprised of incremental shares of common stock issuable upon the exchange of series A and series B convertible preferred stock and the exercise of warrants and stock options, are not reflected in diluted net loss per share because such shares are anti-dilutive.

(g) Reclassification

Certain prior year balances have been reclassified to conform to current year presentation.

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 3—Bridge Financing—Convertible Promissory Notes

On December 29, 2009, the Company issued 5% subordinated convertible promissory notes, (“Bridge Notes”), in the aggregate amount of $2.98 million in a private placement (the “Bridge Financing”). The Bridge Notes converted into shares of common stock and warrants upon the consummation of the IPO. The $2.98 million of 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 and the residual amount was allocated to the Bridge Notes, all in accordance with the guidance in ASC 815 (formerly Statement 133) and ASC 815-40 (formerly EITF Issue No. 07-5). While the Bridge Notes had been classified as a short-term liability, the derivative liability has been reclassified under long-term liabilities as it has a five-year exercise period.

Upon the consummation of the IPO the Bridge Notes converted into 864,332 units consisting of one share of common stock and two warrants (the “Conversion Warrants”). The Bridge Notes were converted at a price of $3.45, a 25% discount to the price of the units issued in the IPO. The beneficial conversion feature from this conversion resulted in additional interest expense of $1.1 million which was recorded in the statement of operations. Each Conversion Warrant entitles the holder to purchase one share of common stock at a price equal to 110% of the IPO offering price ($5.06) and expire five years after the IPO. The Conversion Warrants are similar to the warrants issued as part of the units issued in the IPO except that they include additional features with respect to fundamental transactions, cashless exercise, ownership limitations and dilution. As a result, the Conversion Warrants, in accordance with the guidance in ASC 815 (formerly Statement 133) and ASC 815-40 (formerly EITF Issue No. 07-5) have been recorded as a derivative liability and will be adjusted according to fair value at each reporting period (See Note 4). In addition, the Company issued a further 69,132 Special Bridge Warrants to the note holders in order to reflect the conversion at a 25% discount of the offering price.

The following table summarizes the movement during the quarter of the instruments allocated in the Bridge Financing:

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 4—Fair Value Measurements

The Company measures fair value in accordance with ASC 820-10, “Fair Value Measurements and Disclosures” (formerly SFAS 157, “Fair Value Measurements”). ASC 820-10 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, ASC 820-10 establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2—Include other inputs that are directly or indirectly observable in the marketplace.

Level 3—Unobservable inputs which are supported by little or no market activity.

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company measures its cash equivalents, Special Bridge Warrants and Conversion Warrants at fair value. Cash equivalents are classified within Level 1 because they are valued using quoted active market prices. The Special Bridge Warrants and Conversion Warrants are classified within Level 3 because they are valued using the Black-Scholes-Merton model which utilizes significant inputs that are unobservable in the market such as the price of stock, expected stock price volatility and the dividend yield, and the remaining period of time the warrants will be outstanding before they expire.

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009, aggregated by the level in the fair-value hierarchy within which those measurements fall:

In addition to the above, the Company’s financial instruments at June 30, 2010 and December 31, 2009, consisted of cash, accounts receivable, long term deposits, accrued expenses, accrued compensation, related liabilities, and the Venture Loan. The carrying amounts of all the aforementioned financial instruments, approximate fair value, except the Venture Loan (see below).

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The following table summarizes the changes in the Company’s liabilities measured at fair value using significant unobservable inputs (Level 3) during the three and six months ended June 30, 2010:

Carrying amounts and the related estimated fair value of the Venture Loan are as follows:

The fair value of the loan was assessed using an interest rate of 12% which represents market conditions for a similar loan.

Note 5—Venture Loan

On December 29, 2009, the Company entered into a loan modification agreement with the lenders of the Venture Loan. The new facility bears an interest rate of 9.5% per annum, with an effective interest rate of 18%. Following a five month moratorium on principal payments from February—June 2010 the Company will repay the loan monthly using a straight line calculation until March 2013. Future monthly payments of principal and interest amount to approximately $142,000. The Company began to repay the principal from July 1, 2010.

Note 6—Temporary Equity

Upon the consummation of the IPO the series B convertible preferred stock previously classified as temporary equity was granted a 33% stock dividend, subjected to the 1 to 6 reverse split and then exchanged for shares of common stock and recorded as such. The balance was recorded as additional paid-in capital.

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 7—Stockholders’ Equity

Stock Options

During the three and six months ended June 30, 2010, no stock options were awarded other than options to management (see below), 20,833 and 56,384 stock options were forfeited and 6,085 stock options were exercised.

As of June 30, 2010, there was approximately $5.1 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the incentive plans. That cost is expected to be recognized over a weighted-average period of 3.5 years.

On March 17, 2010, the Company’s Board of Directors (the “Board”) approved the granting of options to management, directors and consultants from an additional pool of options equal to 20% of the fully diluted equity of the Company subsequent to the IPO (“Management Options”). The Board approved the granting of 1,392,000 options at an exercise price of $0.01. These options will vest yearly over three and four year periods (according to the applicable schedule of the optionee), with the first portion vesting on the first anniversary of the consummation of the IPO. The Board also approved the granting of 1,420,000 options at an exercise price of $5.50 to its employees, directors and consultants. These options will vest quarterly over four years, with the first portion vesting on the first anniversary of the consummation of the IPO. A further 40,000 options (20,000 options with an exercise price of $0.01 and 20,000 options with an exercise price of $5.50) will be granted as a charitable donation. Expenses for these options have begun to be recorded upon the consummation of the IPO including $393 thousand of expenses during the three months ended June 30, 2010.

Upon the consummation of the IPO, the Company recognized a charitable donation of 20,000 options with an exercise price of $1.50 granted in 2006. The fair value of the donation was calculated using the Black-Scholes-Merton model with an expected life of 6.33 years, a risk-free interest rate of 2.7%, an expected volatility of 56.1% and no dividend yield.

As of June 30, 2010, there were 413,134 Management Options available for grant at an exercise price of $0.01 and a further 385,134 Management Options available for grant at an exercise price of $5.50.

The following table summarizes the option activity for the year 2010 by grant date.

The fair value of the options to employees and directors is calculated using the Lattice model with an expected life of 2.35-5.33 years, a risk-free interest rate of 2.83% and an expected volatility of 64.3% and no dividend yield. The fair value of the common stock used for this calculation was $2.62. The fair value of options to non-employees is calculated using the Black-Scholes-Merton model with an expected life of 5.75 years, a risk free interest rate of 2.14% and an expected volatility of 55% and no dividend yield.

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Vringo, Inc. and Subsidiary

(a Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 8—Commitments and Contingencies

Future minimum lease payments under non-cancelable operating leases for office space and cars, as of June 30, 2010, are as follows:

Rental expense for operating leases for both office space and cars for the six months ended June 30, 2010 and 2009 was $65 thousand, and $80 thousand, respectively. Rental expense for operating leases for both office space and cars for the three months ended June 30, 2010 and 2009 was $39 thousand, and $56 thousand, respectively.

Note 9—Risks and Uncertainties

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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 in this Quarterly Report on Form 10-Q 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 below and included in our Prospectus filed pursuant to Rule 424(b) under the Securities Act with the Securities and Exchange Commission on June 22, 2010. Furthermore, such forward-looking statements speak only as of the date of this Report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

General

We provide a comprehensive platform that allows users to create, download and share mobile entertainment content in the form of video ringtones for mobile phones. We believe that our 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, and provides our business partners with a consumer-friendly and easy-to-integrate monetization platform.

Our strategy to date has primarily focused on product maturation, research and development, distribution and marketing. We recently started focusing on commercializing our service primarily through agreements with mobile carriers and other partners. We have live commercial launches of our service with four mobile carriers operating in Turkey, Malaysia, Armenia and United Arab Emirates as well as a live commercial launch with RTL in Belgium, a major television network in that market. Our carrier partners have an aggregate of approximately 32 million subscribers, of which 66,000 subscribe to our service, as of June 30, 2010 and in addition 23,000 subscribers have enrolled on a free-trial basis. Following the termination of our agreement with Avea in Turkey, we signed a deal with Retromedya, a third party service provider there, whereby we will have access to offer our service to the customers of all carriers in Turkey. As of the fourth quarter of 2009, we began to recognize revenues from our carrier subscription service. We are negotiating with additional mobile carriers in a number of different countries and we expect to continue to scale our carrier business in 2010.

Our Business Model

Our business model entails revenue sharing from our mobile carriers using a subscription-based model where users pay a monthly fee for access to the service as well as additional fees for access to certain premium content. We believe that this is a highly scalable model that can be rolled out to many carriers across the world.

We have launched our service together with mobile carriers in Turkey, Malaysia, Armenia and United Arab Emirates. Our mobile carrier partners co-brand our service and help market it to their subscribers. The pricing for subscriptions and content in various countries will vary substantially based on local economic conditions. In general, we aim to sell the monthly subscription for $1 to $3 and we expect to generally receive at least 30% of the monthly subscription revenue. We expect that premium content will generally be sold for $1 to $2 per item although this price and the monthly subscription rate may vary substantially by country. Operators usually do not charge us or our users for any data charges associated with using our service or for using the operator’s text messaging infrastructure to communicate with our subscribers.

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Our model consists of growing our user base through carrier partnerships, continuing to ensure we have broad handset reach, enhancing our viral and social tools, maintaining and growing our product and technology leadership, building a strong revenue base of recurring monthly subscription revenue, finding new forms of distribution, exploring monetization through advertising, and revenue through content sales.

Overview

Our financial statements were prepared using principles applicable to a going concern, which contemplates 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. We had approximately $9.7 million of cash and cash equivalents at June 30, 2010. Our average monthly burn rate from operations for the six months ended June 30, 2010 and the year ended December 31, 2009, was $0.5 million, and $0.4 million, respectively. On April 1, 2009, we commenced repayment of a $5.0 million loan over a thirty-six month period (resulting in repayments amounting to approximately $0, $0.1 million and $0.8 million during the three and six months ended June 30, 2010 and the year ended December 31, 2009, respectively). This loan was modified to permit us to defer principal payments due during and subsequent to February 2010 until the consummation of our Initial Public Offering. Subsequent to the closing of the offering, we have recommenced principal payments and the loan will be repaid over 33 months until March 2013.

We are a development stage company. From inception, we have raised approximately $28.5 million. In May 2006, we raised $2.35 million through the issuance of 588 shares of Series A Convertible Preferred Stock. We issued 2,353,299 additional shares of Series A Convertible Preferred Stock as a stock dividend in August 2006, resulting in a total of 2,353,887 shares of Series A Convertible Preferred Stock outstanding. In February 2007, we completed a financing of $2.1 million of convertible notes, which was later exchanged and included as part of the Series B Financing. In July 2007, we raised a further $10.0 million through the issuance of 4,592,794 shares of Series B Convertible Preferred Stock and the issuance of 200,694 shares of common stock. In addition, in September 2008, we closed a $5.0 million loan from SVB/Gold Hill Capital. In December 2009, we completed a bridge round of financing of $3.0 million of convertible notes. These notes were converted into equity upon the closing of our offering. In our Initial Public Offering we raised $11.0 million through the sale of 2,392,000 units. Immediately prior to the closing of the IPO, the Series A Preferred Stock and the Series B Preferred Stock were granted a stock dividend of 15% and 33% respectively and exchanged (at a 1:1 ratio) for common stock following a 1 to 6 reverse split. These amounts have been used to finance our operations until now as we have not yet generated any significant revenues. From inception until June 30, 2010, we recorded losses of $26.7 million and a net cash outflow from operations of $20.3 million.

A substantial portion of our cash received and anticipated revenues are based in dollars and euros, while a significant portion of our expenses, principally salaries and related personnel expenses, are paid in Israeli currency by our subsidiary. As a result, we are exposed to an exchange rate risk if the value of the dollar or euro significantly depreciates vis-à-vis the value of the New Israeli Shekel.

Revenue

We recognize revenue from monthly subscription from carriers when all the conditions for revenue recognition are met: (i) persuasive evidence of an arrangement exists, (ii) collection of the fee is probable, (iii) the sales price is fixed and determinable and (iv) delivery has occurred or services have been rendered. Our subscription service arrangements are evidenced by a written document signed by both parties. Our revenues from monthly subscription fees and content purchases are recognized when we have received confirmation from the carrier that the amount is due to us, which provides proof that the services have been rendered, and making collection probable.

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 a “hosting solution” as defined in ASC 605-10-S99 (SAB Topic 13.A.3.f). As these fees are part of a hosting solution that we provide to the carrier in Armenia, and that the hosting is provided on our servers for the entire 24 month period of the arrangement with this carrier, the revenues relating to the monthly subscription, set-up fees and billing integration have been recognized over the 24-month period in the agreement. Since the non-refundable up-front fee was paid in full to us in October 2009, we have determined that the collection is certain, an arrangement exists and the sales price has been fixed. As we have received customer acceptance from the carrier that the services have been rendered, that requirement is also met.

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Revenues from minimum monthly revenue guarantees from carriers are recognized at the end of each billing period for the service provided as we have an agreement with the carrier, the fee has been agreed upon contractually and the collection of this fee is probable.

Costs and Expenses

Cost of revenue

Cost of revenue consists primarily of expenses directly related to providing our service in launched markets. These expenses include the costs associated with production servers serving the end-users, royalty fees for content sales and the direct costs of billing services and text messaging providers.

Research and development expenses

Research and development expenses consist primarily of salary expenses of our development and quality assurance engineers in our research and development facility in Israel, outsourcing of certain development activities, preparation of patent filings, and server and support functions for our development environment.

Marketing expenses

Marketing expenses include the salary of all business development and marketing personnel, 50% of the CEO’s salary, travel expenses relating to business development activity and tradeshows, as well as public relations, advertising and customer acquisition expenses. As we increase our sales, certain commissions to agents will also be included in sales and marketing expenses as well as purchases of content that will increase the attractiveness of our service to end-users. Royalties related to the sale of that content will be recorded in cost of revenue.

General and administrative expenses

General and administrative expenses include 50% of the CEO’s salary, the salary of our finance and administrative personnel, rental costs for both the U.S. and Israeli offices, legal and accounting costs and telephone and other office expenses including depreciation. We expect a our general and administrative expenses in the coming twelve months following the consummation of our initial public offering to increase significantly as we incur additional costs of being a public company. These costs will include increased legal and accounting costs, additional insurance costs, director compensation costs and increased compensation costs as a result of the recording of the Management Options. This is in addition to the specific increases in professional fees as a result of recording of the placement agent warrants.

Non-operating expenses (income)

Until September 2008, our non-operating expense (income) was primarily from yields from our cash and cash equivalents. Subsequent to September 2008, as our cash resources have been depleted, we have received lower yields resulting from lower interest rates and we have drawn on our $5.0 million loan from Silicon Valley Bank and Gold Hill, or the venture loan. Accordingly, our finance expense since that date has been primarily from the interest payments on the venture loan. From December 2009 and until the consummation of our offering on June 21, 2010, these costs also included $0.1 million of interest expense on the convertible bridge loan. Non-operating expense also includes transaction gains (losses) from foreign exchange rate differences. In addition, non-operating expenses include a loss of $0.2 million (as restated) recorded as a result of the extinguishment of debt related to the loan modification agreement signed on December 29, 2009 with Silicon Valley Bank and Gold Hill, $1.1 million recorded as interest expense from the Beneficial Conversion Feature as a result of the conversion of the Bridge loan into equity, $1.2 million recorded as additional amortization on the convertible bridge loan and $1.3 million recorded on account of the lead investor warrants. Non-operating expenses were offset by non-operating income of $0.5 million of income from changes in fair value of the Special Bridge Warrants and the Conversion Warrants. We expect that our non-operating expenses (income) will be directly impacted by changes in fair value of these warrants over the next 5 years.

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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, equipment and intangible assets and different methods and timing for certain expenses. Furthermore, permanent differences arise from certain income and expense items recorded for financial reporting purposes but not recognizable for income tax purposes. In addition, our income tax expense has been adjusted for the effect of foreign income from our wholly owned subsidiary. At June 30, 2010, our deferred tax assets generated from our activities were entirely offset by a valuation allowance because realization depends on generating future taxable income, which, in our estimation, is not more likely than not to be realized. The deferred tax assets generated from our subsidiary’s operations are not offset by an allowance, as in our estimation, it is more likely than not to be realized.

Our subsidiary generates net income from services it provides to us. The subsidiary charges us for research and development and certain management services which it provides us, plus a profit margin on such costs, which is currently 8%. However, the subsidiary is a “beneficiary enterprise” as defined in amendment No. 60 to the Israeli Law for the Encouragement of Capital Investment, 1959, which means that income arising from its approved research and development activities is subject to zero percent tax for a period of two years and a reduced tax rate for the subsequent five years. The subsidiary elected to receive the zero percent tax benefits for the fiscal years of 2007 and 2008. Beginning in 2009, the subsidiary is subject to taxes on its income. This tax liability has been recorded in our financial statements for the three and six months ended June 30, 2010 and for the year ended December 31, 2009.

Results of Operations

Three Months and Six Months Ended June 30, 2010 and 2009 and the development stage period (cumulative from inception through June 30, 2010)

The following analysis compares the results of our operations for the three and six months ended June 30, 2010 to the results of operations for the three and six months ended June 30, 2009 and the results of our operations from inception through June 30, 2010.

Revenue

During the three and six months ended June 30, 2010, we recorded revenues of $44,000 and $74,000, which represents an increase of $44,000 and $74,000 from our revenues for the three and six months ended June 30, 2009. The increase in revenue from the first quarter to the second quarter was due to an increase in revenues from our revenue-sharing agreement in Malaysia whereby we recognized $15,000 in the second quarter and $9,000 in the first quarter (a growth of 167% quarter on quarter). We also recognized $15,000 in minimum guarantees from our service in the United Arab Emirates (up from $10,000 in the first quarter). Our revenues from our service in Armenia remained at $9,000 per quarter and we also recognized approximately $3,000 from our revenue-sharing agreement in Turkey (up from approximately $2,000 in the first quarter). We expect to continue to generate a substantial portion of our revenues for the coming quarters from: (i) continuing to recognize the revenue from our agreement with Vivacell in Armenia, (ii) minimum monthly guarantees relating to our service in the United Arab Emirates and (iii) our revenue-sharing agreements in Turkey and Malaysia. In July 2010, signed an agreement to expand our coverage in Turkey as the result of our agreement with Retromedya which will replace our revenue-sharing agreement with Avea. We expect that as a result of our agreement with Retromedya we will be able o reach a larger mobile subscriber base in Turkey. From inception through June 30, 2010, we have recorded revenues of $94,000, which amount includes $36,000 from our services in Armenia, $25,000 from our services in the United Arab Emirates, $27,000 from our services in Malaysia and $6,000 from our services in Turkey. We did not record any revenues for the three and six months ended June 30, 2009, as we were mainly focused on our research and development activities during that period and we did not begin to record revenue until the third quarter of 2009.

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Cost of Revenue

During the three and six months ended June 30, 2010, our cost of revenue was $34,000 and $67,000, which represents an increase of $34,000 and $67,000 from our cost of revenue for the three and six months ended June 30, 2009. For the second quarter of 2010 our cost of revenue was stable in comparison to the first quarter of 2010. Cost of revenue is comprised of services related to the provision of content to end-users and hosted servers needed to support the service in markets where we have launched our services. As our service grows and we launch in other territories, we expect that cost of revenue will increase as we provide more content and other services to the users of our service. As some of these costs are fixed irrespective of our revenues, we expect our gross margin to increase over time. We believe that we currently have enough server capacity to service up to two million global users before we need to expand our server capacity. From inception through June 30, 2010, our total cost of revenue was $98,000. We did not record any cost of revenues for the three and six months ended June 30, 2009, as we were mainly focused on our research and development activities during that period and we did not begin to record revenue until the third quarter of 2009.

Research and Development