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XFCH > SEC Filings for XFCH > Form 10-Q on 15-Nov-2012All Recent SEC Filings

Show all filings for X-FACTOR COMMUNICATIONS HOLDINGS, INC.

Form 10-Q for X-FACTOR COMMUNICATIONS HOLDINGS, INC.


15-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our audited balance sheets as of December 31, 2011 and 2010 and the related statements of operations and members' deficit and cash flows for the years ended December 31, 2011 and 2010 and the notes attached thereto and the unaudited consolidated balance sheet as of September 30, 2012 and the related unaudited consolidated statements of operations and stockholders' and members' deficit and cash flows for the nine and three months ended September 30, 2012 and 2011 and the notes attached thereto. Such 2011 financial statements exclude the effects of the Merger and the related reorganization. This interim financial information reflects, in the opinion of management, all adjustments necessary (consisting only of normal recurring adjustments and changes in estimates, where appropriate) to present fairly the results for the interim periods. The results of operations and cash flows for such interim periods are not necessarily indicative of the results for the full year.

All statements contained herein that are not historical facts, including, but not limited to, statements regarding anticipated future capital requirements, our future development plans, our ability to obtain debt, equity or other financing, and our ability to generate cash from operations, are based on current expectations. The discussion of results, causes and trends should not be construed to imply any conclusion that such results or trends will necessarily continue in the future. The Company operates in one segment and therefore segment information is not presented.

The statements contained herein, other than historical information, are or may be deemed to be forward-looking statements and involve factors, risks and uncertainties that may cause our actual results in future periods to differ materially from such statements. These factors, risks and uncertainties are discussed below and include market acceptance and availability of digital media communication services, rapid technological change affecting demand for our services, competition from other digital media communication service providers, deteriorating economic conditions, the availability of sufficient financial resources to enable us to pay our existing obligations and expand our operations, adequacy of internal controls, being an early stage software development company, as well as other risks and uncertainties that may be detailed from time to time in our filings with the Securities and Exchange Commission.

Overview

X-Factor Communications Holdings, Inc. (formerly, Organic Spice Imports, Inc.) ("Holdings" or the "Company"), through its wholly-owned subsidiary X-Factor Communications, LLC ("X-Factor"), a New York limited liability company, located in South Hackensack, New Jersey, provides interactive digital media network software and services. The X-Factor Digital Media Network Platform, our cloud-based digital signage, web and mobile solution, is delivered as a software-as-a-service and under a software license model, enabling our customers to build simple yet scalable advertising and corporate digital media networks. The Company's webcasting solution, a live and on-demand multimedia distribution product delivers rich media content, desktop signage and emergency messaging to mobile and Web devices. The Company's solutions address the rapidly expanding digital media needs of its corporate, public venue, education and government sector customers. The Company sells its software and services throughout the United States. The Company has limited its staffing and marketing efforts, expenditures and expenses to date. Over the past two years the Company has benefited from limited direct sales efforts and sales referrals from Cisco Systems, Inc. ("Cisco") and some of the larger integrators/reseller sales channels in the marketplace. The Company believes it is now positioned to implement an aggressive marketing campaign to increase the sales volume through these sales channels. In addition, the Company has introduced stand-alone solutions to the marketplace that it plans to market along with its partner oriented product portfolio.


Liquidity and Capital Resources

At December 31, 2011 the Company had a members' deficit of $1,294,187, a working capital deficiency of $441,953 and incurred a net loss of $1,502,638 for the year then ended. In addition, there was a decrease in revenue of $929,797 in 2011 when compared to 2010 levels.

At September 30, 2012 the Company had a stockholders' deficit of $1,032,645, a working capital deficiency of $473,648 and incurred a net loss of $2,996,648 and $1,088,704 for the nine and three months then ended, respectively. In addition, there was a decrease in revenue of $129,313 and $96,013 for the nine and three months ended September 30, 2012, respectively, when compared to 2011 levels. There can be no assurance that: (1) existing stockholders will continue to support the operational and financial requirements of the Company, (2) that the Company will be able to raise sufficient equity (see Note 18) or (3) that the Company will continue to be able to comply with existing covenants with creditors in future periods (see Note 20). While the Company has been successful to date in raising funds through sales of securities, the Company does not currently have any sources of committed funding available. At present, these factors raise substantial doubt about the Company's ability to continue as a going concern. The report of our independent registered public accounting firm (as included in our Form 8-K filing dated May 21, 2012) included an explanatory paragraph indicating that there was substantial doubt concerning the Company's ability to operate as a going concern. X-Factor has historically incurred net losses and recurring negative cash flows from operations. Furthermore X-Factor has, in the past, defaulted on debt service payments and been in default of covenants in certain debt agreements and there are no assurances that investors will continue to support X-Factor or that X-Factor will be able to raise sufficient capital or debt financing to sustain operations. These conditions raise substantial doubt about X-Factor's ability to continue as a going concern. The consolidated financial statements do not include any adjustments to the carrying value of assets and liabilities that might result from the outcome of these uncertainties.

During the nine months ended September 30, 2012 and the year ended December 31, 2011, the Company received an aggregate $75,000 and $850,000, respectively; in cash proceeds from the sale of promissory notes (see Note 12). In 2012 the Company received additional net cash proceeds of $1,857,417 raised in connection with the Offering.

The Company believes that the $1,857,417 of net cash proceeds received from the sale of securities in connection with a private placement offering (the "Offering") and the conversion of $881,478 of promissory notes in 2012, along with management's expectation for greater financing opportunities as a result of Holdings' public reporting status (see Note 18), will provide sufficient equity to fund its operations for the next four to six months. There are no assurances, however, that the Company will be able to raise additional capital as may be needed, or increase revenue levels and profitability. Further, if the current economic climate negatively impacts the Company, as it may, and the Company is unable to raise additional capital on acceptable terms, it could have a material adverse effect on the Company's financial condition, future operations and cash flows.

Critical Accounting Policies

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are uncollateralized, non interest bearing, customer obligations due under normal trade terms and are stated at the amount billed to the customer. Payments of accounts receivable are allocated to the specific invoices identified on the customer's remittance advice or, if unspecified, are applied to the earliest unpaid invoices.

The carrying amount of the Company's accounts receivable may, at times, be reduced by a valuation allowance that reflects management's best estimate of the amounts that will not be collected. Management individually reviews all accounts receivable balances periodically and based on an assessment of the current creditworthiness, estimates the portion, if any, of the balance that will not be collected.


Equipment and Leasehold Improvements

Equipment and leasehold improvements are recorded at cost. Depreciation on equipment is recorded over the estimated useful lives of the assets (five years) using the straight-line method. Leasehold improvements are depreciated using the straight-line method over the shorter of the estimated useful life of the asset (seven years) or the expected term of the occupancy. Included in equipment are fixed assets subject to capital leases which are depreciated over the life of the respective asset. Maintenance and repair costs are charged to expense as incurred. Upon sale or retirement, the cost and related accumulated depreciation are eliminated from the respective accounts and any resulting gain or loss will be reported in results of operations.

Long-Lived Assets

The Company periodically evaluates the net realizable value of long-lived assets, principally equipment and leasehold improvements, relying on a number of factors including operating results, business plans, economic projections and anticipated future cash flows. Impairment in the carrying value of an asset is recognized whenever anticipated future undiscounted cash flows from an asset are estimated to be less than its carrying value. The amount of the impairment recognized is the difference between the carrying value of the asset and its fair value. There were no impairment losses recognized in the nine and three month periods ended September 30, 2012 and 2011.

Revenue Recognition

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is reasonably assured. The Company has certain arrangements where it is obligated to deliver multiple products and/or services (multiple elements). In these arrangements, the Company allocates the total revenue among the elements based on the sales price of each element when sold separately using vendor-specific objective evidence. Revenue from multi-year licensing arrangements is accounted for as subscriptions, with billings recorded as unearned revenue and recognized as revenue ratably over the billing coverage period. Unearned revenue also consists of future maintenance and upgrade services that will be provided by the Company in future periods under terms of a non-refundable service contract.

Derivative Financial Instruments

The Company's objectives in using debt-related derivative financial instruments are to obtain the lowest cash cost source of funds. Derivatives are recognized in the balance sheet at fair value based on the criteria specified in Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 815, "Derivatives and Hedging" ("ASC Topic 815"). Under ASC Topic 815, the estimated fair value of the derivative liabilities is revalued at each balance sheet date with the changes in value, if any, recorded in the interest and other expense section of the accompanying Statements of Operations and Members' Deficit.

Equity-Based Compensation

Equity-based awards for common stock have been appropriately accounted for as required by FASB ASC Topic 718, "Compensation - Stock Compensation" ("ASC Topic 718"). Under ASC Topic 718, equity-based awards are valued at fair value on the date of grant and that fair value is recognized over the requisite service period. The Company values its equity-based awards using the Black-Scholes option valuation model. The fair value of the common stock used in these valuation models is based on the most recent sale of a share of common stock of the Company.

The fair value of warrants for common stock issued to consultants or employees are recognized over the requisite service period with a corresponding decrease to members' deficit. Warrants issued to consultants are valued at the fair value of the common stock related to the warrants. Warrants for common stock issued to equity investors have no effect on stockholders' deficit; that is, the fair value of the warrants granted to investors and charged to stockholders' deficit are entirely offset by a corresponding adjustment to stockholders' deficit.


Income Taxes

Holdings operates as a "C" corporation. Prior to the Merger, the Members of X-Factor elected to be treated as a limited liability corporation, under the applicable provisions of the Internal Revenue Code and State of New Jersey tax laws. Holdings uses the asset and liability method to determine our income tax expense or benefit. Deferred tax assets and liabilities are computed based on temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates that are expected to be in effect when the differences are expected to be recovered or settled. Any resulting net deferred tax assets are evaluated for recoverability and an assessment of whether it is more likely than not that such amounts will be realized. Based on an assessment of all available evidence, a valuation allowance has been established against net deferred tax assets (principally net operating losses) at September 30, 2012. For the period from the effective date of the Merger through September 30, 2012 the Company did not record a benefit for income taxes.

Accounting Standards Update ("ASU") 2009-06, which is included as part of FASB ASC Topic 740 "Income Taxes," clarifies the accounting for uncertainty in income taxes recognized in an entity's consolidated financial statements and prescribes a recognition threshold of more-likely-than-not to be sustained upon examination. Measurement of the tax uncertainty occurs if the recognition threshold has been met. The standard also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition requirements. Prior to the Merger, X-Factor operated as a limited liability corporation and Federal and state taxes are passed through to the members, so too would the assessments from any tax examinations and, since the Merger, has generated an operating loss. There are no ongoing or pending examinations by Federal or state tax agencies. The Company has evaluated its tax positions for all currently open tax years, 2008 through 2011, and has concluded that there are no significant uncertain tax positions for either Federal or state purposes.

There were no interest or penalties related to income taxes that have been accrued or recognized as of September 30, 2012 and December 31, 2011 or for the nine and three months ended September 30, 2012 and 2011.

The Company conducts business domestically and, as a result, files Federal and state income tax returns. In the normal course of business, the Company is subject to examination by taxing authorities. The Company has no open tax years prior to the 2008 tax return.

Emerging Growth Company

We are an "emerging growth company" under the Jumpstart Our Business Startups Act (the "JOBS Act"). We have elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(1) of the JOBS Act. This election allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates.


Results of Operations

Nine months ended September 30, 2012 (the "2012 Period") compared to the nine months ended September 30, 2011 (the "2011 Period")

Revenues - Revenues decreased $129,313, or 20.8%, in the 2012 Period to $490,958 from $620,271 in the 2011 Period. The primary reason for the decrease in revenues in 2012 was that starting in 2010; Cisco drastically reduced its purchases of X-Factor's digital signage and advertising software and services. Purchases by Cisco generated $196,898 of revenue in the 2011 Period versus no revenue in the 2012 Period. In addition, the US Postal Service, due to budget constraints, ceased purchasing X-Factor's digital signage software and maintenance services for new locations which caused a $45,224 revenue reduction in the 2012 Period compared to the 2011 Period. This reduction was partially offset by successful efforts by the Company to increase its webcasting business. The following are the changes in the components of X-Factor's revenue:

                                                  Nine Months Ended           Favorable
                                                    September 30,           (Unfavorable)
                                                 2012          2011            Change
       Digital signage software and services   $ 194,351     $ 420,898     $      (226,547 )
       Webcasting                                296,607       199,373              97,234
       Total revenues                          $ 490,958     $ 620,271     $      (129,313 )

Cost of revenues - Cost of revenues increased $1,591, or 0.8% in the 2012 Period to $194,277 from $192,686 in the 2011 Period. Cost of revenues, as a percentage of revenues, were 39.6% in the 2012 Period and 31.1% in the 2011 Period. This increase in cost as a percentage of revenues is caused by the increase in the costs associated with the webcasting business.

Gross Profit - Gross profit decreased $130,904, or 30.6% in the 2012 Period to $296,681 from $427,585 in the 2011 Period. Gross profit, as a percentage of revenues, was 60.4% in the 2012 Period and 68.9% in the 2011 Period. This change was related to the reduction in revenues for digital signage software and services which have a higher gross profit compared to webcasting revenues.

Salaries and fringe benefits expenses - Compensation costs increased $175,040, or 49.1% in the 2012 Period to $531,263 from $356,223 in the 2011 Period. Compensation costs, as a percentage of revenues, were 108.2% in the 2012 Period and 57.4% in the 2011 Period. The primary reason for the increase in costs during the 2012 Period was X-Factor's granting of options which caused equity-based compensation to increase by $135,656 from the 2011 Period.

General and administrative expenses - General and administrative expenses increased $486,925, or 55.5% in the 2012 Period to $1,364,540 from $877,615 in the 2011 Period. General and administrative expenses, as a percentage of revenues, were 277.9% in the 2012 Period and 141.5% in the 2011 Period. The following are the significant changes in the components of the Company's general and administrative expenses:

                                                         Nine Months Ended            Favorable
                                                           September 30,            (Unfavorable)
                                                        2012           2011            Change
Professional fees and consultants                    $   842,820     $ 155,019     $      (687,801 )
Professional fees and consultants - equity based         209,325       501,247             291,922
Travel                                                    86,635        65,450             (21,185 )
Bad debts                                                    300        25,000              24,700
Communication expenses                                    37,781        41,750               3,969
Insurance                                                 29,787         4,781             (25,006 )
SEC printing and filing fees                              28,437             -             (28,437 )
Settlement of customer dispute                                 -        26,000              26,000
Computer and office supplies                              63,326        28,079             (35,247 )
Advertising and marketing                                 31,584         3,261             (28,323 )
Miscellaneous expenses                                    34,545        27,028              (7,517 )
Total general and administrative                     $ 1,364,540     $ 877,615     $      (486,925 )


Depreciation and amortization - Depreciation and amortization expenses decreased $11,080, or 21.7%, in the 2012 Period to $39,936 from $51,016 in the 2011 Period. The decrease was due to some assets being fully depreciated and a lower level of equipment and leasehold improvement additions in all periods.

Loss from operations - Loss from operations increased by $781,789, or 91.2% in the 2012 Period to $1,639,058 from $857,269 in the 2011 Period.

Other expense - Other expense increased by $1,142,883 in the 2012 Period to $1,357,590 from $214,707 in the 2011 Period. Due to amendments to, and the conversion of, various Notes Payable to Related Parties in the 2012 Period, the related unamortized discounts and financing costs were expensed and shown as a Loss on Extinguishment or Modification of Debt. Professional fees related to the Merger were expensed as incurred. Due to increases in the market price of the Company's common stock there was an increase in the fair value of derivative financial instruments. The following are the changes in the components of the Company's other expenses:

                                                         Nine Months Ended            Favorable
                                                           September 30,            (Unfavorable)
                                                        2012           2011            Change
Loss on Extinguishment or Modification of Debt       $   515,135     $       -     $      (515,135 )
Professional fees related to Merger                      202,867        22,477            (180,390 )
Change in fair value of derivative financial
instruments for Related Parties                          401,461             -            (401,461 )
Interest                                                  81,464        62,155             (19,309 )
Accretion of discount on notes                           138,590       117,476             (21,114 )
Amortization of prepaid financing costs                   11,869         8,748              (3,121 )
Other expenses                                             6,204         3,851              (2,353 )
Total other expenses                                 $ 1,357,590     $ 214,707     $    (1,142,883 )

Income taxes - As a result of X-Factor being a limited liability company all profits and losses of X-Factor prior to the Merger flowed through to the individual members of X-Factor. Accordingly, X-Factor did not record a tax provision, incur any liability for incomes taxes nor record a benefit for income taxes or any deferred tax assets or liabilities for Federal or state tax purposes.

Holdings operates as a "C" corporation. Net deferred tax assets are evaluated for recoverability and an assessment of whether it is more likely than not that such amounts will be realized. Based on an assessment of all available evidence, a valuation allowance has been established against net deferred tax assets (principally net operating losses) at September 30, 2012 and for the period from the date of the Merger through September 30, 2012 the Company did not record a benefit for income taxes.

Net loss - The decrease in gross profit, increase in operating expenses and increase in other expenses are caused primarily by non-recurring expenses related to the Offering, extinguishment and modification of debt and the change in fair value of derivative financial instruments, resulting in the net loss increasing by $1,924,672, in the 2012 Period to $2,996,648 from $1,071,976 in the 2011 Period.

Three months ended September 30, 2012 (the "2012 Quarter") compared to the three months ended September 30, 2011 (the "2011 Quarter")

Revenues - Revenues decreased $96,013, or 36.8%, in the 2012 Quarter to $165,165 from $261,178 in the 2011 Quarter. The primary reason for the decrease in revenues in 2012 was in 2011 Cisco drastically reduced its purchases of X-Factor's digital signage and advertising software and services. Purchases by Cisco generated $121,170 of revenue in the 2011 Quarter versus no revenue in the 2012 Quarter. In addition, the US Postal Service, due to budget constraints, ceased purchasing X-Factor's digital signage software and maintenance services for new locations which caused a $29,744 revenue reduction in the 2012 Quarter compared to the 2011 Quarter. This reduction was partially offset by successful efforts by the Company to increase their webcasting business. The following are the changes in the components of X-Factor's revenue:


                                                 Three Months Ended           Favorable
                                                    September 30,           (Unfavorable)
                                                 2012          2011            Change
       Digital signage software and services   $ 122,667     $ 231,153     $      (108,486 )
       Webcasting                                 42,498        30,025              12,473
       Total revenues                          $ 165,165     $ 261,178     $       (96,013 )

Cost of revenues - Cost of revenues increased $21,557, or 54.5% in the 2012 Quarter to $61,119 from $39,562 in the 2011 Quarter. Cost of revenues, as a percentage of revenues, were 37.0% in the 2012 Quarter and 15.1% in the 2011 Quarter.

Gross Profit - Gross profit decreased $117,570, or 53.1% in the 2012 Quarter to $104,046 from $221,616 in the 2011 Quarter. Gross profit, as a percentage of revenues, was 63.0% in the 2012 Quarter and 84.9% in the 2011 Quarter.

Salaries and fringe benefits expenses - Compensation costs increased $241,284, or 349.2% in the 2012 Quarter to $310,388 from $69,104 in the 2011 Quarter. Compensation costs, as a percentage of revenues, were 187.9% in the 2012 Quarter and 26.5% in the 2011 Quarter. The primary reason for the increase in costs during the 2012 Quarter was X-Factor's granting of options which caused equity-based compensation to increase by $201,141 from the 2011 Period.

General and administrative expenses - General and administrative expenses increased $235,012, or 80.8% in the 2012 Quarter to $525,857 from $290,845 in the 2011 Quarter. General and administrative expenses, as a percentage of revenues, were 318.4% in the 2012 Quarter and 111.4% in the 2011 Quarter. The following are the significant changes in the components of the Company's general and administrative expenses:

                                                       Three Months Ended           Favorable
                                                          September 30,           (Unfavorable)
                                                       2012          2011            Change
. . .
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