10-Q 1 xfone10q.htm xfone10q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
       For the quarterly period ended June 30, 2010
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ____________ to ____________
 
Commission file number:  001-32521
 
XFONE, INC.
(Exact name of registrant as specified in its charter)
 
Nevada
 
11-3618510
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
5307 W. Loop 289
Lubbock, Texas 79414
 (Address of principal executive offices)
 
806-771-5212
 (Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).        Yes o  No o
 
Indicate by check mark whether the registrant is a large accelerated 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.
 
Large accelerated filer      o Accelerated filer  o
Non-accelerated filer         o   Smaller reporting company x
                                                                            
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o  No x
 
As of August 13, 2010, 21,119,488 shares of the Company’s common stock, $0.001 par value, were issued and outstanding.
 
-1-

 
 
XFONE, INC. AND SUBSIDIARIES
 
 
Index
 

 
 
-2-

 
 
PART I:
 
FINANCIAL INFORMATION
 
Item 1:
Condensed Consolidated Financial Statements and Notes (Unaudited) - Period Ended June 30, 2010
 
Xfone, Inc. and Subsidiaries
 
 
 
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
June 30, 2010
 

 
-3-

 
 
 
 
 
-4-

 
 

Xfone, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
   
   
June 30,
   
December 31,
 
   
2010
   
2009
 
   
Unaudited
       
             
 CURRENT ASSETS:
           
Cash
 
$
3,760,271
   
$
 2,467,028
 
Accounts receivable, net
   
2,677,315
     
2,855,136
 
Prepaid expenses and other receivables
   
2,379,533
     
2,423,402
 
Deferred taxes
   
456,315
     
569,152
 
Inventory
   
196,585
     
199,392
 
Current assets of discontinued operations in the United Kingdom
   
2,982,342
     
2,932,345
 
Current assets of discontinued operations in Israel
   
2,253,745
     
2,164,287
 
Total current assets
   
14,706,106
     
13,610,742
 
                 
BONDS ISSUANCE COSTS , NET
   
1,577,607
     
1,725,705
 
                 
OTHER LONG TERM ASSETS
   
1,302,209
     
929,417
 
                 
FIXED ASSETS, NET
   
54,568,985
     
51,546,695
 
                 
OTHER ASSETS, NET
   
1,550,593
     
1,932,771
 
                 
ASSETS OF DISCONTINUED OPERATIONS IN THE UNITED KINGDOM
   
5,772,480
     
6,719,663
 
                 
ASSETS OF DISCONTINUED OPERATIONS IN ISRAEL
   
1,780,715
     
2,010,289
 
                 
Total assets
 
$
81,258,695
   
$
78,475,282
 
                 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 
 
 
-5-

 

Xfone, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
June 30,
December 31,
 
 
2010
   
2009
 
 
Unaudited
       
CURRENT LIABILITIES:
           
Short-term bank credit and current maturities of notes payable
 
$
4,114,313
   
$
7,029,842
 
Trade payables
   
6,216,342
     
7,120,474
 
Other liabilities and accrued expenses
   
3,618,295
     
3,922,741
 
Current maturities of obligations under capital leases
   
230,868
     
253,634
 
Current maturities of bonds
   
3,546,808
     
3,637,146
 
Current liabilities of discontinued operations in the United Kingdom
   
4,162,608
     
4,131,849
 
Current liabilities of discontinued operations in Israel
   
2,268,370
     
2,906,259
 
                 
Total current liabilities
   
24,157,604
     
29,001,945
 
                 
DEFERRED TAXES, NET
   
3,259,389
     
3,733,929
 
                 
NOTES PAYABLE FROM THE UNITED STATES DEPARTMENT OF AGRICULTURE, NET OF CURRENT MATURITIES
   
6,785,799
     
5,311,032
 
                 
NOTES PAYABLE, NET OF CURRENT MATURITIES
   
2,805,900
     
43,012
 
                 
BONDS PAYABLES , NET OF CURRENT MATURITIES
   
17,169,245
     
17,510,812
 
                 
OBLIGATIONS UNDER CAPITAL LEASES , NET OF CURRENT MATURITIES
   
179,824
     
256,790
 
                 
OTHER LONG TERM LIABILITIES
   
716,646
     
293,953
 
                 
SEVERANCE PAY
   
57,753
     
50,268
 
                 
LIABILITIES OF DISCONTINUED OPERATIONS IN THE UNITED KINGDOM
   
160,404
     
172,809
 
                 
LIABILITIES OF DISCONTINUED OPERATIONS IN ISRAEL
   
500,138
     
418,039
 
                 
Total liabilities
   
55,792,702
     
56,792,589
 
                 
COMMITMENTS AND CONTINGENT LIABILITIES
               
                 

SHAREHOLDERS' EQUITY:
               
Common stock of $0.001 par value: 75,000,000 shares authorized; 21,119,488 and 18,376,075  issued and outstanding at June 30,2010 and December 31, 2009
   
21,119
     
18,376 
 
Additional paid-in capital
   
47,835,370
     
43,362,217
 
Foreign currency translation adjustment
   
(2,991,690
)
   
(2,860,983
)
Retained earnings
   
(19,797,950)
)
   
(19,072,582
                 
Total shareholders' equity
   
25,066,849
     
21,447,028
 
                 
Non – Controlling interest
   
399,144
     
235,665
 
                 
Total equity
   
25,465,993
     
21,682,693
 
                 
Total liabilities and shareholders' equity
 
$
81,258,695
   
$
78,475,282
 
The accompanying notes are an integral part of these condensed consolidated financial statements
 
 
-6-

 


Xfone, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATION
(Unaudited)
 
   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Revenues
 
$
14,429,559
   
$
15,455,409
   
$
28,986,997
   
$
31,105,422
 
Cost of revenues
   
7,592,359
     
8,408,974
     
15,296,524
     
17,064,790
 
Gross profit
   
6,837,200
     
7,046,435
     
13,690,473
     
14,040,632
 
                                 
Operating expenses:
                               
Marketing and selling
   
1,072,906
     
1,134,071
     
2,180,798
     
2,324,805
 
General and administrative
   
5,251,349
     
5,057,631
     
10,683,349
     
10,486,731
 
Total operating expenses
   
6,324,255
     
6,191,702
     
12,864,147
     
12,811,536
 
                                 
Operating profit
   
512,945
     
854,733
     
826,326
     
1,229,096
 
                                 
Financing expense, net
   
(162,390
)
   
(2,543,326
)
   
(1,257,116
)
   
(997,294
)
Other expenses 
   
(148,091
)
   
(94,653
)
   
(293,336)
     
(188,781
)
                                 
Income (loss) from continued operations before taxes and non-controlling interest
   
202,464
     
(1,783,246
   
(724,126
)
   
43,021
 
                                 
Income tax benefit (expense)
   
(69,613
)
   
289,676
     
252,616
     
319,959
 
                                 
Net Income (loss) from continued operations
   
132,851
     
(1,493,570
)
   
(471,510)
     
362,980
 
                                 
Income (loss) from discontinued operations in the United Kingdom and Israel, before taxes
   
354,539
     
(360,841
)
   
94,876
     
147,209
 
                                 
Income tax expense on discontinued operations in the United Kingdom and Israel
   
(92,161)
     
(147,482
)
   
(185,255
)
   
(174,167
)
                                 
Net income (loss)
   
395,229
     
(2,001,893
)
   
(561,889
)
   
336,022
 
                                 
Less: Net income (loss) attributed to non-controlling interest (related to discontinued operations)
   
(66,339
)
   
138,716
     
(163,479
)
   
119,162
 
                                 
Net income (loss) attributed to shareholders
 
$
328,890
   
$
(1,863,177
)
 
$
(725,368
)
 
$
455,184
 
                                 
Basic income (loss) per share:
                               
Income (loss) from continued operations
 
$
0.006
   
$
(0.081
)
 
$
(0.024
)
 
$
0.020
 
Income (loss) from discontinued operations
   
0.010
     
(0.020
)
   
(0.012
)
   
0.005
 
Basic and diluted
 
 $
0.016
   
 $
(0.101
)
 
$
(0.036
)
 
 $
0.025
 
                                 
                                 
Diluted income (loss) per share:
                               
Income (loss) from continued operations
 
$
0.006
   
$
(0.081
)
 
$
(0.024
)
 
$
0.020
 
Income (loss) from discontinued operations
   
0.009
     
(0.020
)
   
(0.012
)
   
0.005
 
Basic and diluted
 
$
0.015
   
$
(0.101
)
 
$
(0.036
)
 
$
0.025
 
                                 
Basic weighted average number of shares outstanding:
   
21,119,488
     
18,376,075
     
19,877,000
     
18,376,075
 
                                 
Diluted weighted average number of shares outstanding:
   
21,387,872
     
18,376,075
     
19,877,000
     
18,376,075
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
 
 
-7-

 
 

Xfone, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
             
   
Six Months Ended
 
   
June 30 ,
 
   
2010
   
2009
 
Cash flow from operating activities:
           
Net income (loss)
 
$
(561,889
)
 
$
336,022
 
Adjustments required to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
2,257,300
     
1,922,084
 
Compensation  in connection with the issuance of warrants and options
   
451,383
     
304,034
 
Impairment of goodwill of discontinued operations
   
800,000
     
-
 
Accrued interest and exchange rate changes on outstanding Bonds
   
(417,102
   
(185,036
Decrease (increase) in account receivables
   
338,524
     
1,910,081
 
Bad debt provision
   
98,916
     
(14,963
Decrease (increase) in inventories
   
2,807
     
5,103
 
Decrease (increase) in long term receivables
   
(367,757
)
   
73,663
 
Decrease (increase) in bonds issuance expenses, net
   
148,098
     
10,736
 
Decrease (increase) in prepaid expenses and other receivables
   
(675,940
)
   
744,498
 
Increase (decrease) in trade payables
   
(711,647
)
   
(975,943
Increase (decrease) in other liabilities and accrued expenses
   
(56,793
)
   
(1,683,590
)
Increase (decrease) in severance pay
   
16,015
     
71,486
 
Increase (decrease) in other long term liabilities
   
429,419
     
(108,842
Deferred tax provision
   
(410,813
)
   
(255,419
)
                 
Net cash provided by operating activities
   
1,340,521
     
2,153,914
 
                 
Cash flow from investing activities:
               
Purchase of equipment
   
(2,143,948
)
   
(2,660,221
)
Purchase of equipment for the project under the United States Department of Agriculture
   
(2,457,290
)
   
(1,530,252
)
                 
 Net cash used in investing activities
   
(4,601,238
)
   
(4,190,473
)
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 
 
 
-8-

 

Xfone, Inc. and Subsidiaries
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
 
(Unaudited)
 
Six Months Ended
 
 
June 30 ,
 
 
2010
 
2009
 
         
Cash flow from financing activities:
           
Repayment of long term loans from banks and others
 
 $
(380,121
)
 
 $
(2,112,874
)
Repayment of capital lease obligation
   
(149,789
)
   
(225,146
Repayment of long term loans from United States Department of Agriculture
   
(196,688
)
   
-
 
Proceeds from exercise of options
   
75,753
     
-
 
Proceeds from long term loans
   
2,837,298
     
-
 
Increase (decrease) in short-term bank credit, net
   
(3,723,220
   
719,695
 
Proceeds from long term loans from banks
   
406,835
     
1,396,698
 
Proceeds from long term loans from the United States Department of Agriculture
   
1,766,564
     
2,662,585
 
Proceeds from issuance of shares and detachable warrants, net of issuance expenses
   
3,948,760
     
-
 
Net cash provided by (used in) financing activities
   
4,585,392
     
2,440,958
 
                 
Effect of exchange rate changes on cash and cash equivalents
   
7,373
     
12,653
 
                 
Net increase (decrease) in cash and cash equivalents
   
1,332,048
     
417,052
 
                 
Cash and cash equivalents at the beginning of the period
   
2,819,393
     
3,078,474
 
                 
Cash and cash equivalents at the end of the period (*)
 
$
4,151,441
   
$
3,495,526
 
                 
Supplemental disclosure of cash flows activities:
       
           
Cash paid for:
         
           
Interest
  $ 1,284,270     $ 1,239,337  
                 
Taxes
  $ 402,125     $ 200,005  
                 

(*) Cash and cash equivalents as of June 30, 2010 includes $391,170 of cash related to discontinued operations.

The accompanying notes are an integral part of these consolidated financial statements
 
 
 
-9-

 
 
Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)
 
Note 1 - Organization and Nature of Business

 
A.
Xfone, Inc. ("Xfone" or "the Company") was incorporated in Nevada, U.S.A. in September 2000. The Company is a holding and managing company providing voice, video and data telecommunications services, including: local, long distance and international telephony services; video; prepaid and postpaid calling cards; cellular services; Internet services; messaging services (Email/Fax Broadcast, Email2Fax and Cyber-Number); and reselling opportunities, with operations in the United States, United Kingdom and Israel. Xfone serves customers worldwide.

Xfone's holdings in subsidiaries as of June 30, 2010 were as follows:
 
 
NTS Communications, Inc. ("NTS") and its seven wholly owned subsidiaries, NTS Construction Company, Garey M. Wallace Company, Inc., Midcom of Arizona, Inc., Communications Brokers Inc., NTS Telephone Company, LLC, NTS Management Company, LLC and PRIDE Network, Inc. - wholly owned U.S. subsidiary.

 
Xfone USA, Inc. and its two wholly owned subsidiaries, eXpeTel Communications, Inc. and Gulf Coast Utilities, Inc. (collectively, "Xfone USA") - wholly owned U.S. subsidiary.

 
Swiftnet Limited ("Swiftnet") - wholly owned U.K. subsidiary.
 
 
Equitalk.co.uk Limited ("Equitalk") - wholly owned U.K. subsidiary.
 
 
Auracall Limited ("Auracall") - wholly owned U.K. subsidiary of Swiftnet.
  
 
Story Telecom, Inc. and its wholly owned U.K. subsidiary, Story Telecom Limited (collectively, "Story Telecom") - wholly owned U.S. subsidiary.
  
 
Xfone 018 Ltd. ("Xfone 018") - majority owned Israeli subsidiary in which Xfone holds a 69% ownership share.

On July 29, 2010 the Company completed its disposition of Swiftnet, Auracall, Equitalk and Story Telecom pursuant to a certain Agreement, dated January 29, 2010. See also note 3.
 
Note 2 - Significant Accounting Policies

The interim condensed financial statements are prepared in accordance with generally accepted accounting principles in the United States. The significant accounting policies followed in the preparation of the financial statements, applied on a consistent basis, are as follows:
 
 
A.
Principles of Consolidation and Basis of Financial Statement Presentation

The consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the US ("US GAAP") and include the accounts of the Company and its subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation. Minority interest in the loss of a subsidiary will be recorded according to the respective equity interest of the minority and up to its exposure and/or legal obligation to cover the subsidiary losses in the event that equity is reduced to zero or below.
 
 
B.
Foreign Currency Translation

For operations in local currency environments, assets and liabilities are translated at year-end exchange rates with cumulative translation adjustments included as a component of shareholders’ equity and income and expense items are translated at average foreign exchange rates prevailing during the year.  Foreign currency transactions gains and losses are included in the results of operations.
 
 
 
-10-

 
 
Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)

Note 2 - Significant Accounting Policies (Cont.)

 
C.
Accounts Receivable

Accounts receivable are recorded at net realizable value consisting of the carrying amount less the allowance for uncollectible accounts.

The Company uses the allowance method to account for uncollectible accounts receivable balances. Under the allowance method, estimate of uncollectible customer balances is made using factors such as the credit quality of the customer and the economic conditions in the market. An allowance for doubtful accounts is determined with respect to those amounts that the Company has determined to be doubtful of collection. When an account balance is past due and attempts have been made to collect the receivable through legal or other means the amount is considered uncollectible and is written off against the allowance balance.

Accounts receivable are presented net of an allowance for doubtful accounts of $316,366 and $288,912 at June 30, 2010 and December 31, 2009, respectively.

 
D.
Other Intangible Assets

Other intangible assets consist of a license to provide communication services in the United States.

Customer relations related to mergers and acquisitions are amortized over a period between 2-13 years from the date of the purchase.


 
E.
Earnings Per Share

Basic earnings per share ("EPS") is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. For the six months ended June 30, 2010, there were no dilutive shares as all options and warrants were out-of-the-money.  For the six months ended June 30, 2010, there were no dilutive shares as the inclusion of in-the-money option and warrants would have been anti-dilutive.
 
 
F.
Stock-Based Compensation
 
The Company accounts for stock-based compensation in accordance with “FASB ASC 718-10.”  Stock-based compensation expense recognized during the period is based on the value of the portion of share-based awards that are ultimately expected to vest during the period. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. The fair value of restricted stock is determined based on the number of shares granted and the closing price of the Company’s common stock on the date of grant. Compensation expense for all share-based payment awards is recognized using the straight-line amortization method over the vesting period.
 
 
 
-11-

 
 
Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)

 Note 2 - Significant Accounting Policies (Cont.)


 
G.
Reclassification

As reported in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2009, subsequent to the year ended December 31, 2009, the Company’s board of directors made a strategic decision to concentrate on the Company's operations in the U.S.  As a result of this decision, the Company decided to discontinue its operations in the U.K. and Israel. The assets, liabilities and results of operations of the U.K. and Israel operations have been classified as discontinued operations for all periods presented (see Note 3). Certain amounts in the 2009 financial statements have been reclassified to conform to the current year presentation. Such reclassifications did not impact the Company's gross profit or net income.
 
 
H.
Basis of Presentation
 
The interim condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information, including note disclosures, normally included in financial statements which are prepared in accordance with US GAAP has been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures included are adequate to make the information presented not misleading.

In management’s opinion, the condensed consolidated balance sheet as of June 30, 2010 (unaudited) and December 31, 2009 (audited), the unaudited condensed consolidated statements of operations for the six months ended June 30, 2010 and 2009, and the unaudited condensed consolidated statements of cash flows for the six months ended June 30, 2010 and 2009, contained herein, reflect all adjustments, consisting solely of normal recurring items, which are necessary for the fair presentation of the Company's financial position, results of operations and cash flows on a basis consistent with that of the Company's prior audited consolidated financial statements. However, the results of operations for the interim periods may not be indicative of results to be expected for the full fiscal year. Therefore these financial statements should be read in conjunction with the audited financial statements and notes thereto and summary of significant accounting policies included in the Company’s Form 10-K for the year ended December 31, 2009.
 
The Company has evaluated subsequent events occurring through the date on which this Quarterly Report on Form 10-Q was filed. 

 
I.
Income Taxes
 
The Company accounts for income taxes under FASB ASC 740-10 (Prior Authoritative Literature: Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes). Deferred tax assets and liabilities are based on the difference between the financial statement and tax basis of assets and liabilities as measured by the enacted tax rates which are anticipated to be in effect when these differences reverse. The deferred tax provision is the result of the net change in the deferred tax assets and liabilities. A valuation allowance is established when it is necessary to reduce deferred tax assets to amounts expected to be realized.

 
 
-12-

 

Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)

Note 2 - Significant Accounting Policies (Cont.)
 
 
J.
Derivative Instruments

Effective January 1, 2009, the Company adopted SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities— an amendment of FASB Statement No. 133, as codified in ASC 815. ASC 815 requires entities to provide qualitative disclosures about the objectives and strategies for using derivatives, quantitative data about the fair value of any gains and losses on derivative contracts, and details of credit risk related contingent features in their hedged positions. ASC 815 also requires entities to disclose more information about the location and amounts of derivative instruments in financial statements; how derivatives and related hedges are accounted for; and how the hedges affect the entity's financial position, financial performance, and cash flows. The adoption of this new guidance on January 1, 2009 has been incorporated into the notes to the Company's consolidated financial statements. As of June 30, 2010, the Company does not have open positions.
 
The amount recorded in financing expenses in the Condensed Consolidated Statements of Operations for the six months ended June 30, 2009 that resulted from the above referenced hedging transactions was $5,374.

 
K.
Recent Accounting Pronouncements
 
 
Fair Value Measurements and Disclosures. In January 2010, the FASB issued “Fair Value Measurements and Disclosures—Improving Disclosures about Fair Value Measurements” (Accounting Standards Update (ASU) 2010-06), which requires new disclosures and explanations for transfers of financial assets and liabilities between certain levels in the fair value hierarchy. ASU 2010-06 also clarifies that fair value measurement disclosures are required for each class of financial asset and liability, which may be a subset of a caption in the consolidated balance sheets, and those disclosures should include a discussion of inputs and valuation techniques. For financial assets and liabilities subject to lowest-measurements, ASU 2010-06, further requires that the Company separately present purchases, sales, issuances, and settlements instead of netting these changes. With respect to matters other than lowest-level measurements, the Company adopted ASU 2010-06 beginning with the quarter ended March 31, 2010 with the remaining disclosure requirements becoming effective for fiscal years and interim periods beginning on or after December 15, 2010 (i.e., the quarter ending March 31, 2011, for the Company). Adoption of this standard did not have any material impact on the Company's financial statements.
 

 
 
-13-

 
 

Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)

Note 3 – Discontinued operations

A.
Operations in the U.K.
 

On January 29, 2010, the Company entered into an agreement (the “Agreement”) with Abraham Keinan, a significant shareholder and Chairman of the Board of the Company (“Keinan”), and AMIT K LTD, a company registered in England & Wales which is wholly owned and controlled by Keinan (“Buyer”), for the sale  (the “Transaction”) of Swiftnet, Auracall, Equitalk and Story Telecom (the “UK Subsidiaries”). Pursuant to the Agreement, the consideration paid by Buyer and/or Keinan to Xfone would be comprised of the following components:

 1.
A release of the Company from the repayment of the loan from Iddo Keinan, the son of Mr. Keinan and an employee of Swiftnet dated December 10, 2009, pursuant to which Iddo Keinan extended to Swiftnet a loan of £860,044 ($1,292,353);.
 2.
A release of the Company from its obligation to Bank Leumi (UK) Plc. for of £150,000 ($228,375), thereby releasing the Company from its obligation to Bank Leumi (UK) Plc.; and
 3.
An annual earn-out payment over the following years beginning on the consummation of the Transaction. The aggregate Earn-Out Payments shall be equal to but shall not exceed $1,858,325 in the aggregate. 
 4.
Release of intercompany balances between Xfone and the UK Subsidiaries amounting $1,718,659 as of June 30, 2010

On July 29, 2010 the Company completed its disposition of the UK Subsidiaries.

As a result of the Agreement to sell the UK Subsidiaries, the assets and liabilities related to UK Subsidiaries have been classified as “held for sale” in the Company’s financial statements in accordance with ASC 360, (formerly SFAS No. 144), Accounting for the Impairment or Disposal of Long-Lived Assets. ASC 360 requires an asset group that is held for sale to be recorded at the lower of its carrying amount or fair value less costs to sell. As a result of classifying the Company's UK subsidiaries as discontinued operations the Company recorded a goodwill impairment of $800,000.

The assets and liabilities of the discontinued operations in the U.K. are as follows:

   
June 30,
 
   
2010
 
       
Cash
 
$
214,881
 
Other current assets
   
2,767,461
 
Fixed assets, net
   
852,958
 
Goodwill
   
4,788,096
 
Other assets
   
131,426
 
Note payable
   
(1,292,353
Other current liabilities
   
(2,870,255
Other long-term liability
   
(160,404
)
         
Net assets
 
$
4,431,810
 
         
 
 
-14-

 

Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)

Note 3 – Discontinued operations (Cont.)

The results of discontinued operations in the U.K. are as follows:

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Revenues
 
$
2,556,886
   
$
4,049,266
   
$
5,864,395
   
$
7,699,806
 
Cost of revenues
   
729,777
     
1,786,164
     
2,084,363
     
3,652,462
 
                                 
Gross profit
   
1,827,109
     
2,263,102
     
3,780,032
     
4,047,344
 
                                 
Operating expenses:
                               
Marketing and selling
   
1,088,986
     
1,198,678
     
2,226,053
     
2,315,155
 
General and administrative
   
696,278
     
754,953
     
1,295,059
     
998,618
 
Impairment of goodwill
   
-
     
-
     
800,000
     
-
 
Total operating expenses
   
1,785,264
     
1,953,631
     
4,321,112
     
3,313,773
 
                                 
Operating profit (loss)
   
41,845
     
309,471
     
(541,080
)
   
733,571
 
                                 
Financing expenses, net
   
(17,424
)
   
(13,531
)
   
(67,609
)
   
(30,169
)
                                 
Income (loss) before taxes 
   
24,421
     
295,940
     
(608,689
)
   
703,402
 
                                 
Income tax benefit (expense)
   
-
     
(4,960
)
   
-
     
(2,529
)
                                 
Net income (loss) from discontinued operation in the United Kingdom
 
$
24,421
   
$
290,980
   
$
(608,689
)
 
$
700,873
 

(*) Intercompany revenues, for services provided by the discontinued operations in the UK to the discontinued operation in Israel, of $397,101 and $989,174 for the six months ended June 30, 2010 and 2009, respectively, are attributed to the discontinued operations in the UK. The associated costs of these revenues are also attributed to the discontinued operations in the UK.

 
 
-15-

 
Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)

Note 3 – Discontinued operations (Cont.)

B.
Operations in Israel
 

On May 14, 2010, an agreement (the “Agreement”) was entered into between the Company, the Company’s 31% minority interest partners (the “Minority Partners”) in Xfone 018 and Marathon Telecom Ltd. (“Marathon Telecom”), for the sale by the Company of its 69% interest in Xfone 018, and the sale by the Minority Partners of their 31% interest in Xfone 018 (collectively, the “Holdings”) to Marathon Telecom (the “Transaction”). The entry into the Agreement follows the non-binding memorandum of understanding (the “MoU”) which the parties had entered into on March 2, 2010.

The aggregate purchase price to be paid by Marathon Telecom in exchange for the interests in Xfone 018 is approximately $7,850,000, which represents a price for 100% of the interests in Xfone 018 free of any financial debt. The financial debt of Xfone 018 on the date of the Agreement, excluding debt due to the Company, is approximately $1,100,000.  In connection with the Transaction, the Company will be repaid its debt, and will receive 69% of the net proceeds after all other financial debt of Xfone 018 has been paid.

Pursuant to the Agreement, the consummation of the Transaction was subject to certain conditions and approvals, including, receipt of the approval of the Minister of Communications in Israel which was received on August 11, 2010.

As a result of the Company’s entry into the MoU and the Agreement, the assets and liabilities related to Xfone 018 have been classified as “held for sale” in the Company’s financial statements in accordance with ASC 360, (formerly SFAS No. 144), Accounting for the Impairment or Disposal of Long-Lived Assets. ASC 360 requires an asset group that is held for sale to be recorded at the lower of its carrying amount or fair value less costs to sell.

The assets and liabilities of the discontinued operations in Israel are as follows:
   
June 30
 
   
2010
 
       
Cash
 
$
176,289
 
Other current assets
   
2,077,456
 
Fixed assets, net
   
1,472,017
 
Long-term assets
   
58,799
 
Other long-term assets
   
249,899
 
Current maturities of notes payable
   
(259,360
Other current liabilities
   
(2,408,154
Long-term notes payable
   
(385,363
)
Other long-term liability
   
(114,775
)
         
Net assets
 
$
866,808
 
         

 
 
-16-

 

Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)

Note 3 – Discontinued operations (Cont.)

The results of discontinued operations in Israel are as follows:

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Revenues
 
$
2,280,029
   
$
1,915,598
   
$
4,535,430
   
$
4,089,480
 
Cost of revenues
   
1,254,828
     
1,090,503
     
2,406,916
     
2,346,846
 
                                 
Gross profit
   
1,025,201
     
825,095
     
2,128,514
     
1,742,634
 
                                 
                                 
Operating expenses:
                               
Marketing and selling
   
205,358
     
394,731
     
447,931
     
802,130
 
General and administrative
   
440,205
     
477,306
     
882,959
     
819,536
 
Non-recurring loss
   
-
     
506,176
     
-
     
506,176
 
Total operating expenses
   
645,563
     
1,378,213
     
1,330,890
     
2,127,842
 
                                 
Operating profit (loss)
   
379,638
     
(553,118
)
   
797,624
     
(385,208
)
                                 
Financing expenses, net
   
(40,476
)
   
(103,663
)
   
(85,016
)
   
(170,985
)
                                 
Income (loss) before taxes 
   
339,162
     
(656,781
)
   
712,608
     
(556,193
)
                                 
Income tax expense
   
(92,162
)
   
(142,522
)
   
(185,256
)
   
(171,638
)
                                 
Net income (loss)
   
247,000
     
(799,303
)
   
527,352
     
(727,831
)
                                 
Income attributed to non-controlling interest
   
(66,339
)
   
138,716
     
(163,479
)
   
119,162
 
                                 
Net income (loss) from discontinued operation in the Israel
 
$
180,661
   
$
(660,587
 
$
363,873
   
$
(608,669
)
                                 

(*) Intercompany revenues, for services provided by the discontinued operation in Israel to the discontinued operation in the UK, of $74,285 and $25,148 for the six months ended June 30, 2010 and 2009, respectively, are attributed to the discontinued operations in Israel. The associated costs of these revenues are also attributed to the discontinued operations in Israel.

 
 
-17-

 

Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)
 
Note 4 – Notes payable

A.  
NTS has a loan with a commercial bank with an outstanding balance of $1,380,204 as of June 30, 2010.  The loan is secured by an assignment of all NTS' trade accounts receivable. The loan bears interest at a rate equivalent to Wall Street Journal Prime, but not less than 6% per annum. The Wall Street Journal Prime rate was 3.25% at June 30, 2010. The loan is repayable in equal monthly installments of $61,212 each. The Company negotiated with the bank the repayment schedule and the parties agreed to postpone the repayment of the loan from its original due date of May 28, 2010 to September 25, 2010.

B.  
NTS Telephone Company, LLC, a wholly owned subsidiary of NTS has received approval from the Rural Utilities Service (“RUS”), a division of the United States Department of Agriculture, for an $11.8 million, 17-year debt facility to complete a telecommunications overbuild project in Levelland, Texas. The RUS loan is non-recourse to NTS and all other NTS subsidiaries and is a cost-of-money loan, bearing interest at the average rate for 10-year U.S. Treasury obligations. Advances are requested as the construction progresses, and the interest rate is set based upon the prevailing rate at the time of each individual advance. The current average interest rate is approximately 3.20%. 
 
The total aggregate amount of these loans as of June 30, 2010 and December 31, 2009 are $7,143,976 and $5,574,100, respectively. The loans are to be repaid in monthly installments until 2024.
 
C.  
Long-term loan from Burlingame Equity Investors, LP (“Burlingame”) (See Note 5.B)

On March 23, 2010, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with an existing shareholder, Burlingame Equity Investors, LP (“Burlingame”). As part of the Purchase Agreement, the Company issued a senior promissory note in the aggregate principal amount of $3,500,000, maturing on March 22, 2012.  Interest accrues at an annual rate of 10% and is payable quarterly. The note has equal liquidation rights with the Company's Series A Bonds issued in Israel on December 13, 2007. The Company evaluated the fair value of each of the three securities that were issued under the Purchase Agreement (i.e., the promissory note, 2,173,913 shares of the Company’s common stock, and a warrant to purchase 950,000 shares of the Company’s common stock) and recorded the promissory note at its fair value of $2,556,240. The difference between the fair value and the principal amount will be expense ratably over the life of the promissory note.

 
 
-18-

 


Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)
 
Note 5 - Capital Structure, stock options, warrants
 
A.  
Issuance of options to officers and employees

On February 15, 2010, the Company granted the following options to officers and employees under the Company’s 2007 Stock Incentive Plan:

 
(1) The Company's President, Chief Executive Officer and director was granted options to purchase 1,500,000 shares of common stock, fully vested, exercisable at $1.10 per share and expiring five years from the date of grant. Based on the assumptions below, the Company estimated that the fair value of the options at $294,386.
   
 
(2) The Company's Chief Financial Officer, was granted options to purchase 400,000 shares of common stock, exercisable at $1.10 per share and expiring seven years from the grant date. The options will vest as to 25% of the underlying shares 12 months from the date of grant. The remaining 75% of the options shall vest in equal quarterly installments after 15 months from the date of grant. In the event of a change of control of the Company, any unvested and outstanding portion of the options shall immediately and fully vest. Based on the assumptions below, the Company estimated that the fair value of the options at $107,050.
   
 
(3) An aggregate of 1,372,500 options to purchase shares of common stock were granted to other employees of the Company and its subsidiaries.  Each such option is exercisable at $1.10 per share and expires seven years from the date of grant.  Of these options, 85,000 options are fully vested on the date of grant, and the remaining 1,287,500 options will vest as to 25% of the underlying shares 12 months from the date of grant, with the remaining 75% of the options vesting in equal quarterly installments after 15 months from the date of grant. Additionally, 125,000 of the options will immediately and fully vest in the event of a change in control of the Company. Based on the assumption below, the Company estimated that the fair value of the options at $367,311. On March 22, 2010, 69,500 of these options were exercised.
 
The Company’s aggregate equity-based compensation expense for the six months ended June 30, 2010 and 2009 totaled $451,383 and $304,034, respectively.

The weighted average estimated fair value of employee stock options granted during the six months ended June 30, 2010 was $0.23 per share, using the Black-Scholes option pricing model, with the following weighted average assumptions (annualized percentages):
 
       
Volatility
    48.5
Risk-free interest rate
    2.76
Dividend yield
    0
Forfeiture rate
    20
 
 
-19-

 


Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)
 
Note 5 - Capital Structure, stock options, warrants (Cont.)

B.  
Securities Purchase Agreement with Burlingame

On March 23, 2010, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with an existing shareholder, Burlingame, for the issuance of the following securities of the Company for an aggregate purchase price of $6,000,000:

 
(1) A senior promissory note in the aggregate principal amount of $3,500,000, maturing on March 22, 2012.  Interest accrues at an annual rate of 10% and is payable quarterly. The note has equal liquidation rights with the Company's Series A Bonds issued in Israel on December 13, 2007.
   
 
(2) 2,173,913 shares of the Company’s common stock at a price of $1.15 per share for a total purchase price of $2,500,000.
   
 
(3) A warrant to purchase 950,000 shares of the Company’s Common Stock, which shall be exercisable at a price of $2.00 per share for a period of 5 years. The number of shares issuable upon exercise of the Warrant, and/or the applicable exercise price, may be proportionately adjusted in the event of a stock dividend, distribution, subdivision, combination, merger, consolidation, sale of assets, spin-off or similar transactions.

C.  
Subscription Agreement with certain investors affiliated with Gagnon Securities LLC

On March 23, 2010, the Company entered into a Subscription Agreement with certain investors affiliated with Gagnon Securities LLC, an existing shareholder (collectively, “Gagnon”), for the issuance of 500,000 Common Stock at a purchase price of $1.15 per share for an aggregate purchase price of $575,000. The Company allocated the proceeds from this agreement based on the relative fair values of the note, common stock and warrant. $2,918,921, $2,556,240, and $524,840 were allocated to the common stock, note and warrant, respectively.
 
Note 6 - Geographical segments Information

As of January 1, 2010, the Company has one reporting segment. The Company's operations in the United Kingdom and Israel are reported as discontinued operations (Note 3).
 
 
 
-20-

 
 
Xfone, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
 (Unaudited)

Note 7 – Legal proceedings

1. FCC Enforcement Bureau
 
On March 6, 2006, the FCC’s Enforcement Bureau initiated an investigation into Telephone Electronic Company’s (“TEC”) compliance with FCC Rules for compensation of payphone service providers.  The Enforcement Bureau issued requests for production to TEC, its affiliates and subsidiaries.  TEC was a majority shareholder of NTS Communications, Inc. ("NTS") at the time of this investigation, prior to the Company's acquisition of NTS on February 26, 2008.  On April 26, 2006, NTS filed its response to the request for production.  The FCC has the authority to issue fines for violations of its regulations.  NTS believes it is in compliance and will not incur any fine.  The investigation is pending.

2. Teresa Leffler vs. Xfone USA

On February 24, 2009, Teresa Leffler, a former employee of Xfone USA, Inc., filed a complaint with the Circuit court of Rankin County, Mississippi, alleging sexual discrimination and sexual harassment by a former employee of Xfone USA, Marshall Wingard, and Xfone USA, that allegedly resulted in injury to her job and reputation, lost wages, mental and physical pain and suffering. Ms. Leffler seeks compensatory damages in the amount of $300,000 and punitive damages in the amount of $300,000. The filing of the complaint follows Ms. Leffler’s receipt of a Notice of Right to Sue (the “Notice”) issued by the U.S. Equal Employment Opportunity Commission (the “EEOC”) on November 21, 2008.  The Notice also stated that the EEOC was terminating its processing of the charge. Xfone USA and Mr. Wingard filed their Original Answers on April 15, 2009. Mr. Wingard was dismissed with prejudice from the suit by agreement and stipulation on May 12, 2009. Ms. Leffler’s complaint was settled for $2,500 on July 2, 2010, and the case was dismissed with prejudice on July 26, 2010.

3. Eliezer Tzur et al. vs. 012 Telecom Ltd. et al.

On January 19, 2010, Eliezer Tzur et al. (the “Petitioners”) filed a request to approve a claim as a class action (the “Class Action Request”) against Xfone 018 Ltd. (“Xfone 018”), the Company's 69% owned Israel based subsidiary, and four other Israeli telecom companies, all of which are entities unrelated to the Company (collectively with Xfone 018, the “Defendants”), in the District Court in Petach Tikva, Israel (the “Israeli Court”).  The Petitioners’ claim alleges that the Defendants have not fully fulfilled their alleged legal requirement to bear the cost of telephone calls by consumers to the Defendants’ respective technical support numbers. One of the Petitioners seeks damages for the cost such telephone calls allegedly made by him during the 5.5-year period preceding the filing of the Class Action Request, which he assessed at NIS 54.45 (approximately $15). The Class Action Request, to the extent it pertains to Xfone 018, states total damages of NIS 7,500,000 (approximately $2,000,000) which reflects the Petitioners’ estimation of damages caused to all consumers that (pursuant to the Class Action Request) allegedly called Xfone 018’s technical support number during a certain period defined in the Class Action Request.  A court hearing with respect to the approval or disapproval of the Class Action Request has been scheduled for September 19, 2010. Xfone 018 and the Petitioners are currently attempting to reach an understanding regarding the scope of the Class Action Request and its justification, if any. The matter is pending and Xfone 018 intends to vigorously defend the Class Action Request.   
 
 
 
-21-

 
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
FORWARD-LOOKING STATEMENTS

The information set forth in this Management's Discussion and Analysis of Financial Condition and Results of  Operations (“MD&A”) contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, including, among others (i) expected changes in Xfone, Inc.'s (referred to herein as the "Company", or "Xfone", "we", "our", "ours" and "us") revenues and profitability, (ii) prospective business opportunities and (iii) our strategy for financing its business. Forward-looking statements are statements other than historical information or statements of current condition. Some forward-looking statements may be identified by use of terms such as “believes”, “anticipates”, “intends” or “expects”. These forward-looking statements relate to our plans, objectives and expectations for future operations. Although we believe that our expectations with respect to the forward-looking statements are based upon reasonable assumptions within the bounds of our knowledge of our business and operations, in light of the risks and uncertainties inherent in all future projections, the inclusion of forward-looking statements in this Quarterly Report should not be regarded as a representation by us or any other person that our objectives or plans will be achieved.

You should read the following discussion and analysis in conjunction with the Condensed Consolidated Financial Statements and Notes attached hereto, and the other financial data appearing elsewhere in this Quarterly Report.

Our revenues and results of operations could differ materially from those projected in the forward-looking statements as a result of numerous factors, including, but not limited to, the following: the risk of significant natural disaster, our inability to insure against certain risks, inflationary and deflationary conditions and cycles, currency exchange rates, changing government regulations domestically and internationally affecting our products and businesses.
 
US Dollars are denoted herein by “USD”, New Israeli Shekels are denoted herein by “NIS”, and the Pound Sterling is denoted herein by “GBP.”
 
OVERVIEW
 
We were incorporated in Nevada, US in September 2000. We are a holding and managing company providing international voice, video and data communications services with operations in the United States, the United Kingdom and Israel offering a wide range of services, including: local, long distance and international telephony services; video; prepaid and postpaid calling cards; cellular services; Internet services; messaging services (Email/Fax Broadcast, Email2Fax and Cyber-Number); and reselling opportunities. We serve customers worldwide.

Our principal executive offices are located in Lubbock, Texas.

Divestitures

As reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, subsequent to the year ended December 31, 2009, our board of directors made a strategic decision to concentrate on our operations in the U.S.  As a result of this decision, we decided to divest our operations in the United Kingdom (“UK”), and Israel. The assets, liabilities and results of operations of the U.K. and Israel operations have been classified as discontinued operations for all periods presented.
 
Detailed discussions of each of these divestitures follow: 

Discontinued operations in the UK. On January 29, 2010, we entered into an agreement (the “Agreement”) with Abraham Keinan, a significant shareholder and Chairman of our Board (“Keinan”), and AMIT K LTD, a company registered in England & Wales which is wholly owned and controlled by Keinan (“Buyer”), for the sale of Swiftnet, Auracall, Equitalk and Story Telecom (the “UK Subsidiaries”), which we owns (the “Transaction”). Pursuant to the Agreement, the consideration to be paid by Buyer and/or Keinan to us shall be comprised of the following three components:

 1.
Our release from the repayment of the loan from Iddo Keinan, the son of Mr. Keinan and an employee of Swiftnet dated December 10, 2009, pursuant to which Iddo Keinan extended to Swiftnet a loan of £860,044 ($1,292,353);.
 2.
Release from our obligation to Bank Leumi (UK) Plc. for of £150,000 ($228,375), thereby releasing us from our obligation to Bank Leumi (UK) Plc.; and
 3.
An annual earn-out payment over the following years beginning on the consummation of the Transaction. The aggregate Earn-Out Payments shall be equal to but shall not exceed $1,858,325 in the aggregate. 
 4.
Release of intercompany balances between us and the UK Subsidiaries. 

Following an approval of the Transaction in a special meeting of our stockholders on July 14, 2010, we completed our disposition of the UK Subsidiaries on July 29, 2010.

 
-22-

 
As a result of the Agreement to sell our holdings in the UK Subsidiaries, the assets and liabilities related to UK Subsidiaries have been classified as “held for sale” in our financial statements in accordance with ASC 360, (formerly SFAS No. 144), Accounting for the Impairment or Disposal of Long-Lived Assets. Furthermore, it has also triggered the need to test the goodwill related to the operations in the UK. Using an estimate of proceeds to be received upon sale as an indicator of the UK operation’s fair value, we determined that $800,000 of UK operation’s goodwill had become impaired, and was, therefore, written off during the quarter ended March 31, 2010 as a component of discontinued operations in the consolidated statement of operations.

The results of discontinued operations in the UK for the three and six months ended June 30, 2010 and 2009 are as follows:

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Revenues
 
$
2,556,886
   
$
4,049,266
   
$
5,864,395
   
$
7,699,806
 
Cost of revenues
   
729,777
     
1,786,164
     
2,084,363
     
3,652,462
 
                                 
Gross profit
   
1,827,109
     
2,263,102
     
3,780,032
     
4,047,344
 
                                 
Operating expenses:
                               
Marketing and selling
   
1,088,986
     
1,198,678
     
2,226,053
     
2,315,155
 
General and administrative
   
696,278
     
754,953
     
1,295,059
     
998,618
 
Impairment of goodwill
   
-
     
-
     
800,000
     
-
 
Total operating expenses
   
1,785,264
     
1,953,631
     
4,321,112
     
3,313,773
 
                                 
Operating profit (loss)
   
41,845
     
309,471
     
(541,080
)
   
733,571
 
                                 
Financing expenses, net
   
(17,424
)
   
(13,531
)
   
(67,609
)
   
(30,169
)
                                 
Income (loss) before taxes 
   
24,421
     
295,940
     
(608,689
)
   
703,402
 
                                 
Income tax benefit (expense)
   
-
     
(4,960
)
   
-
     
(2,529
)
                                 
Net income (loss) from discontinued operation in the United Kingdom
 
$
24,421
   
$
290,980
   
$
(608,689
)
 
$
700,873
 
 
Discontinued operations in Israel On May 14, 2010, we entered into an agreement (the “Agreement”) with our 31% minority interest partners (the “Minority Partners”) in Xfone 018 Ltd. ("Xfone 018"), and Marathon Telecom Ltd. (“Marathon Telecom”), for the sale by us of our 69% interest in Xfone 018, and the sale by the Minority Partners of their 31% interest in Xfone 018 (collectively, the “Holdings”) to Marathon Telecom (the “Transaction”). The entry into the Agreement follows the non-binding memorandum of understanding (the “MoU”) which the parties had entered into on March 2, 2010. The aggregate purchase price to be paid by Marathon Telecom in exchange for the interests in Xfone 018 is approximately $7,850,000, which represents the price for 100% of the interests in Xfone 018 free of any financial debt. The financial debt of Xfone 018 on the date of the Agreement, excluding debt due to us, is approximately $1,100,000.  In connection with the Transaction, we will be repaid our debt, and will receive 69% of the net proceeds after all other financial debt of Xfone 018 has been paid. Pursuant to the Agreement, the consummation of the Transaction was subject to certain conditions and approvals, including, receipt of the approval of the Minister of Communications in Israel which was received on August 11, 2010.

As a result of the Agreement to sell the holdings in Xfone 018, the assets and liabilities related to Xfone 018 have been classified as “held for sale” in our financial statements.

 
-23-

 
The results of discontinued operations in Israel for the six months ended June 30, 2010 and 2009 are as follows:

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Revenues
 
$
2,280,029
   
$
1,915,598
   
$
4,535,430
   
$
4,089,480
 
Cost of revenues
   
1,254,828
     
1,090,503
     
2,406,916
     
2,346,846
 
                                 
Gross profit
   
1,025,201
     
825,095
     
2,128,514
     
1,742,634
 
                                 
                                 
Operating expenses:
                               
Marketing and selling
   
205,358
     
394,731
     
447,931
     
802,130
 
General and administrative
   
440,205
     
477,306
     
882,959
     
819,536
 
Non-recurring loss
   
-
     
506,176
     
-
     
506,176
 
Total operating expenses
   
645,563
     
1,378,213
     
1,330,890
     
2,127,842
 
                                 
Operating profit (loss)
   
379,638
     
(553,118
)
   
797,624
     
(385,208
)
                                 
Financing expenses, net
   
(40,476
)
   
(103,663
)
   
(85,016
)
   
(170,985
)
                                 
Income (loss) before taxes 
   
339,162
     
(656,781
)
   
712,608
     
(556,193
)
                                 
Income tax expense
   
(92,162
)
   
(142,522
)
   
(185,256
)
   
(171,638
)
                                 
Net income (loss)
   
247,000
     
(799,303
)
   
527,352
     
(727,831
)
                                 
Income attributed to non-controlling interest
   
(66,339
)
   
138,716
     
(163,479
)
   
119,162
 
                                 
Net income (loss) from discontinued operation in the Israel
 
$
180,661
   
$
(660,587
 
$
363,873
   
$
(608,669
)
                                 
 
 
-24-

 
RESULTS OF OPERATIONS

Financial Information - Percentage of Revenues
 
   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Revenues
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
Cost of Revenues
   
52.6
%
   
54.4
%
   
52.8
%
   
54.9
%
Gross Profit
   
47.4
%
   
45.6
%
   
47.2.0
%
   
45.1
%
Operating Expenses:
                               
Marketing and Selling
   
7.4
%
   
7.3
%
   
7.5
%
   
7.5
%
General and Administrative
   
36.4
%
   
32.7
%
   
36.9
%
   
33.7
%
Total Operating Expenses
   
43.8
%
   
40.1
%
   
44.4
%
   
41.2
%
Income (loss) from continued operations before taxes and non-controlling interest
   
1.4
%
   
(11.5)
%
   
(2.5)
%
   
0.1
%
                                 
Net Income (loss) from continued operations
   
0.9
%
   
(9.7)
%
   
(1.6)
%
   
1.2
%
                                 
Net Income (loss) attributed to shareholders
   
2.3
%
   
(12.1)
%
   
(2.5)
%
   
1.5
%

COMPARISON OF THE SIX MONTHS PERIODS ENDED JUNE 30, 2010 AND JUNE 30, 2009
 
Revenues. Revenues for the six months ended June 30, 2010 decreased 6.8% to $28,986,997 from $31,105,422 for the same period in 2009. Revenues from our fiber based products ("Fiber-To-The-Premise revenues" or "FTTP revenues") in the six months ended June 30, 2010 increased 17.9% to approximately $4,650,000 from approximately $3,950,000 for the same period in 2009. As percentage of total sales, FTTP revenues in the six months ended June 30, 2010 increased to 16.1% from 12.7% for the same period in 2009. Revenues from our legacy copper network includes revenues from Wholesale, other carriers and other non-FTTP customers. Revenues from our legacy copper network in the six months ended June 30, 2010 decreased 10.4% to approximately $24,330,000 from approximately $27,160,000 in the same period in 2009. As percentage of total sales, non-FTTP revenues in the six months ended June 30, 2010 decreased to 83.9% from 87.3% for the same period in 2009. The increase in our FTTP revenues mainly resulted from the completion of the build out of the FTTP network in Levelland in April 2010 while the decrease in the non-FTTP revenues is resulted from the continuous attrition of non-FTTP residential customers and wholesale customers.

Cost of Revenues. Cost of revenues consists primarily of traffic time purchased from telephone companies and other related charges. Cost of revenues for the six months ended June 30, 2010 decreased 10.4% to $15,296,524 from $17,064,790 for the same period in 2009. Cost of revenues, as a percentage of revenues in the six months ended June 30, 2010, decreased to 52.8% from 54.9% for the same period in 2009. The decrease in the cost of revenues, as a percentage of revenues, is the result of an increase in high-margin FTTP revenues and a decrease in low-margin revenues from wholesale and non-FTTP residential customers.

Marketing and Selling Expenses. Marketing and selling expenses are primarily related to compensation attributed to employees engaged in marketing and selling activities, promotion, advertising and related expenses. Marketing and selling expenses for the six months ended June 30, 2010 decreased 6.2% to $2,180,798 from $2,324,805 for the same period in 2009. The decrease is the result of a decrease in payroll and sales commission.

General and Administrative Expenses. General and administrative expenses consists primarily of compensation costs for administration, finance and general management personnel and consulting fees. General and administrative expenses for the six months ended June 30, 2010, increased 1.9% to $10,683,349 from $10,486,731 for the same period in 2009. General and administrative expenses include stock options compensation which relates to stock options that were granted to our employees and vest during the reported period. Total stock option compensation in the six months ended June 30, 2010 increased by $147,349 (or 48%) to $451,383 from $304,034 for the same period in 2009. In addition, the continuous growth of the operation in Levelland increases our general and administrative expenses by approximately $150,000.
 
-25-

 

Financing Expenses, net. Financing expenses, net, for the six months ended June 30, 2010 increased by $259,822 to $1,257,116 from $997,294 for the same period in 2009. Financing expenses consist of interest payable on our Bonds, the measurement of the Bonds which are stated in NIS and linkage to the CPI based on the exchange rate fluctuation in the USD\NIS. It also includes interest expenses on our interest bearing obligations and the effect of the currency exchange rate on intercompany balances with our subsidiaries which report in NIS and GBP as their functional currencies, which is of a temporary nature under the determination of SFAS 52. The increase in financing expenses is a result of expenses related to warrants that were granted to a lender on March 2010 and amortization of fair value of loan that we borrowed on March 2010. The increase in financing expenses was offset against a decrease in the interest accumulated on the Bonds’ outstanding principal during the six months ended June 30, 2010 and the same period in 2009 and the evaluation of 7.2% in the USD against the GBP during the first six months of 2010 versus a devaluation of 13.8% in the USD against the GBP in the same period in 2009.
 
COMPARISON OF THE THREE MONTHS PERIODS ENDED JUNE 30, 2010 AND JUNE 30, 2009
 
Revenues. Revenues for the quarter ended June 30, 2010 decreased 6.6% to $14,429,559 from $15,455,409 for the same period in 2009. FTTP revenues in the quarter ended June 30, 2010 increased 23.2% to approximately $2,440,000 from approximately $1,980,000 for the same period in 2009. As percentage of total sales, FTTP revenues in the quarter ended June 30, 2010 increased to 16.9% from 12.8% for the same period in 2009. Revenues from our legacy copper network include revenues from Wholesale, other carriers and other non-FTTP customers. Revenues from our legacy copper network in the quarter ended June 30, 2010 decreased 11.0% to approximately $11,972,000 from approximately $13,480,000 in the same period in 2009. As percentage of total sales, non-FTTP revenues in the quarter ended June 30, 2010 decreased to 83.1% from 87.2% for the same period in 2009. The increase in our FTTP revenues is mainly resulted from the completion of the build out of the FTTP network in Levelland in April 2010 while the decrease in the non-FTTP revenues resulted from the continuous attrition of non-FTTP residential customers and wholesale customers.

Cost of Revenues. Cost of revenues consists primarily of traffic time purchased from telephone companies and other related charges. Cost of revenues for the quarter ended June 30, 2010 decreased 9.7% to $7,592,359 from $8,408,974 for the same period in 2009. Cost of revenues, as a percentage of revenues in the quarter ended June 30, 2010, decreased to 52.6% from 54.4% for the same period in 2009. The decrease in the cost of revenues, as a percentage of revenues, is the result of an increase in high margin FTTP revenues and a decrease in low-margin revenues from wholesale and non-FTTP residential customers.

Marketing and Selling Expenses. Marketing and selling expenses are primarily related to compensation attributed to employees engaged in marketing and selling activities, promotion, advertising and related expenses. Marketing and selling expenses for the quarter ended June 30, 2010 decreased 5.4% to $1,072,906 from $1,134,071 for the same period in 2009. The decrease is the result of a decrease in payroll and sales commission.

General and Administrative Expenses. General and administrative expenses consists primarily of compensation costs for administration, finance and general management personnel and consulting fees. General and administrative expenses for the quarter ended June 30, 2010, increased 3.8% to $5,251,349 from $5,057,631 for the same period in 2009. The increase in the general and administrative expenses resulted mainly from additional expenses of approximately $90,000 related to the growth of the FTTP network in Levelland.

Financing Expenses, net. Financing expenses, net, for the quarter ended June 30, 2010 decreased by $2,380,936 to $162,390 from $2,543,326 for the same period in 2009. Financing expenses consist of interest payable on our Bonds, the measurement of the Bonds which are stated in NIS and linkage to the CPI based on the exchange rate fluctuation in the USD\NIS. It also includes interest expenses on our interest bearing obligations and the effect of the currency exchange rate on intercompany balances with our subsidiaries which report in NIS and GBP as their functional currencies, which is of a temporary nature under the determination of SFAS 52. The decrease in financing expenses is the result of the accumulated interest on the Bonds’ outstanding principal during the quarter ended June 30, 2010 and the same period in 2009 and the evaluation of 4.4% in the USD against the NIS during the first quarter of 2010 versus a devaluation of 6.4% in the USD against the GBP in the same period in 2009.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents as of June 30, 2010, amounted to $3,760,271 compared to $2,467,028 as of December 31, 2009, an increase of $1,293,243. Net cash provided by operating activities in the six months ended June 30, 2010 was $1,340,521, a decrease of $813,393 compared to a net cash flow of $2,153,914 in the same period of 2009. The decrease in cash flow from operating activities is mostly related to changes in our working capital in the six months ended June 30, 2010 compared to the same period in 2009. Cash used for investing activities in the six months ended June 30, 2010 was $4,601,238. Out of that amount, $2,457,290 is attributable to the build out of the project under the United States Department of Agriculture in Levelland, TX and $2,143,948 to the purchase of other equipment. Net cash provided by financing activities for the six months ended June 30, 2010 was $4,585,392, and is primarily attributable to proceeds from the issuance of promissory note, stocks and warrants to Burlingame Equity Investors, LP and the issuance of stocks to Gagnon Securities LLC for a total proceeds of $6,575,000.

Our capital investments are primarily related to the build-out of our fiber network, the purchase of equipment and software for services that we provide or intend to provide in Texas, Mississippi and Louisiana.

Capital lease obligations: We are the lessee of switching and other telecom equipment and motor vehicles under capital leases expiring on various dates from 2010 through 2014.
 
 
-26-

 
As of June 30, 2010, our continued operation reported a working capital deficit of $8,256,607 compared to a deficit of $13,449,727 on December 31, 2009. We expect that the proceeds from the divestiture of the UK and the Israeli operations together with the renegotiation of our short-term debt to a commercial bank will cure the deficit in our working capital.

The following table represents our contractual obligations and commercial commitments, excluding interest expense, as of June 30, 2010.
 
                               
   
Payments Due by Period
 
Contractual Obligations
 
Total
   
Less than
1 Year
   
1-3 Years
   
4-5 Years
   
More than
5 Years
 
                               
Domestic credit facility
 
$
1,380,204
   
$
1,380,204
   
$
-
   
$
-
   
$
-
 
Domestic Note Payable
   
2,041,354
     
1,994,878
     
33,596
     
12,880
     
-
 
Foreign credit facility
   
228,375
     
228,375
     
-
     
-
     
-
 
Other notes payable
   
4,934,606
     
1,756,505
     
2923900
     
-
     
254,201
 
Notes Payable from the United States Department of Agriculture
   
7,143,976
     
358,177
     
716,353
     
716,353
     
5,353,093
 
Bonds
   
20,716,053
     
3,546,808
     
7,093,615
     
7,093,615
     
2,982,015
 
Capital leases
   
325,257
     
178, 747
     
146,510
     
-
     
-
 
Operating leases
   
5,923,400
     
2,257,257
     
3,507,328
     
158,816
     
-
 
                                         
Total contractual cash obligations
 
$
42,693,225
   
$
11,522,204
   
$
14,421,302
   
$
7,981,664
   
$
8,589,309
 

We believe that funds expected to be generated from operations, proceeds from the divestiture of our operations in the UK and Israel and the control of capital spending will be sufficient to meet our anticipated cash requirements for operating needs for at least the next 12 months.

XFONE, INC.
 
The Bonds

On December 13, 2007 (the “Date of Issuance”), we accepted offers, for the issuance of securities to Israeli institutional investors, for total gross proceeds of NIS 100,382,100 (approximately $25,562,032, based on the exchange rate as of December 13, 2007) par value non-convertible bonds (Series A) (the “Bonds”). The Bonds were issued for an amount equal to their par value.

The Bonds accrue annual interest that is paid semi-annually on the 1st of June and on the 1st of December of every year from 2008 until 2015 (inclusive). The principal of the Bonds is repaid in eight equal annual payments on the 1st of December of every year from 2008 until 2015 (inclusive). The principal and interest of the Bonds are linked to the Israeli Consumer Price Index.

On November 4, 2008, we filed a public prospectus (the “Prospectus”) with the Israel Securities Authority (the “ISA”) and the Tel Aviv Stock Exchange ("TASE") for listing of the Bonds for trading on the TASE.  On November 11, 2008 (the “Date of Listing”), the Bonds commenced trading on the TASE. From the Date of Issuance until the Date of Listing, the Bonds accrued annual interest at a rate of 9%. As of the Date of Listing, the interest rate for the unpaid balance of the Bonds was reduced by 1% to an annual interest rate of 8%.

The Bonds may only be traded in Israel.  The Bonds were rated A3 by Midroog Limited, an Israeli rating company which is a subsidiary of Moody’s Investor Services. On February 19, 2009, Midroog filed its annual monitoring report (the “Monitoring Report”) with the Tel-Aviv Stock Exchange. According to the Monitoring Report, Midroog’s rating committee reaffirmed the A3 rating assigned to the Bonds. However, the rating committee decided on a negative outlook on the rating of the Bonds, largely, but not exclusively, due to the increase of the risk level in the business environment in which we operate, resulting from the increasing recession in the United States and the threat it poses on our business, since our core activity is based in the U.S.  While the Monitoring Report recognizes that we show relative stability in our financial results and adherence to our expected cash flow coverage ratios, it cites our currency exposure resulting from the NIS index-linked bonds in relation to the USD, which is our major activity currency. On October 26, 2009, Midroog announced a rating downgrade to our series A bonds from A3 to Baa1 and is maintaining the negative outlook. According to the rating report, the rating downgrade reflects a continued downtrend in our revenues, erosion in operating cash flow and coverage ratios, and a significant discrepancy between the level of cash flow and coverage ratios observed at the time of the initial rating and those presently observed. Midroog is maintaining the negative outlook on the rating due to our relatively low liquidity, weak free cash flow and lack of a substantial volume of unused credit facilities. On December 30, 2009, Midroog filed a monitoring report with the TASE announcing the inclusion of the rating of the bond in its watch list with a negative outlook. According to the report Midroog will examine the rating with respect to our ability to repay the full payment due on December 1, 2009, and our future liquidity. On July 1, 2010, Midroog filed with the TASE a rating action report (the “Report”) downgrading the rating of the Bonds from Baa1 to Baa3, announcing that the negative outlook on the rating of the Bonds is replaced with a stable outlook, and removing the rating of the Bonds from Midroog’s watch list.
 
-27-

 

On March 25, 2008, we issued the holders of the Bonds, for no additional consideration, 956,020 (non-tradable) warrants, each exercisable at an exercise price of $3.50 with a term of 4 years, commencing on September 2, 2008.
 
Credit Facility
 
We have a credit facility from Bank Leumi (UK) plc (“Bank Leumi”), of up to £150,000 ($228,375), which we obtained on November 26, 2008 for general working capital purposes (the “Credit Facility”). The Credit Facility is secured by a bank guarantee given to Bank Leumi by FIBI London. The guarantee is based upon a £150,000 deposit by Iddo Keinan, son of Abraham Keinan, our Chairman of the Board, and employee of our wholly-owned UK based subsidiary, Swiftnet Limited, with FIBI London.  The Credit Facility bears interest at a rate based on the London Interbank Offered Rate (“LIBOR”), plus one percent per annum, payable at the end of each three-month interest period. If we were to draw funds in excess of the agreed £150,000 amount without prior consent of Bank Leumi, we will be charged interest at the Base Rate, which is currently 5.5% plus 5% per annum for Sterling balances. On January 29, 2010, we entered into an agreement (the “Purchase Agreement”) with Mr. Keinan and AMIT K LTD, a company registered in England & Wales which is wholly owned and controlled by Mr. Keinan (“Buyer”), pursuant to which Mr. Keinan, through Buyer, agreed to purchase from us, and we agreed to sell, 100% of the entire issued share capital of Swiftnet Limited, Auracall Limited, Equitalk.co.uk Limited, Story Telecom, Inc. and Story Telecom Limited (the “UK Subsidiaries”), which we own (the “Transaction”). The consideration of the Transaction includes, among other things, full redemption by Buyer and/or Mr. Keinan of the Credit Facility thereby releasing us from our obligation to Bank Leumi (UK) Plc. The Transaction was closed on July 29, 2010 and the Credit Facility was fully redeemed pursuant to the Purchase Agreement.
 
Promissory Notes
 
On December 1, 2009, we issued a series of promissory notes in the aggregate amount of approximately $875,000 to various lenders who are either affiliates of ours or people related to certain affiliates and/or business partners of ours.  The notes bear interest at rates between 0% and 10% and mature between one month and one year from issuance.  Certain of the notes are prepayable and contain no prepayment penalties.  A one month note in the amount of approximately $133,000 bears no interest unless it is not paid at maturity and then such loan bears interest at 2% per month until repaid.  The notes are guaranteed by certain of our subsidiaries.  The proceeds of the notes were utilized to repay obligations under our Series A Bonds. As of March 31, 2010, the outstanding balance of these notes was $176,390 which mature on December 2010.
 
Loan Agreement
 
On December 10, 2009, we entered into a Loan Agreement as guarantor, with (i) Swiftnet Limited, our wholly owned United Kingdom subsidiary, as borrower; (ii) Iddo Keinan, as lender; and (iii) our other wholly owned UK Subsidiaries: (a) Auracall Limited, (b) Equitalk.co.uk Limited, and (c) Story Telecom Limited. Pursuant to the Agreement, Iddo Keinan agreed to extend to the Swiftnet Limited a loan in the amount of £860,045 ($1,292,353) no later than December 10, 2009. The loan was advanced as bridge funding of the payment of amounts due on our Series A Bonds. The loan had an initial maturity date of May 30, 2010, which was extended by mutual agreement to July 31, 2010. The loan shall bear interest of 1.3% per month charged on the total amount of the Iddo Keinan’s loan. In consideration for the loan, the following was granted as security in favor of the lender:
 
 
1.  Security interest in: (i) 51% of each of the Class A shares and Class B shares of the Swiftnet; (ii) 51% of the issued share capital of Equitalk; (iii) 100% of the issued share capital of Auracall; (iv) 100% of the issued share capital of Story Telecom;
 
 
2. Debentures over the entire assets of the Swiftnet and each UK Subsidiary.
 
 
3. Security interest in any proceeds of a sale of our interest in the capital stock of Xfone 018, Ltd., in an amount equal to the amount of the Loan.

Upon the closing of the Transaction we were released from our obligation as a guarantor for the loan.
 
Securities Purchase Agreement
 
On March 23, 2010, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with an existing shareholder, Burlingame Equity Investors, LP (“Burlingame”), for the issuance of our following securities for an aggregate purchase price of $6,000,000:
 
 
1.  A senior promissory note in the aggregate principal amount of $3,500,000, maturing on March 22, 2012.  Interest accrues at an annual rate of 10% and is payable quarterly. The note ranks  pari passu  in rights of liquidation with our Series A Bonds.
 
 
2. 2,173,913 shares of our common stock at a price of $1.15 per share for a total purchase price of $2,500,000.
 
 
3. A warrant to purchase 950,000 shares of our Common Stock, which shall be exercisable at a price of $2.00 per share for a period of 5 years. The number of shares issuable upon exercise of the Warrant, and/or the applicable exercise price, may be proportionately adjusted in the event of a stock dividend, distribution, subdivision, combination, merger, consolidation, sale of assets, spin-off or similar transactions.
 
 
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Following the execution of the Purchase Agreement, the transaction was consummated, and Burlingame paid the Purchase Price and we delivered the Note to Burlingame. We intend to use the net proceeds from the transaction for working capital purposes.
 
Subscription Agreement
 
On March 23, 2010, we entered into a Subscription Agreement with certain investors affiliated with Gagnon Securities LLC, an existing shareholder (collectively, “Gagnon”), for the issuance of 500,000 Common Stock at a purchase price of $1.15 per share for an aggregate purchase price of $575,000. We intend to use the net proceeds from the transaction for working capital purposes.

US SUBSIDIARIES
 
Revolving Line of Credit

Our U.S subsidiary, NTS Communications, Inc., has a $2,000,000 revolving line of credit with a commercial bank.  The facility is secured by an assignment of all NTS's trade accounts receivable.  The credit line bears interest at a rate equivalent to Wall Street Journal Prime. The credit line was repaid on April 27, 2010. A related installment note in the original amount of $2,000,000 was executed on April 27, 2009. This note reduced the nominal and funded balance of the previous $4,000,000 line of credit. The installment note, which matures September 25, 2010, bears interest at Wall Street Journal Prime rate and is payable in monthly installments of $61,212. As of June 30, 2010, the outstanding balance of the installment note is $1,380,204.
 
Secured Loan
 
Our U.S subsidiary, NTS Communications, Inc., has secured a loan from a commercial bank on September 18, 2007 in the original amount of $2,500,000 which was to be repaid on the following terms: 12 monthly payments of accrued interest only beginning October 18, 2007, followed by 23 monthly payments of $29,762 plus any accrued interest and a 24th and final payment of all unpaid principal and accrued interest due, on or before September 18, 2010. The loan bears interest at a rate equivalent to Wall Street Journal Prime. The loan is secured by fixed assets. The total aggregate amount of these loans as of June 30, 2010 is $1,909,312.
 
Rural Utilities Service Debt Facility
 
NTS Telephone Company, LLC, a wholly owned subsidiary of NTS Communications, Inc., has received approval from the Rural Utilities Service (“RUS”), a division of the United States Department of Agriculture, for an $11.8 million debt facility to complete a telecommunications overbuild project in Levelland, Texas. The principal of the RUS loan is repaid monthly starting one year from the initial advance date until full repayment after 17 years. The loan bears interest at the average yield on outstanding marketable obligations of the United States having the final maturity comparable to the final maturity of the advance. Advances are provided as the construction progresses, and the interest rate is set based upon the prevailing rate at the time of each individual advance. The note is non-recourse to NTS and all other NTS subsidiaries and is secured by NTS Telephones assets which were $9.7 million at June 30, 2010. As of June 30, 2010, the annual average weighted interest rate on the outstanding advances was 3.20%. The total aggregate amount of these loans as of June 30, 2010 is $7,143,976.

IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS

Our revenues and costs of revenues from continued operation are in USD.

Most of our assets, liabilities (except the Bonds), revenues and expenditures are in USD. The remainder of the assets, liabilities, revenues and expenditures are in GBP and NIS. We anticipate that the portion of USD will continue to grow and the portion of GBP and NIS will decline.

Notwithstanding having our Bonds stated in NIS and linked to the Israeli Consumer Price Index, during the six months ended June 30, 2010, our outstanding liability was decreased by approximately $566,000 as a result of the revaluation of the NIS in relation with the USD.
 
 
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Item 3.
Quantitative and Qualitative Disclosures about Market Risk
 
Not applicable.
 
Item 4T.
Controls and Procedures
 
(a) Management’s Quarterly Report on Internal Control over Financial Reporting.
 
As of the end of the period covered by this Quarterly Report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer/Principal Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer/Principal Accounting Officer have concluded that information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer/Principal Accounting Officer, to allow for timely decisions regarding required disclosure of material information required to be disclosed in the reports that we file or submit under the Exchange Act. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving these objectives and our Chief Executive Officer and Chief Financial Officer/Principal Accounting Officer have concluded that our disclosure controls and procedures are effective to a reasonable assurance level of achieving such objectives. However, it should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
 
(b) Changes in Internal Control Over Financial Reporting.
 
There were no changes in our internal control over financial reporting identified in connection with the evaluation described above during the period covered by this Quarterly Report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
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PART II:
 
OTHER INFORMATION
 
Item 1.
Legal Proceedings
 
I. FCC Enforcement Bureau

On March 6, 2006, the FCC’s Enforcement Bureau initiated an investigation into Telephone Electronic Company’s (“TEC”) compliance with FCC Rules for compensation of payphone service providers.  The Enforcement Bureau issued requests for production to TEC, its affiliates and subsidiaries.  TEC was a majority shareholder of NTS Communications, Inc. ("NTS") at the time of this investigation, prior to our acquisition of NTS on February 26, 2008.  On April 26, 2006, NTS filed its response to the request for production.  The FCC has the authority to issue fines for violations of its regulations.  NTS believes it is in compliance and will not incur any fine.  The investigation is pending.

II. Teresa Leffler vs. Xfone USA

On February 24, 2009, Teresa Leffler, a former employee of Xfone USA, Inc., filed a complaint with the Circuit court of Rankin County, Mississippi, alleging sexual discrimination and sexual harassment by a former employee of Xfone USA, Marshall Wingard, and Xfone USA, that allegedly resulted in injury to her job and reputation, lost wages, mental and physical pain and suffering. Ms. Leffler seeks compensatory damages in the amount of $300,000 and punitive damages in the amount of $300,000. The filing of the complaint follows Ms. Leffler’s receipt of a Notice of Right to Sue (the “Notice”) issued by the U.S. Equal Employment Opportunity Commission (the “EEOC”) on November 21, 2008.  The Notice also stated that the EEOC was terminating its processing of the charge. Xfone USA and Mr. Wingard filed their Original Answers on April 15, 2009. Mr. Wingard was dismissed with prejudice from the suit by agreement and stipulation on May 12, 2009. Ms. Leffler’s complaint was settled for $2,500 on July 2, 2010, and the case was dismissed with prejudice on July 26, 2010.

III. Eliezer Tzur et al. vs. 012 Telecom Ltd. Et al.

On January 19, 2010, Eliezer Tzur et al. (the “Petitioners”) filed a request to approve a claim as a class action (the “Class Action Request”) against Xfone 018 Ltd. (“Xfone 018”), our 69% owned Israel based subsidiary, and four other Israeli telecom companies, all of which are entities unrelated to us (collectively with Xfone 018, the “Defendants”), in the District Court in Petach Tikva, Israel (the “Israeli Court”).  The Petitioners’ claim alleges that the Defendants have not fully fulfilled their alleged legal requirement to bear the cost of telephone calls by consumers to the Defendants’ respective technical support numbers. One of the Petitioners seeks damages for the cost such telephone calls allegedly made by him during the 5.5-year period preceding the filing of the Class Action Request, which he assessed at NIS 54.45 (approximately $15). The Class Action Request, to the extent it pertains to Xfone 018, states total damages of NIS 7,500,000 (approximately $2,000,000) which reflects the Petitioners’ estimation of damages caused to all consumers that (pursuant to the Class Action Request) allegedly called Xfone 018’s technical support number during a certain period defined in the Class Action Request.  A court hearing with respect to the approval or disapproval of the Class Action Request has been scheduled for September 19, 2010. Xfone 018 and the Petitioners are currently attempting to reach an understanding regarding the scope of the Class Action Request and its justification, if any. The matter is pending and Xfone 018 intends to vigorously defend the Class Action Request.
 
Item 1A.
 
Not applicable.
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
None.
 
Item 3.
Defaults upon Senior Securities
 
None.
 
Item 4.
(Removed and Reserved)
 
Item 5.
Other Information
 
None.
 
 
-31-

 
 
Item 6.
Exhibits
 
Exhibit Number
Description
2.
Agreement and plan of reorganization dated September 20, 2000, between the Company and Swiftnet Limited. (1)
3.1
Articles of Incorporation of the Company.(1)
3.1.1
Certificate of Amendment to the Articles of Incorporation of the Company, dated January 18, 2007. (56)
3.11
Reamended and Restated Bylaws of the Company dated January 15, 2009.(55)
3.3
Memorandum of Association of Swiftnet Limited. (1)
3.4
Articles of Association of Swiftnet Limited. (1)
3.6
Bylaws of Xfone USA, Inc. (7)
4.
Specimen Stock Certificate.(1)
5.
Opinion of Gersten Savage LLP. *
10.1
Agreement dated May 11, 2000, between Swiftnet Limited and Guy Nissenson.(1)
10.2
Employment Agreement dated January 1, 2000 with Bosmat Houston. (1)
10.3
Loan Agreement dated August 5, 2000, with Swiftnet Limited, Guy Nissenson, and Nissim Levy.(1)
10.4
Promissory Note dated September 29, 2000, between the Company and Abraham Keinan.(1)
10.5
Stock Purchase Agreement dated June 19, 2000, between Swiftnet Limited, Abraham Keinan, and Campbeltown Business Ltd. (1)
10.6
Consulting Agreement dated May 11, 2000 between Swiftnet Limited and Campbeltown Business Ltd.(1)
10.7
Agreement dated July 30, 2001, with Campbeltown Business Ltd.(1)
10.8
Contract dated June 20, 1998, with WorldCom International Ltd.(1)
10.9
Contract dated April 11, 2000, with VoiceNet Inc.(1)
10.10
Contract dated April 25, 2000, with InTouchUK.com Ltd.(1)
10.11
Letter of Understanding dated July 30, 2001, from Campbeltown Business Ltd. to the Company.(2)
10.12
Agreement dated April 6, 2000, between Adar International, Inc./Mr. Sidney J. Golub and Swiftnet Limited. (2)
10.13
Lease Agreement dated December 4, 1991, between Elmtree Investments Ltd. and Swiftnet Limited.(2)
10.14
Lease Agreement dated October 8, 2001, between Postwick Property Holdings Limited and Swiftnet Limited. (2)
10.15
Agreement dated September 30, 2002, between the Company, Swiftnet Limited., and Nir Davison.(5)
10.16
As to Form: Shares and Warrant Purchase Agreement, Irrevocable Proxy, Warrant A, Warrant B and Registration Rights Agreement of Selling Shareholders Platinum Partners Value Arbitrage Fund LP, Countrywide Partners LLC and WEC Partners LLC. (6)
10.17
As to Form: Shares and Warrant Purchase Agreement, Irrevocable Proxy, Warrant A, Warrant B and Registration Rights Agreement of Selling Shareholders Simon Langbart, Robert Langbart, Arik Ecker, Zwi Ecker, Michael Derman, Errol Derman, Yuval Haim Sobel, Zvi Sobel, Tenram Investment Ltd., Michael Zinn, Michael Weiss. (6)
10.18
As to Form: Shares and Warrant Purchase Agreement, Irrevocable Proxy, Warrant A, Warrant B and Registration Rights Agreement of Selling Shareholders Southridge Partners LP and Southshore Capital Fund Ltd. (6)
10.19
As to Form: Shares and Warrant Purchase Agreement, Irrevocable Proxy, Warrant A, Warrant B and Registration Rights Agreement of Selling Shareholders Crestview Capital Master LLC. (6)
10.20
As to Form: Shares and Warrant Purchase Agreement, Irrevocable Proxy, Warrant A, Warrant B and Registration Rights Agreement of Selling Shareholders Adam Breslawsky, Oded Levy, Michael Epstein, Steven Frank, Joshua Lobel, Joshua Kazan and The Oberon Group LLC. (6)
10.21
Newco (Auracall Limited) Formation Agreement.(6)
10.22
Agreement with ITXC Corporation.(6)
10.23
Agreement with Teleglobe International.(6)
10.23.1
Amendment to Agreement with Teleglobe International.(6)
10.24
Agreement with British Telecommunications.(6)
10.25
Agreement with Easyair Limited (OpenAir).(6)
10.26
Agreement with Worldnet.(6)
10.27
Agreement with Portfolio PR.(6)
 
 
-32-

 
10.28
Agreement with Stern and Company.(6)
10.29
Letter to the Company dated December 31, 2003, from Abraham Keinan.(6)
10.30
Agreement between Swiftnet Limited and Dan Kirschner.(8)
10.31
Agreement and Plan of Merger.(7)
10.32
Escrow Agreement.(7)
10.33
Release Agreement.(7)
10.34
Employment Agreement date March 10, 2005, between Xfone USA, Inc. and Wade Spooner.(7)
10.34.1
Separation Agreement and Release, dated August 15, 2008, between Xfone USA, Inc. and Wade Spooner. (56)
10.35
Employment Agreement date March 10, 2005, between Xfone USA, Inc. and Ted Parsons.(7)
10.35.1
Separation Agreement and Release, dated August 15, 2008, between Xfone USA, Inc. and Ted Parsons. (56)
10.36
First Amendment to Agreement and Plan of Merger (to acquire WS Telecom, Inc.).(11)
10.37
Finders Agreement with The Oberon Group, LLC.(11)
10.38
Agreement with The Oberon Group, LLC.(11)
10.39
Management Agreement between WS Telecom, Inc. and Xfone USA, Inc.(8)
10.40
Engagement Letter to Tommy R. Ferguson, Confidentiality Agreement, and Executive Inventions Agreement dated August 19, 2004. (11)
10.41
Voting Agreement dated September 28, 2004.(11)
10.42
Novation Agreement executed September 27, 2004.(11)
10.43
Novation Agreement executed September 28, 2004.(11)
10.44
Investment Agreement dated August 26, 2004, with Ilan Shoshani.(12)
10.44.1
Addendum and Clarification to the Investment Agreement with Ilan Shoshani dated September 13, 2004. (12)
10.45
Agreement dated November 16, 2004, with Elite Financial Communications Group.(13)
10.46
Financial Services and Business Development Consulting Agreement dated November 18, 2004, with Dionysos Investments (1999) Ltd. (13)
10.47
Agreement and Plan of Merger to acquire I-55 Internet Services, Inc. dated August 18, 2005.(14)
10.48
Agreement and Plan of Merger to acquire I-55 Telecommunications, LLC dated August 26, 2005.(15)
10.49
Securities Purchase Agreement, dated September 27, 2005, by and between the Company and Laurus Master Fund, Ltd. (16)
10.50
Secured Convertible Term Note, dated September 27, 2005, by the Company in favor of Laurus Master Fund, Ltd.; Adjustment Provision Waiver Agreement, dated September 27, 2005, by and between the Company and Laurus Fund, Ltd. (16)
10.51
Common Stock Purchase Warrant, dated September 27, 2005, by the Company in favor of Laurus Master Fund, Ltd. (16)
10.52
Registration Rights Agreement, dated September 27, 2005, by and between the Company and Laurus Master Fund, Ltd. (16)
10.53
Master Security Agreement, dated September 27, 2005, by and between the Company, Xfone USA, Inc., eXpeTel Communications, Inc., Gulf Coast Utilities, Inc., and Laurus Master Fund, Ltd. (16)
10.54
Stock Pledge Agreement, dated September 27, 2005, by and between the Company, Xfone USA, Inc., and Laurus Master Fund, Ltd. (16)
10.55
Subsidiary Guarantee dated September 27, 2005, by Xfone USA, Inc., eXpeTel Communications, Inc. and Gulf Coast Utilities, Inc. in favor of Laurus Master Fund, Ltd. (16)
10.56
Funds Escrow Agreement, dated September 27, 2005, by and between the Company, Laurus Master Fund, Ltd. and Loeb & Loeb LLP; Disbursement Letter, dated September 27, 2005. (16)
10.57
Incremental Funding Side Letter, dated September 27, 2005, by and between the Company and Laurus Master Fund, Ltd. (16)
10.58
Securities Purchase Agreement dated September 28, 2005, by and between the Company and Crestview Capital Mater, LLC, Burlingame Equity Investors, LP, Burlingame Equity Investors II, LP, Burlingame Equity Investors (Offshore), Ltd., and Mercantile Discount - Provident Funds. (16)
10.59
Registration Rights Agreement, dated September 28, 2005, by and between the Company and Crestview Capital Mater, LLC, Burlingame Equity Investors, LP, Burlingame Equity Investors II, LP, Burlingame Equity Investors (Offshore), Ltd., and Mercantile Discount - Provident Funds. (16)
10.60
Common Stock Purchase Warrant, dated September 28, 2005, by the Company in favor of the Crestview Capital Mater, LLC, Burlingame Equity Investors, LP, Burlingame Equity Investors II, LP, Burlingame Equity Investors (Offshore), Ltd., and Mercantile Discount - Provident Funds. (16)
10.61
Escrow Agreement, dated September 28, 2005, by and between the Company, the Purchasers and Feldman Weinstein LLP. (16)
10.62
Management Agreement dated October 11, 2005.(17)
10.63
First Amendment to Agreement and Plan of Merger (to acquire I-55 Internet Services, Inc.), dated October 10, 2005. (17)
10.64
Letter Agreement with MCG Capital Corporation dated October 10, 2005.(17)
 
 
-33-

 
10.65
Securities Purchase Agreement, dated November 23, 2005, between the Company and Mercantile Discount - Provident Funds, Hadar Insurance Company Ltd., The Israeli Phoenix Assurance Company Ltd. and Gaon Gemel Ltd. (18)
10.66
Registration Rights Agreement, dated November 23, 2005, between the Company and Mercantile Discount - Provident Funds, Hadar Insurance Company Ltd., The Israeli Phoenix Assurance Company Ltd. and Gaon Gemel Ltd. (18)
10.67
Common Stock Purchase Warrant, dated November 23, 2005, by the Company in favor of Mercantile Discount - Provident Funds, Hadar Insurance Company Ltd., The Israeli Phoenix Assurance Company Ltd. and Gaon Gemel Ltd. (18)
10.68
Escrow Agreement, dated November 23, 2005, between the Company, the Escrow Agent, and Mercantile Discount - Provident Funds, Hadar Insurance Company Ltd., The Israeli Phoenix Assurance Company Ltd. and Gaon Gemel Ltd. (18)
10.69
Management Agreement with I-55 Telecommunications, LLC dated October 12, 2005.(19)
10.70
Agreement - General Terms and Conditions with EBI Comm, Inc., dated January 1, 2006.(21)
10.71
Asset Purchase Agreement with Canufly.net, Inc., dated January 10, 2006.(21)
10.72
Stock Purchase Agreement dated May 10, 2006, by and among the Company, Story Telec