Form 10-K for the fiscal year ended December 31, 2010
Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 0-29092

 

 

PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   54-1708481

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

7901 Jones Branch Drive, Suite 900, McLean, VA   22102
(Address of principal executive offices)   (Zip Code)

(703) 902-2800

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

None   N/A

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.001 per share

Contingent Value Rights

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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  ¨

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants’ knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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 the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨    Accelerated filer  ¨
Non-accelerated filer  ¨ (Do not check if a smaller reporting company)    Smaller reporting company  x

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

Non-affiliates of Primus Telecommunications Group, Incorporated held 9,518,431 shares of Common Stock as of June 30, 2010. The fair market value of the stock held by non-affiliates is $67,104,939 based on the sale price of the shares on June 30, 2010.

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  x    No  ¨

As of March 15, 2011, 13,118,083 shares of Common Stock, par value $.001, were outstanding.

Documents Incorporated by Reference:

Portions of the definitive Proxy Statement to be delivered to Stockholders in connection with the Annual Meeting of Stockholders are incorporated by reference into Part III.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

Item

  

Description

   Page  
Part I   

1.

  

Business

     3   

1A.

  

Risk Factors

     24   

1B.

  

Unresolved Staff Comments

     46   

2.

  

Properties

     47   

3.

  

Legal Proceedings

     47   

4.

  

(Removed and Reserved)

     47   
Part II   

5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      48   

6.

  

Selected Financial Data

     51   

7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     56   

7A.

  

Quantitative and Qualitative Disclosures about Market Risk

     85   

8.

  

Financial Statements and Supplementary Data

     86   

9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     87   

9A.

  

Controls and Procedures

     87   

9B.

  

Other Information

     88   
Part III   

10.

  

Directors, Executive Officers and Corporate Governance

     89   

11.

  

Executive Compensation

     89   

12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      89   

13.

  

Certain Relationships and Related Transactions, and Director Independence

     89   

14.

  

Principal Accountant Fees and Services

     90   
Part IV   

15.

  

Exhibits and Financial Statement Schedule

     91   

 

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PART I

Introductory Note

We are an integrated facilities-based communications services provider offering a portfolio of international and domestic voice, wireless, Internet, Voice over Internet Protocol (“VoIP”), data, colocation and data center services to customers located primarily in the Australia, Canada, the United States and Brazil. Our primary markets are Australia and Canada where we have deployed significant network infrastructure. We classify our services into three categories: Growth Services, Traditional Services and International Carrier Services. Our focus is on expanding our Growth Services, which includes our broadband, IP-based voice, local, wireless, data and data center services, to fulfill the demand for high quality, competitively priced communications services. This demand is being driven, in part, by the globalization of the world’s economies, the global trend toward telecommunications deregulation and the migration of communication traffic to the Internet. We manage our Traditional Services, which includes our domestic and international long-distance voice, prepaid cards, dial-up Internet services and Australian off-network local services for cash flow generation that we reinvest to develop and market our Growth Services, particularly in our primary markets of Australia and Canada. We provide our international carrier services voice termination services to other telecommunications carriers and resellers requiring IP or time-division multiplexing access.

On February 28, 2011, the Company completed the previously announced merger of PTG Investments, Inc. (“Merger Sub”), a Delaware corporation and a wholly-owned subsidiary of the Company with and into Arbinet Corporation (“Arbinet”) (the “Merger”), pursuant to the Agreement and Plan of Merger dated November 10, 2010, as amended by Amendment No. 1 dated December 14, 2010 (collectively, the “Merger Agreement”) by and among the Company, Merger Sub and Arbinet. As a result of the Merger, Arbinet became a wholly-owned subsidiary of the Company. In connection with the Merger, each share of Arbinet’s common stock, par value $0.0001 per share, issued and outstanding immediately prior to the effective time of the Merger was canceled and converted into the right to receive 0.5817 of a share of Company common stock. The Company intends to integrate Arbinet’s operations into the Company’s International Carrier Services segment.

Unless we indicate otherwise, references in this filing to “we,” “us,” “our,” “Primus,” “the Company,” and “Group” mean Primus Telecommunications Group, Incorporated and its subsidiaries for all periods before completion of the Merger with Arbinet Corporation on February 28, 2011. For forward-looking statements and risk factors described herein and for factual references herein beginning on March 1, 2011 through the filing of this Form 10-K, such references also include our wholly-owned subsidiary, Arbinet Corporation, and its subsidiaries.

 

ITEM 1. BUSINESS

General

We are an integrated facilities-based communications services provider offering a portfolio of international and domestic voice, wireless, Internet, VoIP, data, colocation and data center services to customers located primarily in the Australia, Canada, the United States and Brazil. Our primary markets are Australia and Canada where we have deployed significant network infrastructure. We classify our services into three categories: Growth Services, Traditional Services and International Carrier Services. Our focus is on expanding our Growth Services, which includes our broadband, IP-based voice, local, wireless, data and data center services, to fulfill the demand for high quality, competitively priced communications services. This demand is being driven, in part, by the globalization of the world’s economies, the global trend toward telecommunications deregulation and the migration of communication traffic to the Internet. We manage our Traditional Services, which includes our domestic and international long-distance voice, prepaid cards, dial-up Internet services and Australian off-network local services for cash flow generation that we reinvest to develop and market our Growth Services, particularly in our primary markets of Australia and Canada. We provide our international carrier services voice termination services to other telecommunications carriers and resellers requiring IP or time-division multiplexing access. We were formed as a corporation under the laws of Delaware in 1994.

 

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Through our increased investments in sales and marketing spending focused on our Growth Services we believe that over time our growth in revenue from Growth Services will exceed the decline in our revenue from Traditional Services and Growth Services will increase as a percentage of our total retail revenue.

We target customers with significant telecommunications needs, including small- and medium-sized enterprises (“SMEs”), multinational corporations, residential customers, and other telecommunication carriers and resellers. We provide services over our global, facilities-based network, which consists of:

 

   

10 data centers in 8 cities in Canada, Australia, and Brazil

 

   

18 carrier-grade international gateway and domestic switching systems (the hardware/software devices that direct voice traffic across the network), Internet routers and media gateways in the U.S., Canada, western Europe and the Asia-Pacific region;

 

   

approximately 500 interconnection points to our network, or points of presence (“POPs”), which includes digital subscriber line access multiplexers (“DSLAMs”), which is equipment that allows digital traffic to flow over copper wiring, within our service regions and other markets;

 

   

undersea and land-based fiber optic transmission line systems that we own or lease and that carry voice and data traffic across the network;

 

   

a global network that uses a high-bandwidth network standard ATM+IP; and

 

   

a global VoIP network based on routers and gateways with an open network architecture which connects our partners in over 150 countries.

Our Services

Within our three main service categories, Growth Services, Traditional Services and International Carrier Services, we offer our customers a wide range of products, including:

Growth Services:

 

   

data center services (colocation and managed services);

 

   

Internet, including business and residential broadband services;

 

   

residential and business VoIP services through SIP and hosted IP-PBX;

 

   

local services;

 

   

wireless Mobile Virtual Network Operator (MVNO) services; and

 

   

data, including frame relay.

Traditional Services:

 

   

domestic and international long-distance voice services;

 

   

prepaid phone card services;

 

   

local landline services in Australia that do not utilize our owned network (or “off-net” or “off-network” services); and

 

   

dial-up Internet services.

International Carrier Services:

Following the Arbinet Merger, we began integrating the Arbinet business within our International Carrier Services Operations (formerly known as our wholesale operations). These operations consist of:

 

   

Internet-based protocol and time-division multiplexing international carrier services access and transport.

 

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We continue to selectively target growth opportunities in areas of growing demand for telecommunications, including broadband, VoIP, local, wireless, data and data hosting center services. In order to accomplish this objective, we have sought, and continue to seek to:

 

   

manage our Traditional Services business for cash flow generation and prudently reinvest that cash flow in additional sales and marketing spending to gain market share, develop innovative and differentiated services, expand coverage and capacity of our existing network infrastructure to service new customers and to migrate existing customers onto our network and meeting our debt service obligations;

 

   

prudently expand Growth Services through our enhanced sales and marketing programs in order to steadily improve net revenue and contribution from these Growth Services; and

 

   

make targeted and prudent investments in support systems intended to reduce customer churn and customer service costs.

Strategy

We have refocused our strategy and efforts to enhance the revenue growth from our Growth Services while managing the decline in revenue from our Traditional Services. Key elements of our strategy to achieve these objectives are the following:

 

   

Capitalize on our competitive position in our primary markets to expand Growth Services revenue. We have refocused efforts to transition away from our traditional businesses of domestic and international long-distance voice, prepaid cards and dial-up Internet services to an integrated provider of broadband, VoIP, local, wireless, data and data center services. We believe there is strong demand for high quality, competitively priced communications services that is being driven by the globalization of the world’s economies, the global trend toward telecommunications deregulation and the migration of communication traffic to the Internet. We believe that we can capitalize on this demand given our competitive position by offering bundled communications services at attractive prices, particularly where we have a competitive cost structure as a result of our facilities-based network. We are leveraging our brand recognition, network infrastructure and existing customer base in Australia and Canada where we have competitive operations by virtue of our scale to bundle Growth Services and capture new customers.

 

   

Focus on our primary markets of Australia and Canada where we have established brand-recognition. We are focused on our primary markets of Australia and Canada where we believe we have the scalability and service offerings to effectively compete. For the year ended December 31, 2010, net revenues from our Australia and Canada operations, collectively, generated approximately 66.4% of our total net revenues and 86.6% of our total retail net revenue. We are focused on making prudent and effective investments in Australia and Canada where we believe that these markets present us with the highest potential for future growth. Supporting our strategy, during the year ended December 31, 2010 we spent in excess of 90% of our total capital expenditures in our primary markets of Australia and Canada. Our target customer base consists of SMEs, multinational corporations and residential customers.

 

   

Bundle traditional voice services with growth products to increase margins and create customer loyalty. By bundling our traditional long-distance voice services with one or more of our local, broadband, wireless, data and data center services, combined with a prudent increase in sales and marketing investment, we seek to increase net revenue per customer and improve our competitive ability to attract and retain additional new business and residential customers.

 

   

Leverage our global facilities-based network infrastructure. We have a significant amount of capital already invested in our global, voice and data network and our product capabilities and we are making additional investments in support of our Growth Services. By increasing the volume of voice and data traffic that we carry over our network, we are able to reduce transmission costs and other operating

 

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costs as a percentage of net revenue and enhance our ability to introduce new products and services with more efficient capital expenditures through utilization of available network capacity. In addition, by leveraging multiple customer segments in different geographical regions, including retail and carrier customers, we achieve greater utilization of our network assets, because our network experiences multiple periods of peak usage throughout each day. We are committed to migrating existing customers to our owned facilities (or “on-net”) that in most instances generate significantly higher margins than off-network customers.

 

   

Retail portfolio optimization. Given our retail focus in our primary markets of Australia and Canada where we have extensive operations, we believe there should be opportunities to optimize our remaining retail portfolio to accomplish our strategic objective of positioning us in Growth Services. We will opportunistically assess our alternatives to optimize the economic return from such on-going portfolio restructuring efforts.

 

   

Manage Traditional Services for cash flow which we will reinvest into our Growth Services and use to reduce our debt. The overall market for domestic and international long-distance voice, prepaid cards and dial-up Internet services continues to decline in favor of Internet-based, wireless and broadband communications. To mitigate this revenue decline and preserve cash flow, we focus on customer retention by bundling services, enhancing the customer service experience, and by prudently investing in effective marketing campaigns. For the year ended December 31, 2010, Traditional Services comprised 43% of total net revenue. To further manage cash flow from Traditional Services, we will continue to explore and implement outsourcing or off-shoring options for our non-sales and marketing operations in order to lower costs, improve coordination among our business units to deliver synergy savings and run an aggressive cost management program. We seek to redeploy associated savings and resulting available cash flow into sales and marketing activities for our Growth Services.

2009 Voluntary Reorganization under Chapter 11

On March 16, 2009, Primus Telecommunications Group, Incorporated (“Group” or “PTGI”) and three of its non-operating holding company subsidiaries, Primus Telecommunications Holding, Inc. (“Holding” or “PTHI”), Primus Telecommunications International, Inc. (“PTII”) and Primus Telecommunications IHC, Inc., (“IHC” and together with Group, Holding and PTII, collectively, the “Holding Companies”) each filed a voluntary petition in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) for reorganization relief (“Reorganization”) under chapter 11 of title 11 of the United States Code, 11 U.S.C. §§ 101 et seq., as amended (the “Bankruptcy Code”). None of Group’s operating companies in the United States, Australia, Canada, India, Europe and Brazil were included in the Bankruptcy Court filing. These operating units continued to manage and to operate their businesses normally during the financial reorganization of the Holding Companies.

The consensual plan of reorganization (the “Plan” or “Plan of Reorganization”) was confirmed by the Bankruptcy Court on June 12, 2009 (the “Confirmation Date”). On July 1, 2009 (the “Effective Date”), the Holding Companies consummated their reorganization under the Bankruptcy Code and the Plan became effective. Upon our emergence under the Plan of Reorganization on July 1, the Holding Companies’ principal debt was reduced by $316 million, over 50%, interest payments were reduced by over 50% and certain debt maturities were extended. For additional detail concerning the effects of the Plan of Reorganization, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Emergence from Voluntary Reorganization under Chapter 11 Proceedings.

References to “Successor” or “Successor Company” show the operations of the reorganized Company from and including July 1, 2009. References to “Predecessor” or “Predecessor Company” refer to the operations of the Company prior to July 1, 2009, except for Predecessor’s July 1, 2009 statements of operations, which reflect only the effect of the plan adjustments and fresh-start accounting as of such date and do not reflect any operating results.

 

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Operating Segments

We operate our business segments through a corporate shared services model and through operating segment managers responsible for specific geographic regions in which we operate. We assess performance and allocate resources based on the following operating segments:

Australia. Our Australian operations represented 36.2% of our net revenue for the year ended December 31, 2010. We believe we are the fourth largest full-service provider in Australia, based upon net revenue and the full suite of services provided. Our Australian operations offers a comprehensive range of international and domestic long-distance voice, broadband and dial-up Internet, wireless, local, VoIP, data and data hosting center products, servicing residential and business sectors. Our network employs Nortel DMS-100 telephone exchanges in Sydney, Melbourne, Brisbane, Perth and Adelaide operating through 66 POPs to provide national coverage for voice services. We operate a prepaid calling platform as well as a platform for delivery of enhanced toll-free service. The voice network supports direct access integrated services digital network (“ISDN”) and telephone line services across Sydney, Melbourne, Brisbane, Perth and Adelaide and some select regional areas of the country. VoIP services are offered to business and consumer customers using softswitch platforms operating in Sydney and Melbourne. Primus Australia owns a national IP network for delivery of business and consumer Internet service. Dial-up Internet is available nationally under a single access code. DSL service is provided on-net through 281 Primus DSLAMs and via international carrier services DSLAM access providing reach to more than 400 exchanges nationally. The DSLAMs are capable of delivering a full suite of telecommunication products including asymmetric and symmetric IP services, telephone line, ISDN, frame relay and ATM. Primus Australia offers ATM, frame relay, IP virtual private networking (“VPN”) with quality of service (“QoS”) and managed routers. Metropolitan fiber networks exist in Sydney, Melbourne, Brisbane, Perth and Adelaide to provide high capacity backhaul for domestic carrier interconnects, DSLAM backhaul and fiber connectivity to select customer premises.

A data center in Melbourne offers managed hosting, colocation, and e-commerce applications. Our data centers in Sydney and Melbourne are primarily used for colocation services. The Company plans to add growth capacity to these locations in the future.

We market our services primarily through a combination of direct sales to independent agents, corporate and SME customers, internet based marketing aimed at residential customers, and telemarketing and media advertising aimed at residential customers.

We operate a call center in Melbourne that services all of Australia. We employ staff in Sydney who run our Australian network management center that operates seven days per week, 24 hours per day, 365 days per year.

Canada. Our Canadian operations represented 30.2% of net revenue for year ended December 31, 2010. We believe we are one of the largest alternative consumer service providers in Canada based on net revenue. We provide international and domestic long-distance voice, local, broadband and dial-up Internet, data and data center services, VoIP and wireless services to SMEs, residential customers and government agencies. We have sales and customer service offices in key cities throughout Canada, including Vancouver, Toronto, Ottawa, Calgary and Edmonton. We operate international gateway switching, infrastructure in Toronto, Montreal, Ottawa, London, Edomnton and Vancouver and a nationwide SS7 network with signal transfer points (“STPs”) in Vancouver and Toronto. We maintain POPs in all major cities in Canada, and have use of a nationwide integrated network backbone for our voice, data, Internet and private line services. Each of the 24 nodes on the backbone is equipped with synchronous optical networking (“SONET”) add/drop, ATM, and IP equipment to provide a complete spectrum of voice and data communications products to our customers. In September 2009, we signed a new contract with Rogers Wireless Partnership which will significantly expand our coverage area and provide increased wireless data functionality to customers. Additionally, we operate next generation IP voice switches in Toronto, Vancouver, Montreal, Ottawa, London and Edmonton which provide on-net equal access coverage to an estimated 90% of the population of Canada. Together with and through a competitive local

 

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exchange carrier (“CLEC”) partner, we are co-located at 70 incumbent local exchange carriers (“ILECs”) central offices to provide DSL services, T1 access, network interconnection and local dial-tone. We operate a voice dial access network which consists of 70 POPs across the country.

We also own and operate a total of seven data centers in five major cities in Canada: two data centers in Ottawa (totaling 30,000 square feet), two data centers in Toronto (totaling 18,000 square feet), a 52,000 square foot data center in London, Ontario, a 17,000 square foot data center in Edmonton, Alberta and a 2,500 square foot data center in Vancouver through which we offer colocation, managed hosting, storage and other value added services. We have an extensive Internet network and we believe that we provide dial-up and ISDN Internet coverage to over 700 communities across Canada through a network of 51 POPs.

We market our services primarily through a combination of direct sales to independent agents, corporate and SME customers, internet based marketing aimed at residential customers, and telemarketing and media advertising aimed at residential customers.

International Carrier Services. Our International Carrier Services operations represented 23.3% of our net revenue for the year ended December 31, 2010. Our International Carrier Services business segment provides domestic and international minute transport and termination services and targets a diverse customer base including Tier 1 international carriers, multi-national carriers, wireless providers, VoIP providers, cable companies and Internet service providers (“ISPs”).

United States. Our U.S. operations represented 6.6% of our net revenue for the year ended December 31, 2010. In the U.S., we provide international and domestic voice, data, business-class broadband, hosted IP-PBX, SIP trunking and VoIP services to SMEs and residential customers. We operate international gateway telephone switches in the New York City area, Los Angeles, and Miami which are connected with Canada and countries in Europe, Latin America and the Asia-Pacific region through owned and leased international fiber cable systems. We have deployed intelligent softswitch architecture to our gateways in New York, Los Angeles and Miami. We lease and own domestic fiber in the U.S. to interconnect our switches, data centers, and POPs. We use a direct sales organization to sell to business customers. Our direct sales personnel offer business customers voice and hosted IP-PBX services. See “—Sales and Marketing; Direct Sales Force.” To reach residential customers, we have advertised in national and regional newspapers, other publications, and television channels whose market targets are expatriates, to offer competitive rates for international and domestic telephone calls, data, Internet and VoIP services. We have telemarketing centers in Florida and Iowa. We also sell retail VoIP services through Web-based on-line interactive marketing. We utilize independent agents to reach and enhance sales to both business and residential customers. We maintain customer service centers in Florida, Virginia and Iowa and also outsource selected customer service functions. We operate a 24-hour global network management control center in India which monitors our global voice, Internet and data traffic. Additionally, we offer local and long-distance voice, and DSL services to SMEs in Puerto Rico.

Europe. During the third quarter of 2010 the Company discontinued its Europe segment, which is also known as European retail operations and has presented the results of the Europe segment as discontinued operations and held for sale as of September 30, 2010. As a result, the Company has applied retrospective adjustments for 2009, 2008 and 2007 to reflect the effects of the discontinued operations that occurred subsequent to December 31, 2009. Accordingly, revenue, costs, and expenses of the discontinued operations have been excluded from the respective captions in the consolidated statements of operations. The Company did not retrospectively adjust its 2009 or 2008 Consolidated Balance Sheet as held for sale criteria was not met until the third quarter of 2010, as such, financial information for the Europe segment will appear, as applicable, where balance sheet information is presented, see Note 19, “Discontinued Operations,” for further information.

Our European International Carrier Services operations are headquartered in London.

Brazil. Our Brazilian operations, headquartered in São Paulo, represented 3.6% of our net revenue for the year ended December 31, 2010. Our Brazilian business segment primarily consists of data hosting center services and retail and international carrier services VoIP services.

 

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Network

General. We operate a global telecommunications network consisting of traditional and next-generation international gateway and domestic switches and related peripheral equipment, carrier-grade routers and switches for Internet and data services, data hosting and co-location centers, and undersea and trans-continental fiber optic cable systems. To ensure high-quality communications services, our network employs digital switching and fiber optic technologies, incorporates the use of SS7/C7 signaling, and is supported by comprehensive network monitoring and technical support services.

Switching Systems. Our network makes use of 13 carrier-grade domestic and international gateway switch systems, Internet routers and media gateways throughout the North America, Europe, and Asia-Pacific regions.

The locations and types of our switching systems are as follows:

 

Location

  

Type of Switch

New York City area (two locations)

   International Gateway

Los Angeles

   International Gateway

Toronto

   International Gateway

Vancouver

   International Gateway

London

   International Gateway

Sydney

   International Gateway

Frankfurt

   Internet Peering POP

Makati City

   Internet Peering POP

Adelaide

   Domestic

Brisbane

   Domestic

Melbourne

   Domestic

Perth

   Domestic

We also operate a global VoIP network with an open network architecture which connects with our partners in over 150 countries through the use of open settlement protocol.

Fiber Optic Cable Systems. We have purchased and leased undersea and land-based fiber optic cable transmission capacity to connect our various switching systems. We either lease lines on a term basis for a fixed cost or purchase economic interests in transmission capacity through minimum assignable ownership units or indefeasible rights of use to international traffic destinations.

Throughout the previous years we have purchased or acquired through acquisitions various oceanic fiber capacity and land based capacity. This capacity along with leased fiber capacity allows our switching platforms in our operating units to be connected and pass voice and data traffic.

Foreign Carrier Agreements. In selected countries where competition with the traditional Post Telegraph and Telecommunications companies (“PTTs”) is limited, we have entered into foreign carrier agreements with PTTs or other service providers which permit us to provide traffic into and receive return traffic from these countries.

Network Management and Control. We own and operate network management control centers in Toronto, Canada; London, England; New Delhi, India; and Sydney, Australia, which are used to monitor and control our switching systems, global data network, and other digital transmission equipment used in our network. These network management control centers operate seven days per week, 24 hours per day, 365 days per year.

Network for Data and Internet Services. We have built an Internet backbone network that enables our global network to carry Internet and data traffic for our business, residential, carrier and ISP customers. This network uses packet switched technology, including IP and ATM. This network allows us to offer to customers data and

 

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voice communications services, including, dial-up, broadband and dedicated Internet access, hosting, e-commerce, managed VPN services, VoIP, ATM and frame relay data services.

Data Centers. We offer world-class data center facilities with advanced 24 hours per day, 365 days per year customer access, onsite engineering support and help desk services; dedicated HVAC and environmental control systems; multi-stage fire suppression systems; uninterruptible power supply and backup generator; redundant data connections and services; routing and switching; shared and secure rack space; physical access technologies and practices; closed-circuit television and video security systems; and 24 x 7 building system and network monitoring. Our Australian data center facilities in Melbourne and Sydney occupy approximately 15,000 square feet. Canada offers national data center coverage with locations in Toronto, Vancouver, Edmonton, London, and Ottawa, with a total combined square footage of 73,000 square feet. Additionally, we own a data center facility in Brazil.

Customers

Our residential customers are attracted to us because of competitive pricing as compared to traditional carriers and responsive customer service and support. We offer VoIP, broadband and dial-up Internet access, local access and wireless products to our residential customers in select markets. We are expanding our local and broadband offerings to additional markets and bundling them with traditional voice services.

Our business sales and marketing efforts primarily target SMEs with data, voice, internet and managed hosting needs. We also target large multinational businesses.

We compete for the business of other telecommunications carriers and resellers primarily on the basis of price, service quality and presence. Sales to other carriers and resellers help us to negotiate better termination costs for our retail business units and increase the utilization of our network, thereby reducing our fixed costs per minute of use, as well as permitting our network to be interconnected with other major carriers to provide global coverage.

No single customer accounted for greater than 10% of net revenue for the year ended December 31, 2010 or for the year ended December 31, 2009.

Sales and Marketing

We market our services through a variety of sales channels, as summarized below:

 

   

Direct Sales Force. Our direct sales force is focused on business customers, including multinational businesses and international governmental organizations. They are engaged in generating new accounts and in the retention of current customers and cross selling products to current customers. A variety of products are utilized to maximize the customer’s lifecycle, based on the customers current product mix. Direct sales personnel are generally compensated with a base salary plus commissions. We have sales offices in Edmonton, Calgary, Toronto, Vancouver, Ottawa, London, Adelaide, Brisbane, Melbourne, Perth, Sydney, Sao Paulo, Chicago and Tampa. In addition, we maintain a direct sales team which exclusively sells services to international carrier services customers including other telecommunications carriers and resellers.

 

   

Independent Sales Agents. We also sell our services through independent sales agents and representatives, who typically focus on SMEs and residential consumers. An agent receives commissions based on revenue generated by customers obtained for us by the agent. The agents are nonexclusive to us and we require our agents and representatives to maintain minimum revenues.

 

   

Telemarketing. We employ full-time and part-time inbound and outbound telemarketing sales personnel, and we selectively outsource certain telemarketing functions to supplement sales efforts targeted at residential and small business customers.

 

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Direct Marketing. We use a variety of print, television and radio advertising to increase name recognition and generate new customers. We reach potential customers by advertising in newspapers and on select radio and television programs.

 

   

Web-based Marketing. We use a variety of web-based tools, including search marketing, banner ads and pop-up windows to target Internet users who prefer to purchase and research their purchase decisions on-line.

 

   

Third Party Distribution Agreements and Affinity Channels. Through use of the Primus brand, we have been able to establish relationships to market our services through external retailers, manufacturers, affinity and preferred partnerships and programs. These relationships allow us to increase awareness of our services among customers and reduce the cost of customer acquisition.

Management Information and Billing Systems

We operate various management information, network and customer billing systems in our different operating subsidiaries to support the functions of network and traffic management, customer service and customer billing. For financial reporting, we consolidate information from each of our markets into a single database. For our billing requirements we use several systems developed in-house as well as a few third party systems.

We believe that our financial reporting and billing systems are generally adequate to meet our business needs. We continually consider and evaluate whether our financial reporting and billing systems are generally adequate to meet our business needs, and in the future, we may determine that we need to invest additional capital to purchase hardware and software, license more specialized software and increase our capacity.

Competition

Voice

The telecommunications industry is highly competitive and significantly affected by regulatory changes, marketing and pricing decisions of the larger industry participants and the introduction of new services made possible by technological advances. We believe that long-distance service providers compete on the basis of price, customer service, product quality and breadth and bundling of services offered. In each country of operation, we have numerous competitors including wireline, wireless, VoIP and cable competitors. We believe that as the international telecommunications markets continue to deregulate, competition in these markets will increase. Prices for long-distance voice calls in the markets in which we compete have declined historically and are likely to continue to decrease. In addition, many of our competitors are significantly larger, have substantially greater financial, technical and marketing resources, larger networks and more products for bundling.

Privatization and deregulation have had, and are expected to continue to have, significant effects on competition in the industry. For example, as a result of legislation enacted in the U.S., regional bell operating companies (“RBOCs”) entered the long-distance market; long-distance carriers have entered the local telephone services market; and cable television companies and utilities are allowed to enter both the local and long-distance telecommunications markets. Consolidation among these large companies is also occurring, which could change the dynamics of pricing and marketing. In addition, alternatives to wireline services, such as wireless and VoIP services, are significant competitive threats. This increase in competition adversely affects net revenue per minute and usage of traditional wireline services, and these trends are expected to continue.

The following is a brief summary of the competitive environment in our principal service regions:

United States. In the U.S., which is among the most competitive and deregulated long-distance markets in the world, competition is based on pricing, customer service, network quality and the ability to provide value-added services and the bundling of services. AT&T, Inc. and Verizon Communications, Inc. are the largest

 

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suppliers of long-distance services. Wireless carriers have gained significant ground particularly in the domestic long-distance markets, and VoIP cable-based service providers present a growing source of competition.

Australia. Australia is one of the most deregulated and competitive communications markets in the Asia-Pacific region. Our principal competitors in Australia are Telstra Corporation Limited (“Telstra”), the dominant carrier, SingTel Optus Pty Limited, iiNet Limited, SP Telemedia Limited (known as TPG) and until recently AAPT, an affiliate of Telecom New Zealand, which recently withdrew from the residential services market, selling its residential customer base to iiNet. AAPT remains a significant competitor, along with Macquarie Telecom, in relation to the corporate and SME markets. Repeated pricing threats and actions by Telstra present serious competitive challenges (see “Government Regulation—Australia”). In December 2010 the Australian government passed legislation to reform the regulatory pricing arrangements and provide for the separation of Telstra’s international carrier services and retail arms, which in association with the construction of a government owned national broadband network is designed to promote better competition.

Canada. The Canadian communications market is highly competitive and is dominated by a few established carriers whose marketing and pricing decisions have a significant impact on the other industry participants, including us. In residential markets, we compete with each of the incumbent telecommunication companies (of which the largest are those owned by BCE, Inc. (“Bell Canada”) in eastern Canada, and TELUS Corporation (“TELUS”)and MTS Allstream, Inc. in western Canada) in their respective territories and the large cable companies, including Rogers and Shaw Communications Inc., who have launched their telecom service portfolio. We also compete against smaller resellers. In the highly competitive business market, we compete with Bell Canada and TELUS, who are both expanding beyond their traditional territories and competing with each other across the country, and with the national division of MTS Allstream, Inc., Rogers Communications, Inc. (“Rogers”), Shaw Communications, Inc. and other smaller carriers, including Bragg Communications Inc., COGECO Inc. and Quebecor Inc. Major wireless carriers are also a significant source of competition. In 2008 the Canadian Radio-television and Telecommunications Commission (“CRTC”) conducted a review of the regulatory framework for international carrier services and the definition of essential services.

Internet and Data

The market for Internet services and data services is extremely competitive. We anticipate that competition will continue to intensify. Our current and prospective competitors offering these services include national, international, regional and local ISPs, web hosting companies, other long-distance and international long-distance telecommunications companies, local exchange carriers (“LECs”), cable television, direct broadcast satellite, wireless communications providers and on-line service providers. Many of these competitors have significantly greater resources, product portfolios, market presence and brand recognition than we do.

Government Regulation

We are subject to varying degrees of regulation in each of the jurisdictions in which we operate. Local laws and regulations, and the interpretation of such laws and regulations, differ among those jurisdictions. There can be no assurance that (1) future regulatory, judicial and legislative changes will not have a material adverse effect on us; (2) domestic or international regulators or third parties will not raise material issues with regard to our compliance or noncompliance with applicable regulations; or (3) regulatory activities will not have a material adverse effect on us.

Regulation of the telecommunications industry continues to change rapidly both domestically and globally. Privatization, deregulation, changes in regulation, consolidation, and technological change have had, and will continue to have, significant effects on competition in the industry. Over time we have become subject to increasing competition in all of the markets in which we operate, and we expect such increases in competitive pressure to continue. Although we believe that continuing deregulation with respect to portions of the telecommunications industry will create opportunities for firms such as us, there can be no assurance that deregulation and changes in regulation will be implemented in a manner that would benefit us.

 

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The regulatory frameworks in certain jurisdictions in which we provide services are described below:

United States

In the U.S., our services are subject to the provisions of the Communications Act of 1934, as amended (the “Communications Act”), and other federal laws, the Federal Communications Commission (“FCC”) regulations, and the applicable laws and regulations of the various states.

Certain of our services (our “telecommunications services”) constitute common carrier offerings subject to Title II of the Communications Act and associated FCC regulations and similar state laws. Among other things, these requirements impose an obligation to offer service on a nondiscriminatory basis at just and reasonable rates, and to obtain regulatory approval prior to withdrawing from the provision of regulated services, to any assignment of authorizations, or to any transfer of legal or actual control of the company.

Our interstate telecommunications services are subject to various specific common carrier telecommunications requirements set forth in the Communications Act and the FCC’s rules, including operating, reporting and fee requirements. Both federal and state regulatory agencies have broad authority to impose monetary and other penalties on us for violations of regulatory requirements.

International Service Regulation. The FCC has jurisdiction over common carrier services linking points in the U.S. to points in other countries. We provide such services. Providers of such international common carrier services must obtain authority from the FCC under Section 214 of the Communications Act. We have obtained the authorizations required to use, on a facilities and resale basis, various transmission media for the provision of international switched services and international private line services on a non-dominant carrier basis. The FCC is considering a number of possible changes to its rules governing international common carriers. We cannot predict how the FCC will resolve those issues or how its decisions will affect our international business. FCC rules permit non-dominant carriers such as us to offer some services on a detariffed basis, where competition can provide consumers with lower rates and choices among carriers and services. With some exceptions, current FCC rules require facilities-based U.S. carriers, like us, with operating agreements with dominant foreign carriers, to abide by the FCC’s International Settlements Policy by following uniform accounting rates, an even split in settlement rates, and proportionate return of traffic, for agreements with carriers on certain routes. U.S. carrier arrangements with non-dominant foreign carriers or on a substantial number of international routes where competition exists are not subject to these requirements. We may take advantage of these more flexible arrangements with non-dominant foreign carriers, and the greater pricing flexibility that may result, but we may also face greater price competition from other international service carriers.

Domestic Service Regulation. With respect to our domestic U.S. telecommunications services, we are considered a non-dominant interstate carrier subject to regulation by the FCC. We are not required to obtain FCC authority to initiate or expand our domestic interstate operations, but we may be required to obtain FCC approval to assume control of another telecommunications carrier or its assets, to transfer control of our operations to another entity, or to discontinue service. We are also required to file various reports and pay various fees and assessments to the FCC and various state commissions. Among other things, interstate common carriers must offer service on a nondiscriminatory basis at just and reasonable rates. The FCC has jurisdiction to hear complaints regarding our compliance or non-compliance with these and other requirements of the Communications Act and the FCC’s rules, including, for example, alleged unauthorized changes in a customer’s preferred carrier. We are also subject to the Communications Assistance for Law Enforcement Act (“CALEA”) and associated FCC regulations which require telecommunications carriers and VoIP providers to configure their networks to facilitate law enforcement authorities to perform electronic surveillance; to the Do-Not-Call Registry and related restrictions set out the specific parameters for telemarketing solicitation and prohibit outbound telemarketing in some circumstances; and to the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003, which places certain restrictions on commercial electronic mail messages.

 

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Normally our long-distance customers, and the recipients of calls from our customers, do not connect directly to our network but, instead, are connected to our network by means of the local facilities of LECs, which impose regulated charges on us, called switched access charges, to originate and terminate calls over their local facilities. In some cases, FCC rules cap these charges, and, in the case of incumbent LECs, impose additional restrictions on their ability to change their charges. The FCC may modify its rules regarding LEC access charges, including both the caps and the restrictions on incumbent LECs, which could result in an increase in our termination and origination costs over time.

Interstate telecommunications carriers and VoIP providers are required to contribute to the federal Universal Service Fund (“USF”). The FCC is considering revising its USF mechanisms and the services considered when calculating the USF contribution. We cannot predict the outcome of these proceedings or their potential effect on our USF contributions. Some changes to the USF under consideration by the FCC may affect different entities more than others, and we may be disadvantaged as compared to our competitors as a result of FCC decisions regarding USF. In addition, the FCC may extend the obligation to contribute to the USF to certain services that we offer but that are not currently assessed USF contributions.

Voice-over-Internet Protocol (VoIP). VoIP services that permit subscribers to send calls to and receive calls from the traditional telephone network, known as interconnected VoIP services, are generally subject to the regulatory authority of the FCC. We offer such services. For many years the FCC has been considering whether to classify such services as “telecommunications services” or “information services” under the Communications Act. Information services are generally subject to less regulation than telecommunications services. However, the FCC has extended a number of regulatory obligations normally applicable to telecommunications services to VoIP services, irrespective of the lack of clarity regarding the classification of such services. These include (1) the obligation to contribute to the USF; (2) the obligation to comply with CALEA; (3) the obligation to comply with the FCC’s rules regarding protecting customer proprietary network information (“CPNI”); (4) the obligation to provide enhanced 911 emergency services (“E911”) services, and to disclose limitations on such services to end users; (5) the obligation to permit customers to keep their telephone number when changing from one carrier to another; (6) the obligation to deploy equipment and provide services that make reasonable accommodations for the needs of disabled persons and; (7) the obligation to pay a variety of regulatory fees; . We cannot predict what other regulatory obligations, if any, will be imposed on our VoIP operations, nor can we predict whether the FCC will eventually classify VoIP as a telecommunications service and, if it does, what additional regulatory obligations, if any, the FCC would choose to impose on such services. The uncertainty regarding the regulatory obligations applicable to interconnected VoIP services presents a number of situations which could have a material negative impact on our operating costs and profitability. These potential regulatory developments include:

 

   

In 2005, the FCC ruled that “nomadic” interconnected VoIP services are interstate in nature, and, therefore, that nomadic VoIP providers are not subject to most state-level public utility/common carrier regulations. We believe that our own VoIP service is subject to this ruling. While several states have asserted jurisdiction over “fixed” interconnected VoIP services, none has yet attempted to regulate nomadic VoIP. That said, we cannot predict whether any individual states would make such an effort, nor can we predict the outcome of any such effort.

 

   

We believe that our VoIP network is in compliance with the requirements of CALEA. However, we cannot predict whether law enforcement or the FCC will agree in all cases, nor can we predict whether we may be subject to fines or penalties if we are found not in compliance with CALEA.

 

   

With respect to our VoIP-related 911 obligations, we have contracted with a third-party provider that is a market leader in emergency 911 service solutions to provide these services. Our ability to expand our VoIP services in the future may depend on the ability of that provider to provide E911 access or on any additional 911-related obligations the FCC may impose. At present, and similar to many other VoIP providers, for some of our customers we cannot offer VoIP E911 services that route emergency calls in a manner fully consistent with the FCC rules. We are addressing this issue with our VoIP E911 solutions provider. The FCC may determine that our VoIP E911 solution for some of our customers

 

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does not satisfy the FCC’s requirements, in which case the FCC could require us to disconnect a significant number of our VoIP subscribers, which could have a material adverse effect on the Company’s financial position, results of operations and cash flows. In addition, the FCC is considering whether it should impose additional VoIP E911 obligations on interconnected VoIP providers including consideration of a requirement that interconnected VoIP providers automatically determine the physical location of their customer rather than allowing customers to manually register their location. We cannot predict the outcome of this proceeding, nor its impact on us, at this time.

 

   

The FCC’s CPNI rules, to which our VoIP operations are subject, are intended to protect customer information from unauthorized use or disclosure. We may be subject to enforcement actions including, but not limited to, fines, cease and desist orders, or other penalties if we fail to comply with the CPNI obligations.

 

   

Section 255 of the Communications Act and associated FCC rulings require traditional phone providers and manufacturers of associated equipment to ensure that their equipment and services meet certain obligations regarding access by persons with disabilities. The FCC has extended those requirement to providers of interconnected VoIP services and to manufacturers of specially designed equipment used to provide those services. While we believe that we are in compliance with these requirements, we can have no assurance that the FCC might not find us not to be in compliance, which could subject us to sanctions including fines.

 

   

The FCC has also extended to VoIP providers the obligations of Section 225 of the Communications Act, which (among other things) requires contributing to the Telecommunications Relay Services fund, and the offering of 711 abbreviated dialing for access to relay services. We may be subject to enforcement actions including, but not limited to, fines, cease and desist orders, or other penalties if we are not able to comply with them. For example, the FCC mandates that interconnected VoIP providers like us must transmit 711 calls to a relay center that facilitates the ability of speech- and hearing-impaired individuals to communicate. The FCC issued a temporary waiver of that requirement insofar as it requires such providers to transmit the 711 call to an “appropriate relay center,” meaning the relay center(s) serving the state in which the caller is geographically located or the relay center(s) corresponding to the caller’s last registered address. We are currently not able to route such calls in this manner, but we are working on implementing a call routing solution which will route 711 calls to the appropriate relay center as defined in the FCC’s order. We may be subject to enforcement actions including, but not limited to, fines, cease and desist orders, or other penalties if we are not able to comply with these new disability provisions.

 

   

The FCC now requires interconnected VoIP service providers like us to pay regulatory fees to the FCC. The assessment of these fees has increased our costs and reduced our profitability and caused us to increase the price of our retail service offerings.

State Regulation. Traditional long-distance calls for which the caller and recipient are both located in the same state are subject to regulation by that state. Our intrastate long-distance operations are therefore subject to various state laws and regulations, including, in most jurisdictions, certification and tariff filing requirements. Primus Telecommunications, Inc. (“PTI”), our principal operating subsidiary in the U.S., maintains the necessary certificate and tariff approvals, to provide intrastate long-distance service in 49 states and Puerto Rico. PTI also maintains the necessary certificate to provide local services in Puerto Rico. Some states also require the filing of periodic reports, the payment of various fees and surcharges and compliance with service standards and consumer protection rules. States often require prior approval or notification for certain stock or asset transfers or, in several states, for the issuance of securities, debt or for name changes. As a certificated carrier, consumers may file complaints against us at the public service commissions. Certificates of authority can generally be conditioned, modified, cancelled, terminated, or revoked by state regulatory authorities for failure to comply with state law and/or rules, regulations and policies of the state regulatory authorities. Fines and other penalties also may be imposed for such violations. Public service commissions also regulate access charges and other pricing for telecommunications services within each state. The RBOCs and other LECs have been seeking reduction of

 

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state regulatory requirements, including greater pricing flexibility which, if granted, could subject us to increased price competition. We may also be required to contribute to universal service funds in some states.

State Taxes and Fees Applicable to VoIP Services. We have historically not collected or remitted state or municipal taxes (such as sales and use, excise, utility user, and ad valorem taxes), fees or surcharges on the charges to our customers for our VoIP services. With limited exceptions, we do not believe that we have sufficient nexus in most states/local jurisdictions to be subject to state or municipal taxes, surcharges or other fees. In 2010, however, the FCC ruled that states may require interconnected VoIP service providers to contribute to state USF funds, and expressly deferred ruling on whether we must do so retroactively. We are still assessing the applicability of this ruling to our business and developing compliance plans. This ruling may expose us to other state and local assessments on our VoIP services, and we may be subject to retroactive liability for VoIP-specific taxes, fees and surcharges in a number of states and potentially, penalties and interest. Retroactive liability for such taxes, fees or surcharges, as well as penalties and interest, may adversely impact our financial position and we would not be able to recoup any of these liabilities from our customers. If we must collect such state taxes, fees and surcharges on a going-forward basis, we will likely pass such charges through to our customers. The impact of this price increase on our customers or our inability to recoup our costs or liabilities could have a material adverse effect on the financial position, results of operations and cash flows of our VoIP business.

Australia

The provision of our telecommunications services is subject to federal regulation in Australia. The two primary instruments of regulation are the Telecommunications Act 1997 and federal regulation of network access pricing and anti-competitive practices pursuant to the Trade Practices Act 1974 (the “Trade Practices Act”). The current regulatory framework came into effect in July 1997.

We are licensed as a carrier under the Telecommunications Act 1997, which permits us to own or operate transmission infrastructure that is used to supply carriage services to the public. With respect to providing carriage services to the public, we must comply with legislated “service provider” rules contained in the Telecommunications Act 1997 covering matters such as operator services, regulation of land access, directory assistance, provision of information to allow maintenance of an integrated public number database and itemized billing.

In December 2010 the Government introduced significant reform to the regulatory framework through the introduction of the Telecommunications Legislation Amendment (Competition and Consumer Safeguards) Act 2010. That legislation provided for the structural separation of Telstra (to create distinct retail and international carrier services operations), revised the legislative provisions that deal with interconnection pricing, and introduced additional consumer protection measures. The interconnection revisions establish a mechanism by which the terms and conditions of access to a declared service can be determined in advance by the Australian Competition and Consumer Commission (“ACCC”) (whereas previously these were determined through an arbitration process and were largely retrospective in application). The telecommunications specific provisions in the Trade Practices Act are intended to ensure fair and competitive access to essential facilities and monopoly services, and address anti-competitive conduct of carriers, particularly those with substantial market power such as Telstra. The right of access provisions also apply to any carrier that owns or controls essential infrastructure or services that have been declared by the ACCC on grounds that access should be provided for the purposes of competition. The recent reforms generally represent improvement in the conditions and prospects for competitors such as Primus, and should ultimately lead to better price certainty and less regulatory risk.

In April 2009 the Government announced its intention to construct a national broadband network (“NBN”). The government subsequently established NBN Co to construct and operate a fiber to the home NBN, with final appointments to the executive team made in early 2010. After a successful trial in Tasmania, a number of initial deployment sites have now been selected across mainland Australia for testing purposes. Work has commenced

 

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on these sites. NBN Co has announced a 9 1/2 year rollout and it is expected that legislation will be introduced within the next few months setting out the governance and regulatory framework for NBN Co. This development represents the prospect of long-term improvement in the conditions for industry competitors such as Primus Telecom, given the Government’s intention that NBN Co operate as a stand-alone international carrier services company, therefore removing some of the friction that currently exists between competitors and the (vertically integrated) monopoly international carrier services service provider, Telstra.

Two federal regulatory authorities principally exercise control over the broad range of issues affecting the operation of the Australian telecommunications industry. The Australian Communications & Media Authority (the “ACMA”) is the authority regulating matters including the licensing of carriers and technical matters, and the ACCC has the role of promotion of competition and consumer protection and in particular dealing with carrier to carrier interconnection and network access. Telstra, the dominant carrier and former Government owned monopoly, has historically challenged many of the key principles applied by the ACCC to access pricing, and has previously applied to the High Court of Australia to overturn its obligation to provide access to unbundled local loop lines (and also access to those lines pursuant to spectrum sharing). While that petition to the highest court in Australia was unsuccessful, over the course of many years Telstra has continued to lodge, mostly unsuccessful, challenges against ACCC regulatory decisions. Telstra has also lodged a number of exemption applications with the ACCC submitting that it should be exempted from an obligation to provide “regulated” international carrier services telecommunications services on various routes and locations in Australia. Some of these applications have been successful, particularly in respect to international carrier services line rental, the local carriage service and public switched telephone network originating access services supplied from certain CBD and metro exchanges, and also some transmission services where the ACCC considered sufficient alternative supply was available. There is a risk that Telstra will significantly increase its prices in respect of these exempt services and/or deny us access to essential services we need to compete.

It is not clear to what extent Telstra will continue to combat competition regulation and ACCC determinations given the passage of the recent reform legislation, the construction of a government owned “international carrier services-only” NBN, and the publicly announced expectation that Telstra will cooperate with NBN Co and migrate its services to the NBN as part of a (presently non-binding) “heads of Agreement” reached with NBN Co. At this time Telstra is actively engaging in regulatory proceedings conducted by the ACCC to determine interconnection pricing to apply to regulated international carrier services (WLR, LCS, PSTN, SSS, transmission and ULL services, to the extent they remain regulated access services and are not exempted). Telstra is petitioning for higher rates and the ACCC is expected to finalize 3 to 5 year pricing determinations for these services over the course of 2011. There are limited rights of review (restricted to judicial review proceedings) that Telstra (or access seekers) are able to pursue in respect to these determinations. To the extent the access determinations are favorable; Primus will be seeking to adopt those regulatory pricing determinations over the course of 2011(on expiry of current pricing agreements for relevant regulated international carrier services)

In December 2009 the Government announced a policy to require ISPs to impose mandatory filtering of certain objectionable and illegal material through blocking access to specified URLs. This initiative has presently been delayed while the Government has directed a review of content classification rules and at this stage it’s not clear what direction the policy will take and consequently what cost and operational implications this policy could have on Primus. More detail on these implications should emerge over coming months.

In addition to the Trade Practices Act and the Telecommunications Act 1997, the industry is also subject to other federal legislation, state legislation, various regulations pursuant to delegated authority and legislation, ministerial declarations, codes, directions, licenses, and statements of Australian government policy. Some of the industry codes are being reviewed over the course of 2011; however we do not anticipate these revisions to lead to any material detrimental outcomes for Primus.

 

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Licensed carriers are subject to charges that are intended to cover the costs of regulating the telecommunications industry and are obliged to comply with license conditions (including obligations to comply with the Telecommunications Act 1997 and with the telecommunications access regime and related facilities access obligations). Carriers also must meet the cost of the Universal Service Obligations (“USO”), which assists in providing all Australians, particularly in remote areas, with reasonable access to standard telephone services. Telstra is currently the sole universal service provider. Since 2000, the responsible Minister of the Australian government may make a determination of the amount of USO subsidies, with advice from the ACMA. No methodology is provided in legislation and the Minister could make a determination of a Universal Service Levy (“USL”) that would be material to us. However, the USL has been set previously at levels that we do not consider to have a material impact. The ACMA implemented a determination for 2010 that is consistent with earlier determinations. However, the Government has since moved to indicate a preference that the industry be locked into subsidizing rural and regional services for a further 10 year period while the NBN is being rolled out. The Government is currently consulting on this proposal, which could impose an increased burden on us.

The Government has recently commenced a review of communications and media regulation in recognition of ‘convergence’. At this time the Government has published the terms of reference, and the inquiry will proceed over the course of 2011. It’s not clear what may result from the review, however we note there have been calls for better harmonization of regulation across the various content platforms.

Fair Trading Practices. The ACCC enforces legislation (the Trade Practices Act) for the promotion of competition and consumer protection, and is responsible for regulating rights of access to services (including pricing for access) and interconnection. The ACCC can issue a competition notice to a carrier which has engaged in anti-competitive conduct. Where a competition notice has been issued, the ACCC can seek pecuniary penalties, and other carriers can seek damages. Under the Trade Practices Act other carriers can also initiate their own proceedings in the event of violation of competition laws.

Consumer Protection. The ACCC’s consumer protection role as set out in the Trade Practices Act is also shared with other state based regulators. Each state has its own Fair Trading Act administered by consumer affairs authorities and ACMA undertakes some activities in consumer protection predominantly in connection with industry codes of conduct. The Trade Practices Act has recently been amended to prohibit “unfair terms” contained in standard form agreements. The ACCC is presently working with the telecommunications industry to ensure compliance and we expect satisfactory resolution. As a service provider we must also be a member of the Telecommunications Industry Ombudsman (“TIO”) Scheme. The TIO is responsible for handling complaints from consumers about carriers and Internet service providers. The TIO may impose financial penalties upon carriers that do not satisfactorily deal with consumer complaints.

Canada

We are a reseller of telecommunications services in Canada. Because we do not own or operate transmission facilities in Canada, we are not subject to direct regulation by the CRTC pursuant to the Telecommunications Act (as amended, the “Canadian Telecommunications Act”). We may resell long-distance service, local telephone service, wireless service and Internet access without the regulation of our rates, prices or the requirement to file tariffs. In addition, as described below, as a reseller we are not subject to restrictions on foreign ownership or control.

Regulation. The CRTC has issued various decisions and constructed certain frameworks that directly affect our obligations and operations as a reseller.

In 2000, the CRTC implemented a revenue-based contribution regime to replace the per minute contribution charge formerly in place to support universal access. The revenue-based contribution mechanism collects from a wider base of telecommunications service providers, including resellers, and has lowered our contribution expenses since 2001.

 

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We are required to hold a license to provide Basic International Telecommunications Services (a “BITS” license) pursuant to which we are subject to the requirements not to engage in anti-competitive conduct in relation to the provision of international telecommunications services and the requirement to observe the contribution regime described immediately above.

We operate as a local services reseller, both in reselling CLEC local services and in the provision of local VoIP services interconnected with the public switched telephone network. As such, we are subject to a number of obligations that are passed on through our contractual arrangements with LECs from which we purchase services. These include:

 

   

Registration. We are required to be registered with the CRTC to provide these services.

 

   

The provision of 911 services. For fixed services such as our circuit-switched local services, we are required to provide the same standard of 911 service as the underlying LEC. For our VoIP services, however, which are considered to be “nomadic” by the CRTC, we are required to implement an interim solution under which the CRTC requires us to employ the zero-dialed emergency routing services provided by the ILEC in its serving territory in order to route 911 calls to an operator, who determines the caller’s location in the first instance. A CRTC Interconnection Steering Committee submitted a report to the CRTC in 2007 establishing some of the parameters for a permanent solution for the provision of emergency services by nomadic VoIP providers. A CRTC proceeding is currently underway to identify remaining parameters for such a solution.

 

   

Customer notifications. Local VoIP providers are subject to stringent and detailed customer notification requirements regarding the limitations associated with their 911 services. These include warnings to be included in all of the providers’ print, online and broadcasting marketing materials.

 

   

Number portability. Although local voice resellers and VoIP providers must obtain their numbers from a LEC, they are subject to the requirement to permit porting out of local numbers.

 

   

Privacy safeguards. Local resellers are required to provide certain privacy safeguards, including the provision of the privacy indicator, automated universal per-call blocking of calling line identification and others. To the extent that VoIP providers are unable to provide these privacy safeguards, they are required to inform their customers of this fact.

 

   

Message Relay Service. All local resellers, including VoIP providers, are required to provide access to message relay service (“MRS”). This is to include both Teletypewriter Relay Service (“TTY Relay”) and, as of July 21, 2010, Internet Protocol Relay Service (“IP Relay”).

We also operate as a non-facilities based Internet service provider, both as a reseller of high speed Internet service and a digital subscriber line provider. As such, we are subject to certain obligations passed on through our contractual arrangements with LECs from which we purchase services. These include:

 

   

Registration. We are required to be registered with the CRTC to provide these services.

 

   

Disclosure. All Internet service providers are required to disclose the technological and economic traffic management practices that are applied to their Internet services.

We are also subject to other obligations related to our operations. These include:

 

   

Compliance Filings. We are required to satisfy various compliance and reporting obligations to the CRTC.

 

   

Digital Network Service Restrictions. We are obligated to not partake in the simple resale of digital network services, which we use to access certain customers and interconnect the sites where we have located equipment.

In a Price Cap decision issued in May 2002, the CRTC lowered the prices incumbent providers can charge competitors for a range of competitor services, i.e., certain facilities and services required by competitors to

 

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provide telecommunications services to their end-customers and mandated by the CRTC (see discussion of the new framework for international carrier services, below). The Price Cap formula set out in this decision required the ILECs to revise the rates of selected services (primarily local telecommunications services) yearly by the rate of inflation minus a productivity offset of 3.5%. The rates of other service groupings were “capped” and others were “uncapped” with upward pricing constraints. The CRTC typically relied on a four-year Price Cap period, but in 2005 it decided to extend the period by one year in order to complete a public proceeding to establish the parameters of the next Price Cap period. In a decision dated April 2007, the CRTC issued the parameters of the new Price Cap framework. The new Price Cap framework is similar to the previous framework in that rates for service groupings are “capped,” “uncapped” and subject to upward or downward pricing constraints. The productivity offset still applies to selected services. CRTC decided not to impose an expiry date for the current Price Cap framework. Accordingly, the current Price Cap framework continues to allow for certain savings on competitor services for resellers.

In 2005 the federal government appointed a Telecom Policy Review Panel to review Canada’s telecommunications policy framework. The Panel’s report was released in March of 2006. Following the release of the report, the federal government issued a Policy Direction to the CRTC on December 18, 2006 that required, among other things, that in exercising its powers and duties, it rely on market forces to the maximum extent feasible. The Policy Direction has had an impact on the CRTC’s latest decision involving essential facilities and international carrier services, described immediately below. The Policy Direction directs the CRTC to take into account the principles of technological and competitive neutrality, the potential for incumbents to exercise market power in the international carrier services and retail markets for the service in the absence of mandated access to international carrier services, and the impediments faced by new and existing carriers seeking to develop competing network facilities.

On March 3, 2008, the CRTC issued a decision revising the definition of an essential service and the classifications and pricing principles under which facilities-based carriers are to offer international carrier services to competitors at regulated rates. Under this revised regulatory framework for international carrier services, the CRTC has classified existing international carrier services into six categories: essential, conditional essential, conditional mandated non-essential, public good, interconnection, and non- essential subject to phase-out. More than a third of international carrier services will be deregulated by 2012, including intra-exchange transport services which we use to interconnect our sites where we have located DSLAM equipment. The area likely to have the next-largest impact involves high-speed access to business services, which is to be deregulated in 2013.

In a regulatory policy update related to the new wholesale framework, dated January 2009, the CRTC determined that it would be appropriate to allow for negotiated agreements for certain services that were mandated pursuant to the wholesale framework (i.e., those services classified as “conditional essential” and “conditional mandated non-essential”). Accordingly, we now have the ability to purchase these services on a tariff basis or through a negotiated agreement. Though there has not been a significant uptake in the purchase of services on a negotiated basis, this continues to provide us with flexibility to capitalize on preferable arrangements that may arise.

In addition to the above, our competitors filed applications to review or appeal other aspects of the CRTC’s new wholesale framework, as well as other wholesale data and Internet service obligations. In a decision dated January 2009, the CRTC withdrew a directive contained in the wholesale framework decision that would have required the ILECs to provide unbundled access to the facilities used to provide Internet service to all end-users that they are able to serve. In parallel, the CRTC initiated a proceeding to consider the appropriateness of mandating certain ILEC and cable company wholesale high-speed access services, including unbundled access to next-generation facilities. In March 2009, several of our competitors applied to the Governor in Council for the variance or rescission of CRTC decisions related to wholesale data or Internet services, in which the CRTC directed the ILECs to provide wholesale ADSL services at speeds equivalent to their retail offerings. In an Order in Council dated December 2009, the Governor in Council referred these decisions back to the CRTC for reconsideration. In a decision dated August 2010, the CRTC upheld its decision to require the ILECs and cable companies’ to provide wholesale Internet services at speeds equivalent to their retail offerings. In the same

 

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decision, the CRTC denied competitor requests for unbundled access to the ILEC and cable company facilities used to provide Internet services, including higher-speed services, to all end-users that they are able to serve.

In a decision dated October 2009, the CRTC set out a framework which will guide the implementation of Internet traffic management practices by ISPs and facilitate reviews of such practices against that framework. The Commission expressed clear preference for the use of economic traffic management practices relative to technological traffic management practices, as they provide greater control to the market and the customer. The framework for technological traffic management practices is focused on four rules: Internet traffic management practices must be designed to address the stated need and achieve the stated purpose and effect, and nothing else; they must result in as little discrimination or preference as reasonably possible; they must result in as little harm to end-users and others as reasonably possible; and economic approaches, such as network investment, would not have reasonably addressed the need or effectively achieved the same purpose. As a result of this decision, we may continue to utilize the traffic management practices that we have implemented on our retail Internet service that is provided via ILEC unbundled facilities obtained through arrangements with CLECs. However, we are obliged to disclose any traffic management practices, economical or technological, that we employ and to notify our customers of any changes to such practices, with a 30-day wait period after notification before we can implement them. In addition, our arrangements with ILECs or with CLECs require that the practices we implement respect the above-mentioned framework. Finally, the CRTC also determined that it would not require prior approval of the continued application of traffic management practices by the providers of wholesale Internet access services, provided that these are not more restrictive than those imposed on its retail customers and do not affect its wholesale customers disproportionately. As a result, our customers that are served via wholesale Internet services are, or may be, subject to the traffic management practices of the wholesale provider.

In decisions dated August 2009 and May 2010, the CRTC granted interim and final approval to an application by an ILEC, Bell Canada, to implement usage-based billing on its wholesale Internet access service. In a subsequent October 2010 decision upon an appeal by Bell Canada, the CRTC removed certain conditions it had imposed on Bell Canada in the May 2010 decision and approved the implemention of usage-based billing in the first quarter of 2011. In a decision dated January 2011, the CRTC directed all ILECs and cable carriers who impose usage-based billing on their wholesale Internet services to apply wholesale usage-based billing rates at 85% of the rates applied to their equivalent retail services. Pursuant to political and public pressure prior to implementation, the CRTC has initiated a new proceeding to review the usage-based billing framework for wholesale Internet access services. This proceeding is expected to complete in 2011. If the decisions related to usage-based billing stand, it will require us to pass down the cost of usage-based billing incurred by us through the Internet usage of our end-users that are served via Bell Canada’s wholesale Internet access service to those customers. It is possible that other ILECs will also implement usage-based billing on their wholesale Internet services. This would also permit us to implement usage-based billing on our retail Internet service that is provided via ILEC unbundled facilities obtained through CLEC arrangements.

In an application dated June 2009, an ILEC, Bell Canada, requested approval to increase the tariffed rates for its unbundled local loops. Increases in the tariffed rates for these unbundled facilites will increase the cost of the unbundled facilities that we obtain through CLEC arrangements and use to provide retail telephone and Internet services. In a decision dated January 2011, the CRTC approved certain rate increases and rate decreases for Bell Canada’s unbundled local loops. In the three unbundled local loop rate bands where Primus operates, the monthly rates decreased by 20 percent and increased by 6 percent and 10 percent, as opposed to the requested increases of 25 percent, 62 percent and 36 percent. In addition, there were certain increases and decreases to non-recurring service charges for unbundled local loop orders. An application has been submitted by another party to appeal the rate increases. If the rate increases stand, it is expected that these cost increases will be passed down to our end-users.

Competition. Long-distance competition has been in place in Canada since 1990 for long-distance resellers and since 1992 for facilities-based carriers. In June 1992, the CRTC issued Telecom Decision CRTC 92-12 requiring the ILECs to interconnect their networks with their facilities-based, as well as reseller, competitors. Since 1994, the ILECs have been required to provide “equal access,” which eliminated the need for customers of competitive long-distance providers to dial additional digits when placing long-distance calls. Bell Canada and

 

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TELUS Corporation are the two largest ILECs in Canada, with the former operating mainly in the Canadian provinces of Ontario and Quebec and the latter operating mainly in the Canadian provinces of British Columbia and Alberta. MTS Allstream, Inc., the ILEC serving the Canadian province of Manitoba, has acquired Allstream, Inc. (formerly AT&T Canada Corp.) in 2004 and is now competing nationally as well. The other nationwide competitor, Call-Net Enterprises Inc., which operated as Sprint Canada, was acquired by Rogers in 2005. Cable TV companies, such as Rogers, Shaw Communications Inc. and Vidéotron Limited, launched their local telephone services in July 2005 and have had a great deal of success thus far. Their local service is provided either via their cable network or acquired CLEC (i.e., Call-Net) or on a resold basis from an underlying LEC.

As markets become competitive, the Canadian Telecommunications Act permits the CRTC to forbear from regulating the rates and terms of service of Canadian carriers. The long-distance rates of Canadian ILECs have largely been forborne from regulation since 1997. The ILECs’ rates for retail Internet services were forborne from regulation in 1999. On April 6, 2006, the CRTC established a framework for forbearance in respect of local services by defining the geographic markets in which the CRTC will forbear from regulating as the criteria for deregulation are met, and by establishing these criteria. On April 4, 2007 the Governor-in-Council varied this framework by reducing the size of the geographic market in which the criteria are to be met and by relaxing the criteria to be met. As of June 2009 approximately 77% of all residential local lines and 68% of commercial local lines in Canada have been deregulated.

The Competition Bureau issued an Information Bulletin on the Abuse of Dominance Provisions as applied to the Telecommunications Industry on June 6, 2008, in which the Bureau describes its approach in reviewing abuse of dominance complaints in telecommunications markets where the CRTC has forborne from regulating conduct.

On March 12, 2009, the Canadian Competition Act was amended to provide the Competition Tribunal with the power to order the payment of an administrative monetary penalty of up to 15 million Canadian dollars in cases of abuse of dominant position. Subject to any relevant defenses, these amendments apply to telecommunications service providers.

Foreign Ownership Restrictions. Under the Canadian Telecommunications Act and the Radiocommunication Act, and certain regulations promulgated thereunder (i.e., the Radiocommunication Regulations and the Canadian Telecommunications Common Carrier Ownership and Control Regulations), foreign ownership restrictions apply to telecommunications common carriers and radiocommunication carriers (“Canadian carriers”), a concept which includes, for example, CLECs and microwave license holders, but not to companies, such as resellers, that do not own or operate transmission facilities. Accordingly, resellers may be wholly foreign-owned and controlled.

The restrictions applicable to Canadian carriers limit the amount of foreign investment in Canadian carriers to no more than 20% of the voting equity of a Canadian carrier operating company and no more than 33 1/3% of the voting equity of a Canadian carrier holding company. The restrictions also limit the number of seats which may be occupied by non-Canadians on the board of directors of a Canadian carrier operating company to 20%. In addition, under Canadian law, a majority of Canadians must occupy the seats on the board of directors of a Canadian carrier holding company. Although there is no restriction on foreign investors holding non-voting equity in a Canadian carrier, the law requires that the Canadian carrier not be “controlled in fact” by non-Canadians. The concept of “control in fact” is very broad, and takes into account all commercial arrangements between the Canadian carrier and third parties.

The Canadian issuer, along with several other telecommunications service providers, have sought to have the Canadian government review foreign ownership restrictions with a view to lowering these restrictions or eliminating them. In April 2003, the Industry Committee of the House of Commons recommended removing these restrictions in their entirety, for both telecommunications common carriers and for broadcasting distribution undertakings (“BDUs”) such as cable companies. In June 2003, however, another committee of the House of Commons (the Heritage Committee) expressed concerns that changes in ownership restrictions for either telecommunications common carriers or BDUs could have an adverse impact on the broadcasting system. In its September 2003 response to the Industry Committee’s recommendation, the government acknowledged the

 

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appropriateness of the committee’s conclusion that removing foreign investment restrictions would benefit the telecommunications industry. However, the government also noted the concerns expressed by the Heritage Committee. The government recognized that it has a responsibility to determine how best to reconcile the conflicting recommendations of the two committees and undertook to analyze this question and be in a position to examine possible solutions by the spring of 2004. However, no solutions were brought forward in 2005 although the issue was raised once again by the Telecom Policy Review Panel (“TPRP”), who recommended in its Final Report that the foreign ownership restrictions be relaxed. In July 2007, Industry Canada announced the creation of the Competition Policy Review Panel (the “Panel”), which was asked to provide recommendations to the government on how to enhance Canadian competitiveness. The Panel’s duties included a sector specific review of the current telecommunications foreign ownership restrictions. We filed a submission in favor of eliminating the restrictions and also presented options to accommodate concerns such as national security. In its report dated June 2008, the Panel supported the TPRP’s recommendations regarding the easing of foreign ownership restrictions. Specifically, the Panel recommended a two phase approach to liberalize the Canadian foreign ownership restrictions. The initial phase would permit foreign companies to establish new telecommunication companies or acquire existing telecommunication companies with less than a 10% share of the Canadian telecommunication market. The second phase would consist of further liberalization upon a review of existing cultural policies and an assessment of the impact of the foreign investment resulting from the initial phase. In its March 2010 budget, the Government indicated support for the removal of foreign ownership rules and moved immediately to remove the foreign ownership restrictions on Canadian satellites. Industry Canada subsequently announced another consultation to again consider the removal of the foreign ownership restrictions in the telecommunications industry. We filed a submission in favor of the model proposed by the TPRP and the Panel or, alternatively, the complete removal of the restrictions. However, despite the support of the TPRP and the Panel it is premature to predict whether any recommendation to remove the restrictions for telecommunications common carriers will be implemented. In July 2009, the CRTC issued a new Canadian ownership and control review policy which subjects foreign investment arrangements in Canadian carriers to more formal procedures. These new procedures include greater public scrutiny of the investment arrangements, in some cases extending to detailed disclosure requirements, and may involve significant delays and limit investors’ opportunity to consult informally with the regulator.

Employees

The following table summarizes the number of our employees as of December 31, 2010 by region:

 

     Total  

Canada

     745   

Australia

     574   

United States

     125   

India

     136   

Europe (International Carrier Services)

     45   

Brazil

     47   
        

Total

     1,672   
        

We have never experienced a work stoppage. Only some of our employees in Australia are represented by a labor union and covered by a collective bargaining agreement. We believe that our employee relations are positive.

Other Information

Our Internet address is www.ptgi.com. We make available free of charge through our Internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to the Securities Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the United States Securities and Exchange Commission (“SEC”).

 

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ITEM 1A. RISK FACTORS

A wide range of factors could materially affect the performance of Primus and the Arbinet business, which we acquired on February 28, 2011. In addition to factors affecting specific business operations and the financial results of those operations identified elsewhere in this report, the following factors, among others could adversely affect our operations:

The following is not intended as, and should not be construed as, an exhaustive list of relevant risk factors. There may be other risks that are relevant to an investor’s particular circumstances or generally.

RISKS RELATED TO OUR INDUSTRY AND OVERALL BUSINESS

Continuing global economic conditions could adversely affect our business.

The global economy and capital and credit markets have been experiencing exceptional turmoil and upheaval. Many major economies worldwide entered significant economic recessions beginning in 2007 and continue to experience economic weakness even though economies have begun to show signs of recovery. Ongoing concerns about the systemic impact of potential long-term and widespread recession and potentially prolonged economic recovery, volatile energy costs, geopolitical issues, the availability, cost and terms of credit, consumer and business confidence, substantially increased and increasing unemployment rates and the crisis in the global housing and mortgage markets have all contributed to increased market volatility and diminished expectations for both established and emerging economies, including those in which we operate. In the second half of 2008, added concerns fueled by government interventions in financial systems led to increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions have contributed to significant economic uncertainty, which has not subsequently improved in any significant way globally. The availability, cost and terms of credit also have been and may continue to be adversely affected by illiquid markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce credit to businesses and consumers. These factors have led to a substantial and continuing decrease in spending by businesses and consumers over the past several years, and a corresponding decrease in global infrastructure spending. Continued turbulence in the U.S. and international markets and economies and prolonged declines in business and consumer spending may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers, including our ability to refinance maturing debt instruments and to access the capital markets and obtain capital lease financing to meet liquidity needs. A continuation of this adverse environment may have an impact on our business and financial condition in the following ways as well as in other ways that we currently cannot predict.

 

   

Potential risk in refinancing outstanding debts: Although none of our major debt instruments are scheduled to mature before 2013, at the earliest, if the volatility in the global capital markets were to continue, our ability to refinance our existing indebtedness when due could be severely constrained. See “—Risks Associated with Our Liquidity Needs and Debt Securities.” Any such refinancing could require significantly more expensive interest rates and covenants that restrict our operations to a significantly greater extent.

 

   

Negative impacts from increased financial pressures on customers: Uncertainty about current and future global economic conditions and credit markets may cause consumers, business and governments to defer purchases in response to tighter credit, decreased availability of cash and credit, and declining business and consumer confidence, any of which may affect the usage of our services by the customers and the ability of those customers to pay for our services. Accordingly, future demand for our products and services could differ from our current expectations. Similarly, our customers may experience liquidity issues of their own that adversely affect our ability to collect amounts due from them in a timely fashion or at all. In addition, if the global economy and credit markets continue to deteriorate or cease to recover and our future sales decline, our financial condition and results of operations would be adversely impacted.

 

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Strengthening of the United States Dollar (“USD”) against certain foreign currencies reduces the amount of USDs generated from foreign currency payments from our foreign operating subsidiaries and may adversely affect our results of operations and our ability to service our debt.

A significant portion of our net revenue (about 85% for the year ended December 31, 2010) is derived from sales and operations outside the U.S. The reporting currency for our consolidated financial statements is the USD. Our foreign operating subsidiaries, including our largest operating subsidiaries in Canada and Australia, generate cash in their respective local currencies and fluctuations in exchange rates can have a material adverse impact on amounts of USDs transferred to U.S. parent entities. In the future, we expect to continue to derive a significant portion of our net revenue (which is a substantial source for servicing our significant debt obligations at the parent entity level, as well as a source for making principal payments) and incur a significant portion of our operating costs outside the U.S., and changes in exchange rates have had and may have a significant, and potentially adverse, effect on our results of operations.

From June 30, 2008 through December 31, 2008, the Canadian and Australian dollars (“CAD” and “AUD,” respectively) declined by 17% and 28%, respectively, relative to the USD, and this has had a material adverse impact on amounts of USDs transferred to U.S. parent entities. Conversely, from December 31, 2008 to December 31, 2009, the CAD and AUD increased by 11% and 35%, respectively. From December 31, 2009 to December 31, 2010, the CAD and AUD increased by 5% and 10%, respectively. Due to the large percentage of our operations conducted outside of the U.S., and the cash transfers from these foreign operating subsidiaries to the U.S. parent, a strengthening of the USD relative to one or more of the foregoing foreign currencies could have an adverse impact on future results of operations and could adversely affect our ability to service or repay our consolidated indebtedness and obligations.

We historically have not engaged in hedging transactions. The exposure of our income from operations to fluctuations in foreign currency exchange rates is reduced in part because a majority of the costs that we incur in connection with our foreign operations are also denominated in local currencies. In addition, the operations of affiliates and subsidiaries in foreign countries have been funded with investments and other advances denominated in foreign currencies. Historically, such investments and advances have been long-term in nature, and we accounted for any adjustments resulting from currency translation as a charge or credit to accumulate other comprehensive loss within the stockholders’ deficit section of our consolidated balance sheets. In 2002, agreements with certain subsidiaries were put in place for repayment of a portion of the investments and advances made to those subsidiaries. As we anticipate repayment in the foreseeable future of these amounts, we recognize the unrealized gains and losses in foreign currency transaction gain (loss) on the consolidated statements of operations, and depending upon changes in future currency rates, such gains or losses could have a significant, and potentially adverse, effect on our results of operations.

We are substantially smaller than our major competitors, whose marketing and pricing decisions, and relative size advantage could adversely affect our ability to attract and to retain customers and are likely to continue to cause significant pricing pressures that could adversely affect our net revenues, results of operations and financial condition.

The local, long-distance, Internet, broadband, digital subscriber lines (“DSL”), data and hosting and wireless telecommunications industry is significantly influenced by the marketing and pricing decisions of the larger business participants. Prices in the long-distance industry have continued to decline in recent years and, as competition continues to increase within each of our service segments and each of our product lines, we believe that prices are likely to continue to decrease. The most significant competitors in our primary markets include:

 

   

United States: AT&T Inc., Verizon Communications Inc., Qwest Communications International Inc. and other incumbent carriers, cable companies, including Comcast Corporation, Time Warner Cable Inc., Cablevision Systems Corporation and Charter Communications, Inc., other competitive local exchange carriers, including PaeTec Communications, Inc., Time Warner Telecom Inc., XO Communications Services, Inc. and Frontier Communications Corp., independent VoIP providers,

 

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including Vonage Holdings Corp and Cbeyond, Inc., wireless carriers in the U.S., including Verizon Communications Inc., AT&T Inc., Sprint Corp., T-Mobile USA Inc., MetroPCS Communications, Inc. and Leap Wireless International, Inc., and web based companies, including Skype Technologies S.A. and Google Inc.;

 

   

Australia: Telstra, SingTel Optus Pty Limited, Telecom New Zealand Limited, iiNet Limited, SP Telemedia Limited (known as TPG), Macquarie Telecom Group Ltd. and other smaller national and regional service providers and resellers.; and

 

   

Canada: TELUS, Bell Canada, MTS Allstream, Inc., Saskatchewan Telecommunications, wireless providers, including Rogers, TELUS, Bell Canada, Bragg Communications Inc., COGECO Inc., Quebecor Inc. and Shaw Communications, Inc., cable companies, and other service providers and resellers including Globalive Communications Corp. in Canada.

Customers frequently change local, long-distance, wireless, broadband providers, and ISPs in response to the offering of lower rates or promotional incentives, increasingly as a result of bundling of various services by competitors. Moreover, competitors’ VoIP and broadband product rollouts have added further customer choice and pricing pressure. As a result, customers generally can switch carriers and service offerings at their discretion with little notice to us. Competition in all of our markets is likely to remain intense, or increase in intensity and, as deregulatory influences affect markets outside the U.S., competition in non-U.S. markets is increasing to a level similar to the intense competition in the U.S.

The Arbinet business faces competition for its voice trading services from communication services providers’ legacy processes and new companies that may be able to create centralized trading solutions that replicate Arbinet’s voice trading platform. The Arbinet business’ PrivateExchange and AssuredAxcess solutions may compete with communication services providers’ legacy processes, communication services providers themselves and potentially other companies that provide software and services to communication services providers. The Arbinet business faces competition for its data trading services from Internet service providers and Internet capacity resellers, and to a lesser extent, software-based, Internet infrastructure companies and Internet network service providers. These companies may be more effective in attracting voice traffic than the Arbinet Exchange, (“the Exchange”).

Once communications services providers have established business relationships with competitors to the Arbinet business, it could be extremely difficult to convince them to utilize the Exchange. These competitors may be able to develop services or processes that are superior to Arbinet’s services or processes, or that achieve greater industry acceptance. Where the Arbinet business competes with legacy processes, it may be particularly difficult to convince customers to utilize the Exchange. Since the Exchange provides full disclosure of prices offered by participating sellers on an anonymous basis, buyers may choose to purchase network capacity through the Exchange instead of sending traffic to their existing suppliers at pre-determined, and often higher, contract prices. If suppliers of communications capacity fear or determine that the price disclosure and spot market limit order mechanisms provided by the Exchange will “cannibalize” the greater profit-generating potential of their existing businesses, they may choose to withdraw from the Exchange. If participants withdraw from the Exchange in significant numbers, it could cause the Exchange to fail and materially harm the Arbinet business.

Many of our competitors are significantly larger than us and have substantially greater financial, technical and marketing resources, larger networks, a broader portfolio of service offerings, greater control over network and transmission lines, stronger name recognition and customer loyalty, long-standing relationships with our target customers and lower debt-leverage ratios. As a result, our ability to attract and retain customers may be adversely affected. Many of our competitors enjoy economies of scale that result in low cost structures for transmission and related costs that could cause significant pricing pressures within the industry.

Several long-distance carriers in the U.S., Canada and Australia and the major wireless carriers and cable companies have introduced pricing and product bundling strategies that provide for fixed, low rates or unlimited

 

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plans for domestic and international calls. This strategy could have a material adverse effect on our net revenue per minute, results of operations and financial condition if our pricing, which we set to remain competitive, is not offset by similar declines in our costs. We compete on the basis of price, particularly with respect to our sales to other carriers, and also on the basis of customer service and our ability to provide a variety of telecommunications products and services. If such price pressures and bundling strategies intensify, we may not be able to compete successfully in the future, may face quarterly revenue and operating results variability, and may have heightened difficulty in estimating future revenues or results.

Given strong competition in delivering individual and bundled local, wireless, broadband, DSL, VoIP services, we may not be able to operate successfully or expand these parts of our business.

We have accelerated initiatives to become an integrated wireline, wireless and broadband service provider in order to counter competitive pricing pressures initiated by large incumbent providers in certain of the principal markets where we operate and to stem the loss of certain of our wireline voice and dial-up ISP customers to our competitors’ bundled wireline, wireless and broadband service offerings. Our primary competitors include incumbent telecommunications providers, cable companies and other ISPs that have a significant national or international presence. Many of these operators have substantially greater resources, capital and operational experience than we do. We are experiencing increased competition from traditional telecommunications carriers, cable companies and other new entrants that have expanded into the market for broadband, VoIP, Internet services, data and hosting and traditional voice services. In addition, regulatory developments may impair our ability to compete. Therefore, future operations involving these individual or bundled services may not succeed in the competitive environment, and we (1) may not be able to expand successfully; (2) may experience margin pressure; (3) may face quarterly revenue and operating results variability; (4) may have limited resources to develop and to market the new services; and (5) have heightened difficulty in establishing future revenues or results. As a result, there can be no assurance that we will reverse revenue declines in our traditional long-distance voice and dial-up ISP services or maintain or increase revenues or be able to generate sufficient income from operations or net income in the future or on any predictable or timely basis.

Our positioning in the marketplace and intense domestic and international competition in these services places a significant strain on our resources, and if not managed effectively, could result in operational inefficiencies and other difficulties.

Our positioning in the marketplace to focus on Growth Services segments of the telecom market, including broadband, IP-based voice, local, wireless, data and data center solutions may place a significant strain on our management, operational and financial resources and increase demand on our systems and controls. However, the local and long-distance telecommunications, data, broadband, Internet, VoIP, data and hosting and wireless industries are intensely competitive, present relatively limited barriers to entry in the more deregulated countries in which we operate and involve numerous entities competing for the same customers. Recent and pending deregulation in various countries may encourage new entrants to compete, including ISPs, wireless companies, and cable television companies, who could offer voice, broadband, Internet access and television services, and electric power utilities, who could offer voice and broadband Internet access. For example, the U.S. and many other countries have committed to open their telecommunications markets to competition pursuant to an agreement under the World Trade Organization which began on January 1, 1998. Further, in the U.S., the major landline incumbent carriers (including AT&T Inc. and Verizon Communications Inc.) have for many years also provided long-distance services, and previously independent long-distance providers (including AT&T Inc. and MCI Inc.) have been acquired by the landline incumbents. In addition, many entities, including large cable television companies (including Comcast Corporation, Time Warner Cable Inc., Cablevision Systems Corporation and Charter Communications, Inc.) and utilities have been allowed to enter both the local service and long-distance telecommunications markets.

To manage our market positioning effectively, we must continue to implement and improve our operational and financial systems and controls, invest in critical network infrastructure to expand its coverage and capacity including the data centers expansion, maintain or improve our service quality levels, purchase and utilize other

 

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transmission facilities, evolve our support and billing systems and train and manage our employee base. If we inaccurately forecast the movement of traffic onto our network, we could have insufficient or excessive transmission facilities and disproportionate fixed expenses. As we proceed with our development, operational difficulties could arise from additional demand placed on customer provisioning and support, billing and management information systems, product delivery and fulfillment, support, sales and marketing, administrative resources, network infrastructure, maintenance and upgrading. For instance, we may encounter delays or cost-overruns or suffer other adverse consequences in implementing new systems when required, such as our need to off-shore certain functions. In addition, our operating and financial control systems and infrastructure could be inadequate to ensure timely and accurate financial reporting, which could impact debt covenant compliance.

We have experienced significant historical, and may experience significant future, operating losses and net losses which may hinder our ability to meet our debt service or working capital requirements.

As of June 30, 2009, the Predecessor Company had an accumulated deficit of $1.06 billion. Predecessor incurred net losses of $149.2 million in 2005, $238.0 million in 2006 and $25.0 million in 2008. During the year ended December 31, 2007, Predecessor recognized net income of $15.7 million, of which $32.7 million of revenue was related to the positive impact of foreign currency transaction gains. Even with the elimination of our significant accumulated deficit and the reduction in indebtedness through our reorganization under Chapter 11 in 2009, future losses may continue. In this regard, the Successor Company incurred a net loss of $19.1 million in 2010.

In addition, at September 30, 2010, Arbinet’s accumulated deficit was $134.4 million. Arbinet incurred a net loss of $8.7 million, $14.9 million, $6.9 million, and $0.4 million for the years ended 2009, 2008, 2007 and 2006, respectively. It is expected that the Arbinet business will incur significant future expenses, particularly with respect to the development of new products and services, deployment of additional infrastructure, and expansion in strategic global markets. In order for the Arbinet business to achieve profitability, it must: increase the usage of the Exchange by the members and carrier services customers and attract new customers in order to improve the liquidity of the Exchange; closely manage its expenses; deliver superior service to the members; mitigate the credit risks of its business; and develop and commercialize new products and services. The Arbinet business may not succeed in these activities and may never generate revenues that are significant or large enough to achieve profitability on a quarterly or annual basis.

In light of the foregoing we cannot assure you that we will recognize net income in future periods. If we cannot generate net income or sufficient operating profitability, we may not be able to meet our debt service or working capital requirements.

A deterioration in our relationships with facilities-based carriers could have a material adverse effect upon our business.

We primarily connect our customers’ telephone calls and data/Internet needs through transmission lines that we lease under a variety of arrangements with other facilities-based local, wireless, broadband, data and long-distance carriers. Many of these carriers are, or may become, our competitors. Our ability to maintain and expand our business depends on our ability to maintain favorable relationships with the facilities-based carriers from which we lease transmission lines. If our relationship with one or more of these carriers were to deteriorate or terminate, for any reason, it could have a material adverse effect upon our cost structure, service quality, network diversity, results of operations, financial condition and cash flows.

Uncertainties and risks associated with international markets and regulatory requirements could adversely impact our international operations.

We have significant international operations and, for the year ended December 31, 2010, derived about 85% of our net revenues by providing services outside of the U.S. In international markets, we are smaller than the principal or incumbent telecommunications carrier that operates in each of the foreign jurisdictions where we

 

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operate. In these markets, incumbent carriers: (1) are likely to modify and/or control access to, and pricing of, the local networks; (2) enjoy better brand recognition and brand and customer loyalty; (3) generally offer a wider range of product and services; and (4) have significant operational economies of scale, including a larger backbone network and longer term customer and supplier agreements on preferred and better terms. Moreover, the incumbent carrier may take many months to allow competitors, including us, to interconnect to their switches within our territory, and we are dependent upon their cooperation in migrating customers onto our network. There can be no assurance that we will be able to: (1) obtain the permits and operating licenses required for us to operate in the new service areas; (2) obtain access to local transmission facilities on economically acceptable terms; or (3) market services in international markets.

In addition, operating in international markets generally involves additional risks, including unexpected changes or uncertainties in regulatory requirements, taxes, tariffs, customs and duties. Given the nature of our operations and uncertainties in, or the absence of definitive regulations or interpretations concerning, the taxation of (including value added tax of) certain aspects of our business in certain international jurisdictions in which we conduct (or may be construed by such authorities as conducting or deriving taxable) operations or revenue, we may become subject to assessments for taxes (which may include penalties and interest) which are either unexpected, or have not been accrued for in our historical results of operations or both. This circumstance occurred during March 2008, when we concluded it was probable that assessments would be forthcoming concerning past European prepaid calling services operations, and it is possible that tax uncertainties concerning our international operations could arise in the future. Such developments, in addition to the other uncertainties and risks described above, could have adverse consequences that might result in restatement of prior period results of operations and unanticipated liquidity demands. Additional operating risks and uncertainties in operating in international markets include trade barriers, difficulties in staffing and managing foreign operations, problems in collecting accounts receivable, political risks, fluctuations in currency exchange rates, restrictions associated with the repatriation of funds, technology export and import restrictions, and seasonal reductions in business activity. Our ability to operate and grow our international operations successfully could be adversely impacted by these risks and uncertainties particularly in light of the fact that we derive such a large percentage of our revenues from outside of the U.S.

The telecommunications industry is rapidly changing, and if we are not able to adjust our strategy and resources effectively in the future to meet changing market conditions, we may not be able to compete effectively.

The telecommunications industry is changing rapidly due to deregulation, privatization, consolidation, technological improvements, availability of alternative services such as wireless, broadband, DSL, Internet, VoIP, data and hosting and wireless broadband through use of the fixed wireless spectrum, and the globalization of the world’s economies. In addition, alternative services to traditional fixed wireline services, such as wireless, broadband, Internet and VoIP services, are a substantial competitive threat. As the overall market for domestic and international long-distance and dial-up Internet services continues to decline in favor of Internet-based, wireless, and broadband communications, revenue contribution from our Traditional Services has been consequently declining. If we do not adjust to meet changing market conditions or do not have adequate resources, we may not be able to compete effectively. The telecommunications industry is marked by the introduction of new product and service offerings and technological improvements. Achieving successful financial results will depend on our ability to anticipate, assess and adapt to rapid technological changes, and offer, on a timely and cost-effective basis, services, including the bundling of multiple services that meet evolving industry standards. If we do not anticipate, assess or adapt to such technological changes at a competitive price, maintain competitive services or obtain new technologies on a timely basis or on satisfactory terms, our financial results may be materially and adversely affected.

The rapid enhancement of VoIP and Internet technology may result in increasing levels of traditional domestic and international voice long-distance traffic being transmitted over the Internet, as opposed to

 

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traditional telecommunication networks. Currently, there are significant capital investment savings and cost savings associated with carrying voice traffic employing VoIP technology, as compared to carrying calls over traditional networks. Thus, there exists the possibility that the price of traditional long-distance voice services will decrease in order to be competitive with VoIP. Additionally, competition is expected to be intense to switch customers to VoIP product offerings, as is evidenced by numerous recent market announcements in the U.S. and internationally from industry leaders and competitive carriers concerning significant VoIP initiatives. Our ability effectively to retain our existing customer base and generate new customers, either through our traditional network or our own VoIP offerings, may be adversely affected by accelerated competition arising as a result of VoIP initiatives, as well as regulatory developments that may impede our ability to compete, such as restrictions on access to broadband networks owned and operated by others and the requirements to provide E911. As competition intensifies as a result of deregulatory, market or technological developments, our results of operations and financial condition could be adversely affected.

If we are not able to operate a cost-effective network, we may not be able to grow our business successfully.

Our long-term success depends on our ability to design, implement, operate, manage, maintain and upgrade a reliable and cost-effective network infrastructure, including data hosting centers. In addition, we rely on third party equipment and service vendors to enable us to expand and manage our global network and to provide local, broadband Internet, data and hosting and wireless services. If we fail to generate additional traffic on our network, if we experience technical or logistical impediments to our ability to develop necessary aspects of our network or to migrate traffic and customers onto our network, or if we experience difficulties with our third-party providers, we may not achieve desired economies of scale or otherwise be successful in growing our business.

If we are not able to use and protect intellectual property domestically and internationally, it could have a material adverse effect on our business.

Our ability to compete depends, in part, on our ability to use intellectual property in the U.S. and internationally. We rely on a combination of trade secrets, trademarks and licenses to protect our intellectual property. We are also subject to the risks of claims and litigation alleging infringement of the intellectual property rights of others. The telecommunications industry is subject to frequent litigation regarding patent and other intellectual property rights. We rely upon certain technology, including hardware and software, licensed from third parties. There can be no assurance that the technology licensed by us will continue to provide competitive features and functionality or that licenses for technology currently used by us or other technology that we may seek to license in the future will be available to us on commercially reasonable terms or at all. Although our existing intellectual property licenses are on standard commercial terms made generally available by the companies providing the licenses and, individually, their costs and terms are not material to our business, the loss of, or our inability to maintain existing licenses, could result in shipment delays or reductions until equivalent technology or suitable alternative products could be developed, identified, licensed and integrated and could cause service disruption to our customers. Such delays or reductions in the aggregate could harm our business. We also generally rely on indemnification provisions in licensing contracts to protect against claims of infringement regarding the licensed technology, which indemnification could be affected by, among other things, the financial strength of the licensor.

The loss of key personnel could have a material adverse effect on our business.

The loss of the services of, our Chairman and Chief Executive Officer, or the services of our other key personnel, or our inability to attract and retain additional key management, technical and sales personnel, could have a material adverse effect upon our financial condition and results of operations.

 

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RISKS ASSOCIATED WITH OUR FINANCIAL STATEMENTS

Our disclosure controls and procedures and internal control over financial reporting were determined not to be effective as of December 31, 2006, 2007, 2008 and 2010 due to a material weakness that existed in our internal control over accounting for income taxes and as of December 31, 2009 due to a material weakness that existed in our internal control over accounting for foreign currency transaction gain (loss). If we fail to maintain effective internal control over financial reporting at a reasonable assurance level, we may not be able to accurately report our financial results, which could have a material adverse effect on our operations, investor confidence in our business and the trading prices of our securities.

In evaluating the effectiveness of our internal control over financial reporting, our management identified as of December 31, 2006, 2007, 2008 and 2010 a control deficiency in our controls and procedures over accounting for income taxes and as of December 31, 2009 due to a material weakness over accounting for foreign currency transaction gain (loss), and management concluded in each case that the control deficiency in our internal controls over financial reporting constituted a material weakness. These deficiencies represented a material weakness in internal control over financial reporting on the basis that there is more than a remote likelihood that a material misstatement in our interim or annual financial statements could occur and would not be prevented or detected by our internal control over financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of annual or interim financial statements will not be prevented or detected on a timely basis.

Specifically, management’s assessment of our internal control over financial reporting as of December 31, 2006, 2007, 2008 and 2010 identified a material weakness in internal control related to a lack of documentation, insufficient historical analysis and ineffective reconciliation procedures, primarily caused by lack of personnel with adequate expertise in income tax accounting matters. Since identifying the material weakness concerning accounting for income taxes at December 31, 2006, we have undertaken the following initiatives to remediate the material weakness: hired a new Corporate Tax Director and a Manager of Taxation in our Canadian operating unit; established procedures for foreign finance personnel to communicate regularly any tax concerns with the Corporate Tax Director; purchased and implemented tax provision preparation software; and developed quarterly tax documentation formats. After remediating the material weakness during 2009, we completed in 2010 several complicated financial transactions that were not properly accounted for due to insufficient documentation of historical positions. In addition, the effective performance of our tax controls was limited due to the fact that we failed to completely document our key tax processes and controls, which prevented an effective knowledge transfer to the new Corporate Tax Director, who started in the position on January 3, 2011. Accordingly, as of December 31, 2010 our management concluded that our internal controls surrounding accounting for income taxes are not effective.

In March 2010, the Company determined that an error existed related to accounting for foreign currency transaction gain (loss) on certain inter-company balances. Specifically, this error related to activity in the third quarter 2009 resulting in the Company amending its Form 10-Q for the quarter ended September 30, 2009. This amendment restated our financial statements in order to correct a non-cash error relating to accounting for unrealized foreign currency transaction losses associated with certain inter-company balances that were permanent in nature and, therefore, should have been recorded as currency translation adjustment to accumulated other comprehensive income (loss) in the equity section of the balance sheet. Since identifying this, we have undertaken initiatives to remediate this material weakness by (a) performing additional recalculations and analysis of the foreign currency transaction gain (loss) recorded on these intercompany balances; (b) implementing an improved process for assessing the reasonableness of foreign currency transaction gain (loss) recorded on these intercompany balances; and (c) confirming intercompany settlements related to these balances at a transactional level. As a result of such efforts, the material weakness concerning currency transaction was downgraded to a control deficiency and will not be considered completely remediated until the new controls continue to operate for a sufficient period of time and are sufficiently tested to enable management to conclude that the controls are operating effectively. As of December 31, 2010, management concluded that there was a control deficiency concerning foreign currency transactions. See Item 9A, “Controls and Procedures”.

 

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Our management will consider the design and operating effectiveness of our controls and necessary changes to such controls. However, we can not assure you that additional material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in additional material weaknesses, and cause us to fail to timely meet our periodic reporting obligations or result in material misstatements in our financial statements. The existence of a material weakness could result in future errors in our financial statements that could result in a restatement of financial statements, cause us to fail to meet our reporting obligations and cause investors to lose confidence in our reported financial information.

Financial information in our future financial statements will not be comparable to our financial information from periods before July 1, 2009 due to our Reorganization and the application of fresh-start accounting to our financial statements.

Upon our Holding Companies’ emergence from Chapter 11 on July 1, 2009, we adopted fresh-start accounting in accordance with Accounting Standards Codification (“ASC”) 852, Reorganizations, pursuant to which our reorganization value, which represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the Reorganization, has been allocated to the fair value of assets in conformity with ASC 805, Business Combinations, using the purchase method of accounting for business combinations. We stated liabilities, other than deferred taxes, at a present value of amounts expected to be paid. The amount remaining after allocation of the reorganization value to the fair value of identified tangible and intangible assets is reflected as goodwill, which is subject to periodic evaluation for impairment. In addition, under fresh-start accounting, our accumulated deficit ($1.06 billion at June 30, 2009) has been eliminated. In addition to fresh-start accounting, our consolidated financial statements reflect all effects of the transactions contemplated by the Plan of Reorganization. Thus, our future consolidated balance sheets and consolidated condensed statements of operations data will not be comparable in many respects to our consolidated balance sheets and consolidated condensed statements of operations data for periods prior to our adoption of fresh-start accounting and prior to accounting for the effects of the Reorganization.

RISKS ASSOCIATED WITH THE ARBINET BUSINESS

The members of the Arbinet Exchange may not trade on the Exchange or utilize Arbinet’s other services due to, among other things, the lack of a liquid market, which may materially harm the Arbinet business. Volatility in trading volumes may have a significant adverse effect on the Arbinet business’ financial condition and operating results.

Traditionally, communication services providers buy and sell network capacity in a direct, one-to-one process. The members may not trade on the Exchange unless it provides them with an active and liquid market. Liquidity depends on, among other things, the number of buyers and sellers and the number of competitively priced routes that actively trade on a particular communications route. Arbinet’s ability to increase the number of buyers that actively trade on the Exchange will depend on, among other things, the willingness and ability of prospective sellers to satisfy the quality criteria and price parameters imposed by prospective buyers and, upon the increased participation of competing sellers from which a buyer can choose in order to obtain favorable pricing, achieve cost savings and consistently gain access to the required quality services. Arbinet’s ability to increase the number of sellers that actively trade on the Exchange will depend upon the extent to which there are sufficient numbers of prospective buyers available to increase the likelihood that sellers will generate meaningful sales revenues. Alternatively, the members may not trade on the Exchange if they are not able to realize significant cost savings. This may also result in a decline in trading volume and liquidity of the Exchange. Trading volume is additionally impacted by the mix of hundreds of geographic markets traded on the Exchange. Each market has distinct characteristics, such as price and average call duration. Declines in the trading volume on the Exchange would result in lower revenues to Arbinet and would adversely affect Arbinet’s profitability because of Arbinet’s predominantly fixed cost structure.

 

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The members may not trade on the Exchange because such members may conclude that the Exchange will replace their existing business at lower margins.

If the Exchange continues to be an active, liquid market in which lower-priced alternatives are available to buyers, sellers may conclude that further development of the Exchange will erode their profits and they may stop offering communications capacity on the Exchange. Since the Exchange provides full disclosure of prices offered by participating sellers, buyers may choose to purchase network capacity through the Exchange instead of sending traffic to their existing suppliers at pre-determined, and often higher, contract prices. If suppliers of communications capacity fear or determine that the price disclosure and spot market limit order mechanisms provided by the Exchange will “cannibalize” the greater profit-generating potential of their existing business, they may choose to withdraw from the Exchange, which ultimately could cause the Exchange to fail and materially harm Arbinet’s business.

The combined company’s carrier services strategy may adversely affect the activity of members on the Exchange.

Arbinet has traditionally operated as an anonymous Exchange. However, some of the members may view the merger with Primus as competitive to their businesses and may limit or eliminate their activity on the Exchange. Any such reduction could have a material adverse effect on the Arbinet business’ operating results.

The Arbinet business may incur losses on customer calls that do not match the expected distribution of calls to the offered destination in carrier services.

The trading Exchange operates using the Arbinet business’ defined codes so that the buyer is committed to pay the price for those codes and the seller is committing to offer termination using those codes. In the carrier services offering, Arbinet may compile a destination using multiple suppliers, each with their own prices for regions in that destination. However, portability of numbers between carriers at that destination may alter the price for termination. Arbinet is then offering to provide termination to the broader destination to its customers on the assumption that a certain blend of calling will be achieved. If the customer sends a blend of calls that is substantially different from what is expected and all of those calls are to the more expensive parts of a destination, Arbinet may receive invoices that are significantly greater than expected and may limit its ability to complete a sale to the buyer that is profitable for Arbinet.

The Arbinet business’ standard member enrollment cycle can be long and uncertain and may not result in revenues.

The member enrollment cycle for full membership on the Exchange can be long, and may take up to 12 months or even longer from Arbinet’s initial contact with a communication services provider until that provider signs the membership agreement. Because Arbinet offers a new method of purchasing and selling international long distance voice calls and Internet capacity, Arbinet must invest a substantial amount of time and resources to educate prospective members on services providers regarding the benefits of the Exchange. Factors that contribute to the length and uncertainty of the member enrollment cycle and which may reduce the likelihood that a member will purchase or sell communications traffic through the Exchange include:

 

   

the strength of pre-existing one-to-one relationships that prospective members may already have with their communication services providers;

 

   

existing incentive structures within the members’ organizations that do not reward decision-makers for savings achieved through cost-cutting;

 

   

the experience of the trial trading process by prospective members;

 

   

an aversion to new methods for buying and selling communications capacity; and

 

   

the effect of the limited credit available to prospective members and the associated impact on their spending and cash flow.

 

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Arbinet is exposed to the credit risk of the members not covered by its credit management programs with third parties, which could result in material losses.

There have been adverse changes in the public and private equity and debt markets for communication services providers that have affected their ability to obtain financing or to fund capital expenditures. In some cases, the significant debt burden carried by certain communication services providers has adversely affected their ability to pay their outstanding balances with Arbinet and some of the members have filed for bankruptcy as a result of their debt burdens. Although these members may emerge from bankruptcy proceedings in the future, unsecured creditors, such as Arbinet, often receive partial or no payment toward outstanding obligations. Furthermore, because Arbinet is an international business, Arbinet may be subject to the bankruptcy laws of other nations, which may provide Arbinet limited or no relief. Although these losses have not been significant to date, future losses, if incurred, could be significant, particularly as a result of the impact of adverse economic conditions and the potential further tightening of credit availability on customers, and could harm the Arbinet business and have a material adverse effect on our overall operating results and financial condition.

Arbinet may be unable to effectively manage the pricing risk, which could result in significant losses.

In certain instances, Arbinet offers its customers a fixed rate for specific markets for a set duration. Arbinet may assume the risk on the price of the minutes and Arbinet may not be able to secure the prices from sellers to

ensure Arbinet does not lose money on the minutes purchased by the buyers. Arbinet could incur significant losses related to having a higher cost of minutes sold in relation to the price offered to the buyer of this service.

Expanding and maintaining international operations will subject Arbinet to additional risks and uncertainties.

Arbinet expects to continue the expansion of its international operations, which will subject Arbinet to additional risks and uncertainties. Arbinet has established exchange delivery points in New York City, London, Frankfurt, Miami and Hong Kong, and Arbinet intends to expand its presence. Foreign operations are subject to a variety of additional risks that could have an adverse effect on Arbinet’s business, including:

 

   

difficulties in collecting accounts receivable and longer collection periods;

 

   

changing and conflicting regulatory requirements;

 

   

potentially adverse tax consequences;

 

   

tariffs and general export restrictions;

 

   

difficulties in integrating, staffing and managing foreign operations;

 

   

political instability;

 

   

seasonal reductions in business activity during the summer months in Europe and certain other parts of the world;

 

   

the impact of local economic conditions and practices;

 

   

potential non-enforceability of Arbinet’s intellectual property and proprietary rights in foreign countries; and

 

   

fluctuations in currency exchange rates.

Arbinet’s inability to manage these risks effectively could result in increased costs and distractions and may adversely affect Arbinet’s business, financial condition and operating results.

 

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Arbinet’s pricing in the Exchange and new products and services may not be sustainable and may decline over time.

As prices for international long-distance minutes continue to decline, Arbinet needs to charge the members less for utilization of its services. Arbinet may also need to reduce its prices to drive incremental minutes on the Exchange. As Arbinet has a predominantly fixed-price operating cost structure, Arbinet is evaluating pricing programs that maximize the volume and aggregate fee revenues on the Exchange. Arbinet continues to explore additional volume discounting programs and alternative pricing programs to drive overall fee revenues. Arbinet’s fee revenue per minute may decline in the coming quarters as Arbinet explores these pricing initiatives. Arbinet cannot be certain that its pricing programs will drive significant enough increases in volume to offset the price reduction and, therefore, Arbinet’s aggregate fee revenues may decline due to these pricing programs.

System failures, human error and security breaches could cause Arbinet to lose members and expose Arbinet to liability.

The communications services providers that use Arbinet’s services depend on Arbinet’s ability to accurately track, rate, store and report the traffic and trades that are conducted on its platform. Software defects, system failures, natural disasters, human error and other factors could lead to inaccurate or lost information or the inability to access the exchange. From time to time, Arbinet has experienced temporary service interruptions. Arbinet’s systems could be vulnerable to computer viruses, physical and electronic break-ins and third party security breaches. In a few instances, Arbinet manually input trading data, such as bid and ask prices, at the request of the members, which could give rise to human error and miscommunication of trading information and may result in disputes with the members. Any loss of information or the delivery of inaccurate information due to human error, miscommunication or otherwise or a breach or failure of Arbinet’s security mechanisms that leads to unauthorized disclosure of sensitive information could lead to member dissatisfaction and possible claims against Arbinet for damages.

Undetected defects in Arbinet’s technology could adversely affect its operations.

Arbinet’s technology is complex and is susceptible to errors, defects or performance problems, commonly called “bugs.” Although Arbinet regularly tests its software and systems extensively, Arbinet cannot ensure that its testing will detect every potential error, defect or performance problem. Any such error, defect or performance problem could have an adverse effect on Arbinet’s operations. Users of Arbinet’s services may be particularly sensitive to any defects, errors or performance problems in Arbinet’s systems because a failure of Arbinet’s systems to monitor transactions accurately could adversely affect their own operations.

If Arbinet does not adequately maintain the members’ and customers’ confidential information, Arbinet could be subject to legal liability and its reputation could be harmed.

Any breach of security relating to confidential information of the members or customers could result in legal liability to Arbinet and a reduction in use of the Exchange or cancellation of Arbinet’s services, either of which could materially harm Arbinet’s business. Arbinet’s personnel often receive highly confidential information from buyers and sellers that is stored in Arbinet’s files and on its systems. Similarly, Arbinet receives sensitive pricing information that has historically been maintained as a matter of confidence within buyer and seller organizations.

Arbinet currently has practices, policies and procedures in place to ensure the confidentiality of the members’ and customers’ information. However, Arbinet’s practices, policies and procedures to protect against the risk of inadvertent disclosure or unintentional breaches of security might fail to adequately protect information that Arbinet is obligated to keep confidential. Arbinet may not be successful in adopting more effective systems for maintaining confidential information, so its exposure to the risk of disclosure of the confidential information of the members or customers may grow as Arbinet expands its business and increases the amount of information that it possessed. If Arbinet fails to adequately maintain the members’ or customers’ confidential information, some of them could end their business relationships with Arbinet and Arbinet could be subject to legal liability.

 

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Arbinet may not be able to keep pace with rapid technological changes in the communications services industry.

The communications services industry is subject to constant and rapid technological changes. Arbinet cannot predict the effect of technological changes on its business. New services and technologies may be superior to Arbinet’s services and technologies, or may render Arbinet’s services and technologies obsolete.

To be successful, Arbinet must adapt to and keep pace with rapidly changing technologies by continually improving, expanding and developing new services and technologies to meet customer needs. Arbinet’s success will depend, in part, on its ability to respond to technological advances, meet the evolving needs of members and customers and conform to emerging industry standards on a cost-effective and timely basis, if implemented. Arbinet will need to spend significant amounts of capital to enhance and expand its services to keep pace with changing technologies. Failure to do so may materially harm Arbinet’s business.

Any failure of Arbinet’s physical infrastructure could lead to significant costs and disruptions that could reduce its revenue and harm its business reputation and financial results.

Arbinet’s business depends on providing customers with highly reliable service. Arbinet must protect its infrastructure and any colocated equipment of the members located in Arbinet’s exchange delivery points, or EDPs. Arbinet’s EDPs and the services Arbinet provides are subject to failure resulting from numerous factors, including:

 

   

human error;

 

   

physical or electronic security breaches;

 

   

fire, earthquake, flood and other natural disasters;

 

   

water damage;

 

   

power loss; and

 

   

terrorism, sabotage and vandalism.

Problems at one or more of Arbinet’s EDPs, whether or not within Arbinet’s control, could result in service interruptions or significant equipment damage. Any loss of services, equipment damage or inability to terminate voice calls or supply Internet capacity could reduce the confidence of the members and customers and could consequently impair Arbinet’s ability to obtain and retain members and customers, which would adversely affect both Arbinet’s ability to generate revenues and its operating results.

RISKS RELATING TO, OR FOLLOWING, THE ARBINET MERGER

Primus may not realize the anticipated benefits of the Arbinet merger.

Primus and Arbinet entered into the Merger Agreement with the expectation that the merger would result in various benefits including, among other things, synergies, cost savings, maintaining business and customer levels of activity and operating efficiencies. The success of the merger will depend, in part, on our ability to realize these anticipated benefits from combining the businesses of Primus and Arbinet.

The integration process is subject to a number of uncertainties. Although Primus’s plans for integration are focused on minimizing those uncertainties to help achieve the anticipated benefits, no assurance can be given that these benefits will be realized or, if realized, the timing of their realization. Integration efforts associated with the merger could divert management attention and resources away from operating and strategic objectives and could have an adverse effect on the businesses of both Primus and Arbinet during the transition period. Failure to achieve anticipated benefits could result in increased costs or decreases in the amount of expected revenues and could adversely affect Primus’s future business, financial condition, operating results and prospects. In addition,

 

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we may not be able to eliminate duplicative costs or realize other efficiencies from integrating the businesses to offset part or all of the transaction and merger-related costs incurred by Primus and Arbinet.

The financial forecasts of Primus that include the Arbinet business that may be included in future announcements and disclosures from time to time involve risks, uncertainties and assumptions, many of which are beyond the control of Primus. As a result, they may not prove to be accurate and are not necessarily indicative of current or future values or future performance.

The financial forecasts of Primus that may be contained in future announcements and disclosures from time to time involve risks, uncertainties and assumptions and are not a guarantee of future performance. The future financial results of Primus may materially differ from those expressed in the financial forecasts due to factors that are beyond Primus’s ability to control or predict. Primus cannot provide any assurance that any of its financial forecasts will be realized or that future financial results will not materially vary from the financial forecasts. The financial forecasts may cover multiple years, and the information by its nature becomes subject to greater uncertainty with each successive year. The financial forecasts do not take into account any circumstances or events occurring after the date they were prepared.

The financial forecasts:

 

   

may make numerous assumptions, many of which are beyond the control of Arbinet or Primus and may not prove to be accurate;

 

   

may not necessarily reflect revised prospects for Primus’s businesses, changes in general business or economic conditions, or any other transaction or event that has occurred or that may occur and that was not anticipated at the time the forecasts were prepared;

 

   

may not be necessarily indicative of current or future values or future performance, which may be significantly more favorable or less favorable than is reflected in the forecasts; and

 

   

should not be regarded as a representation that the financial forecasts will be achieved.

The financial forecasts may not be prepared with a view toward public disclosure or compliance with published guidelines of the SEC or the American Institute of Certified Public Accountants for preparation and presentation of prospective financial information or United States generally accepted accounting principles, or U.S. GAAP, and may not reflect the effect of any proposed or other changes in U.S. GAAP that may be made in the future.

The market value of Primus common stock could decline if large amounts of its common stock are sold following the Merger.

Following the Merger, stockholders of Primus and former stockholders of Arbinet will own interests in a combined company operating an expanded business with more assets and a different mix of liabilities. Current stockholders of Primus and Arbinet may not wish to continue to invest in the additional operations of the combined company, or may wish to reduce their investment in the combined company, or for other reasons may wish to dispose of some or all of their interests in Primus following the Merger. If, following the Merger, large amounts of Primus common stock are sold, the price of its common stock could decline.

The Merger may not be accretive and may cause dilution to Primus’s earnings per share, which may negatively affect the market price of Primus’s common stock.

As of the filing date of this Form 10-K, Primus currently anticipates that the Arbinet merger will be accretive to U.S. GAAP earnings per share in 2012 and on an adjusted earnings per share basis in 2011. This expectation is based on preliminary estimates that may materially change. Primus could also encounter additional transaction and integration-related costs or other factors such as the failure to realize all of the benefits

 

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anticipated in the merger. All of these factors could cause dilution to Primus’s earnings per share or decrease or delay the expected accretive effect of the merger and cause a decrease in the price of Primus’s common stock.

Primus’s efforts to have Primus common stock listed for trading on the NASDAQ has not yet been successful, which results in limited liquidity for its stockholders.

Primus has not yet succeeded in having its common stock listed on the NASDAQ, Arbinet stockholders would receive shares of Primus common stock that are not listed on a national securities exchange in return for their shares of Arbinet common stock, which were listed on the NASDAQ Global Market.

RISKS ASSOCIATED WITH OUR LIQUIDITY NEEDS AND DEBT SECURITIES

We may not be able to generate sufficient cash to service all of our indebtedness, and may be forced to take other actions to satisfy our obligations under our indebtedness that may not be successful.

Our ability to satisfy our debt obligations will depend upon, among other things, our future financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, many of which are beyond our control. We cannot assure you that our business will generate cash flow from operations in an amount sufficient to fund our liquidity needs. If our cash flows and capital resources are insufficient to service our indebtedness, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. In addition, the terms of existing or future debt agreements may restrict us from adopting some of these alternatives. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. We may not be able to consummate those dispositions for fair market value or at all. Furthermore, any proceeds that we could realize from any such disposition may not be adequate to meet our debt service obligations then due.

A significant portion of our future cash flow may need to be committed to repurchasing or redeeming certain outstanding debt prior to its stated maturity, rather than for use in our business operations.

If Group and its “restricted subsidiaries” have Excess Cash Flow (as defined below) for any fiscal year commencing with the fiscal year ending December 31, 2010, then the issuers of the 13% Senior Secured Notes due 2016 (the “13% Notes”) are obligated to jointly apply an amount equal to 50% of such Excess Cash Flow for such period (the “Excess Cash Flow Offer Amount”) and to make a joint offer to the holders of the 13% Notes to repurchase all or a portion of such notes as Units with an aggregate repurchase price in cash equal to the Excess Cash Flow Offer Amount (an “Excess Cash Flow Offer”). Excess Cash Flow means for any such fiscal year (a) the excess of (1) consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”) over (2) the sum, subject to certain exceptions, represented by: (i) capital expenditures; (ii) consolidated interest expense paid in cash; (iii) income and franchise taxes paid in cash; and (iv) reductions in certain indebtedness minus (b) the absolute value of negative Excess Cash Flow, if any. See Note 7 to our Consolidated Financial Statements.

Within 110 days after the end of any fiscal year with respect to which an Excess Cash Flow Offer is required, an offer must be sent to each holder of 13% Notes stating the repurchase date, which must be no earlier than 30 days nor later than 60 days from the date such notice is mailed. With respect to each Excess Cash Flow Offer, the Issuers are entitled to reduce the applicable Excess Cash Flow Offer Amount by an amount equal to the sum of (x) the aggregate repurchase price paid for any 13% Notes repurchased by the Issuers in the open market or privately negotiated transaction (and, in each case, cancelled by the Issuers) and (y) the aggregate redemption price paid for any 13% Notes redeemed pursuant to one or more optional redemptions, subject to certain limitations.

 

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If our outstanding 14 1/4% Senior Subordinated Secured Notes due May 2013 (the “14 1/4% Notes”) have not been refinanced in accordance with the terms of its indenture on or prior to January 21, 2013, then the Issuers will be required to redeem the 13% Notes in advance of the 14 1/4% Notes scheduled maturity at a price equal to the then applicable optional redemption price.

If such early redemption of the 13% Notes are required or an Excess Cash Flow Offer is made, there can be no assurance that the Issuers will have available funds sufficient to pay for such redemption or for the Excess Cash Flow purchase price for all the 13% Notes that might be delivered by holders seeking to accept the Excess Cash Flow Offer. Any such failure could have a material adverse effect on us.

We must repay or refinance the 14 1/4% Notes prior to the maturity of the 13% Notes. Failure to do so could have a material adverse effect upon us.

The maturity of the 14 1/4% Notes is earlier than the maturity of the 13% Notes. While we expect to refinance the 14 1/4% Notes, we may not be able to do so or refinancing may not be available on commercially reasonable terms. Our ability to complete a refinancing of the 14 1/4% Notes prior to their maturity is subject to a number of conditions beyond our control. For example, if disruption in the financial markets were to occur at the time that we intended to refinance the 14 1/4% Notes, we might be restricted in our ability to refinance that indebtedness. If we are unable to refinance the 14 1/4% Notes our alternatives would consist of negotiating an extension of such indebtedness with the holders and seeking or raising new capital. If we were unsuccessful, the holders of the 14 1/4% Notes could demand repayment of the indebtedness owed to them on May 20, 2013. As a result, our ability to pay the principal of and interest on such indebtedness would be adversely affected.

We may not be able to repurchase the 14 1/4% Notes or 13% Notes upon a change of control.

Upon the occurrence of certain specific kinds of change of control events, we (or our subsidiaries) will be required to jointly offer to repurchase all outstanding notes at 101% of the principal amount thereof plus, without duplication, accrued and unpaid interest and additional interest, if any, to the date of repurchase. However, it is possible that they will not have sufficient funds at the time of the change of control to make the required repurchase of all notes delivered by holders seeking to exercise their repurchase rights, particularly as that change of control may trigger a similar repurchase requirement for, or result in an event of a default under a debt indenture and may also constitute a cross-default on other indebtedness existing at that time. In addition, certain important corporate events, such as leveraged recapitalization that would increase the level of our indebtedness, would not constitute a “Change of Control” under the indenture.

Our indentures governing our 14 1/4% Notes and 13% Notes contain significant operating and financial restrictions which may limit our ability and our restricted subsidiaries’ ability to operate their business.

The indentures governing our 14 1/4% Notes and 13% Notes contain significant operating and financial restrictions on us and our subsidiaries. These restrictions limit the ability of us and our restricted subsidiaries to, among other things:

 

   

incur additional indebtedness or issue certain preferred shares;

 

   

create liens on certain assets to secure debt;

 

   

pay dividends or make other equity distributions;

 

   

purchase or redeem capital stock;

 

   

make certain investments;

 

   

transfer or sell assets;

 

   

agree to restrictions on the ability of restricted subsidiaries to make payments to us or the issuers;

 

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consolidate, merge, sell or otherwise dispose of all or substantially all of our or an issuer’s assets; and

 

   

engage in transactions with affiliates.

These restrictions could limit the ability of us and our subsidiaries to finance future operations or capital needs, make acquisitions or pursue available business opportunities. We may be required to take action to reduce their debt or act in a manner contrary to our business objectives to satisfy these covenants. Events beyond our control, including changes in economic and business conditions in the markets in which we operate, may affect our ability to do so. We may not be able to satisfy these covenants. A breach of any of the covenants in our debt could result in a default under such debt, which could lead to that debt becoming immediately due and payable and, if such debt is secured, foreclosure on our assets that secure that obligation. A default under a debt instrument could, in turn, result in a default under other obligations and result in other creditors accelerating the payment of other obligations and foreclosing on asset security such debt, if any. Any such defaults could materially impair our financial conditions and liquidity.

Despite current indebtedness levels and restrictive covenants, we and our subsidiaries may still be able to incur substantial additional debt, which could exacerbate the risks described above.

We may be able to incur additional debt in the future, including debt secured by the collateral that secures our 14 1/4% Notes and 13% Notes, as well as other assets that do not secure such notes. Although the terms of the agreements governing our indebtedness contain restrictions on our ability to incur additional indebtedness, those restrictions are subject to a number of exceptions, and the indebtedness incurred in compliance with those restrictions could be substantial. In addition, if we are able to designate some of the restricted subsidiaries under the indenture governing the notes as unrestricted subsidiaries, those unrestricted subsidiaries would be permitted to borrow beyond the limitations specified in the indenture and engage in other activities in which restricted subsidiaries may not engage. If we incur any additional secured debt that ranks equally with the 13% Notes, the holders of that debt will be entitled to share ratably with the holders of the 13% Notes in any proceeds distributed in connection with any bankruptcy, liquidation, reorganization or similar proceedings. Adding new debt to current debt levels could intensify the related risks that we now face.

The issuance of the 13% Notes may subject us to additional currency exchange risks.

The 13% Notes were issued and paid for, and the interest to be paid on those notes will be paid, in U.S. dollars. However, the Canadian issuer of such notes receives revenues primarily in Canadian dollars (“CAD”). As a result, the financial condition of the Canadian issuer might be materially adversely affected if the U.S. dollar appreciates against the CAD. From time to time, if we determine it is appropriate and advisable to do so, we may seek to lessen the effect of exchange rate fluctuations through the use of derivative financial instruments. However, we cannot assure you that we will be successful in these efforts.

ADDITIONAL RISKS RELATED TO REGULATION

We are subject to constantly changing regulation, both in the U.S. and abroad, including the imposition of fees and taxes, the potential adverse effects which may have a material adverse impact on our competitive position, growth and financial performance.

Our operations are subject to constantly changing regulation. There can be no assurance that future regulatory changes will not have a material adverse effect on us, or that domestic, foreign or international regulators or third parties will not raise material issues with regard to our compliance or noncompliance with applicable regulations, any of which could have a material adverse effect upon our competitive position, growth and financial performance. As a multinational telecommunications company, we are subject to varying degrees of regulation in each of the jurisdictions in which we provide our services. Local laws and regulations, and the interpretation of such laws and regulations, differ significantly among the jurisdictions in which we operate. Enforcement and interpretations of these laws and regulations can be unpredictable and are often subject to the

 

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informal views of government officials. Potential future regulatory, judicial, legislative, and government policy changes in jurisdictions where we operate could have a material adverse effect on us. Many regulatory actions are underway or are being contemplated by governmental agencies. For example, in connection with the promulgation of the “National Broadband Plan” announced in March 2010, in April 2010 the FCC stated its intention to initiate dozens of new proceedings to impose new requirements, or modify existing requirements, affecting essentially all entities involved in the provision of communications services. It is impossible to predict at this time what specific rules or requirements the FCC will propose or adopt, or how any such rules or requirements would affect our business or financial results.

The Federal Communications Commission or Congress may revise how companies like us contribute to certain federal programs that could increase our costs, reduce our profitability, or make our services less competitive in the communications marketplace.

In the U.S., the Communications Act and associated FCC regulations, require that every provider of interstate telecommunications carrier contribute, on an equitable and non-discriminatory basis, to federal universal service mechanisms established by the FCC, which affects our cost of providing services. At present, these contributions are calculated based on contributors’ interstate and international revenue derived from U.S. end users for telecommunications or telecommunications services, as those terms are defined under FCC regulations. On April 21, 2010, the FCC issued certain specific new proposals regarding contributions to the universal service fund that, if adopted, could materially affect our own contributions to the fund. These new proposals would affect most of our competitors, but not all of our competitors would be affected in the same way or to the same degree as we would be. The FCC has also announced its intention to propose new rules regarding the universal service program during the first quarter of 2011. It is impossible to predict the impact of these new proposals, if adopted, on our operations and financial results. In addition, AT&T Inc. filed a “Petition for Immediate Commission Action” on July 10, 2009, requesting that the FCC adopt a new mechanism for calculating federal universal service fund contribution that would be applicable to all contributors, including us. The specific proposal, which has been pending at the FCC for some time, is to determine contributions to the USF based on “assessable telephone numbers” rather than interstate and international revenues. This AT&T proposal remains pending. We cannot predict whether the FCC will adopt this or some other contribution methodology, nor can we predict the potential impact on our business at this time. But a revised contribution methodology could increase our contribution obligation, including increasing our contribution disproportionately compared to some of our competitors. In such event, we may need to either raise the total amount of our consumer’s bills, potentially making us less competitive with other providers of communications services, or reduce our profit margins.

In the United States and Canada, there is increasing regulation of Voice over Internet Protocol service offerings. Increased regulation may increase our costs, reduce our profit margins, or make our services less competitive in the communications marketplace.

Increasingly, laws, regulations or rulings that apply to traditional telephone services are being extended to commerce and communications services that utilize Internet Protocol, including VoIP. The increasing growth of the VoIP market and popularity of VoIP products and services heighten the risk that governmental agencies will continue to increase the level of regulation applied to VoIP and the Internet.

We are unable to predict the impact, if any, that future legislation, judicial decisions or regulations concerning Internet Protocol products and services may have on our business, financial condition, and results of operations. Regulation may be targeted towards, among other things, fees, charges, surcharges, and taxation of VoIP services, liability for information retrieved from or transmitted over the Internet, online content regulation, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, filing requirements, consumer protection, public safety issues like E911, CALEA, the provision of online payment services, broadband residential Internet access, and the characteristics and quality of products

 

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and services, any of which could restrict our business or increase our cost of doing business. The rules that the FCC has already extended to interconnected VoIP providers include:

 

   

Rules with respect to the use of CPNI requiring VoIP providers to adhere to particular customer approval processes when using CPNI outside of pre-defined limits and when using CPNI for marketing purposes, and requiring VoIP providers to take certain steps to verify a customer’s identity before releasing any CPNI over the telephone or the Internet, and to report unauthorized disclosures of CPNI.

 

   

In April 2010, the FCC adopted a Notice of Inquiry regarding the possible establishment of a voluntary “cyber security” certification program. At present it is not possible to predict whether any new formal or informal requirements will arise from this proceeding or how any such requirements might affect our business.

 

   

The disability access requirements of Sections 225 and 255 of the Communications Act, which have been interpreted by the FCC to require interconnected VoIP providers to contribute to the telecommunications relay services fund and offer 711 abbreviated dialing access to relay services, and to ensure that VoIP services are accessible to persons with disabilities, if reasonably achievable. In August 2010, the FCC adopted a Further Order and Notice of Proposed Rulemaking with respect to hearing aid compatibility requirements applicable to various services. We cannot predict at this time what new requirements the FCC will establish, if any, or how any such new requirements may affect us.

 

   

Rules requiring VoIP providers to configure VoIP networks in a manner that facilitates lawful surveillance under CALEA.

 

   

Rules requiring VoIP providers to permit customers to retain their assigned telephone numbers when changing carriers including newly established requirements to process customer carrier changes on an expedited basis.

 

   

Rules requiring VoIP providers to provide access to E911 emergency services on terms generally similar to those provided by traditional landline carriers.

 

   

In April 2010, the FCC adopted a Notice of Inquiry regarding the survivability of broadband infrastructure, including in the case of damage due to natural or human-caused disasters or public emergencies.

 

   

In December 2010, the FCC released a Notice of Inquiry regarding “Next Generation 911” service. It is uncertain whether the FCC will adopt specific requirements arising from these proceedings or, if it does, how and whether any such requirements will affect us.

 

   

Rules requiring VoIP providers to pay regulatory fees based on reported interstate and international revenues, including universal service fees.

In Canada the CRTC has extended rules to interconnected VoIP providers that are similar to certain of those described above for the U.S., which rules are also subject to change from time to time. In addition, the CRTC is currently conducting public proceedings on whether to recover its operating fees from all telecommunications service providers, including resellers such as us, rather than only from Canadian carriers; and on whether and how to redefine the Basic Service Objectives, for whose subsidization we and other telecom service providers are required to contribute a proportion of our Canadian telecom service revenues.

We may become subject to increased obligations with regard to accessibility obligations for people with disabilities and more of our service offerings may become subject to disabilities access obligations

In October 2010, the “Twenty-First Century Communications and Video Accessibility Act” was signed into law. The new law requires the FCC to initiate a proceeding to determine what services should be required to offer access for people with disabilities and what those accessibility requirements should entail. The FCC has initiated its rulemaking but the process is in its infancy. At this time, we cannot predict whether we will be subject to

 

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additional accessibility requirements or whether any of our service offerings that are not currently subject to disabilities access requirements will be subject to such obligations.

Proposed future U.S. federal income tax legislation could impact the Company’s effective tax rate.

In May 2009, President Obama’s administration announced proposed future tax legislation that could substantially modify the rules governing the U.S. taxation of certain non-U.S. subsidiaries. These potential changes include, but are not limited to: (1) limitations on the deferral of U.S. taxation of foreign earnings; (2) limitations on the ability to claim and utilize foreign tax credits; and (3) deferral of various tax deductions until non-U.S. earnings are repatriated to the U.S. Many details of the proposal remain unknown, although if any of these proposals are enacted into law they could materially impact our effective tax rate.

The applicability of changes in tax policy to our services will increase their cost to consumers thereby decreasing our competitive price advantage over the competing alternatives available to the customer. Further, we may be subject to liabilities for past taxes, surcharges, fees, penalties and interest.

Unlike those of our competitors who offer traditional landline or wireless services, with respect to our VoIP services, we currently do not collect or remit state or municipal taxes, fees or surcharges on the retail charges we collect from our customers, except where we have determined we are required to do so based on tax law. In some jurisdictions we also did not collect and remit 911 surcharges. In some instances, we have received inquiries or demands from state and municipalities for taxes, fees or surcharges, including, in some instances, 911 fees. Depending on the state, statute or municipal code, we have maintained that these taxes, fees, or surcharges, including 911 fees, do not apply to us. However, recent changes in the law, at the federal, state and local level, may change our legal obligations. Accordingly, some taxes, fees or surcharges, including 911 fees, could apply to us retroactively and we could be subject to penalties and interest.

Other international governmental regulation could limit our ability to provide our services, make them more expensive and may have a material adverse impact on our competitive position, growth and financial performance.

Our international operations are also subject to regulatory risks, including the risk that regulations in some jurisdictions will prohibit us from providing our services cost-effectively or at all, which could limit our growth. We cannot make assurances that these conditions will not have a material effect on our revenues and growth in the future. International regulatory considerations that affect or limit our business include:

 

   

ongoing regulatory proceedings regarding efforts by Telstra in Australia to increase prices and charges and to deny access to essential facilities and services needed by us to compete;

 

   

the ultimate outcome of the process launched by the Australian government to help fund the construction of a new national broadband network, including whether and the terms upon which (a) we will have access to such network, and (b) the duration for which the copper wire based last mile infrastructure we use to furnish broadband services using our DSLAM network infrastructure will be continued;

 

   

a regulatory reform package recently announced by the Australian government that, if enacted, will (a) separate Telstra’s retail arm from its international carrier services business (via either functional or structural separation); and (b) provide the ACCC with greater powers to set access prices;

 

   

general changes in access charges and contribution payments could adversely affect our cost of providing long-distance, wireless, broadband, VoIP, local and other services; and

 

   

regulatory proceedings in Canada determining whether and the extent to which regulation should mandate access to networks and interconnection including intra-exchange transport services which we use to interconnect our DSLAM colocation sites and high speed access to residential and business services.

 

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Any adverse developments implicating the foregoing could materially adversely affect our business, financial condition, result of operations and prospects.

We may be exposed to significant liability resulting from our noncompliance with FCC orders regarding E911 services.

FCC rules require VoIP providers interconnected to the public switched telephone network to provide E911 service in a manner similar to traditional wireline carriers. This requirement took effect as of November 2005. Like many interconnected VoIP providers, Lingo, Inc. (“Lingo”), a subsidiary of ours which sells such services, was able to meet this deadline for some but not all of its customers. We sought a waiver from the FCC asking for additional time to complete deploying our E911 service. The FCC has not yet addressed our waiver petition. As of September 30, 2010, approximately 99% of our Lingo customers were equipped with E911 service as required by the FCC’s rules. If and to the extent that we are determined to be out of compliance with the FCC order regarding E911 services we may be subject to fines, penalties, cease and desist orders prohibiting Lingo from providing service on the federal and state levels or any combination of the foregoing.

The FCC rules also require interconnected VoIP providers to distribute stickers and labels informing customers of the limitations on their emergency services as compared with traditional landline E911 service, as well as to notify and obtain affirmative acknowledgement from customers that they are aware of those limitations. The FCC’s Enforcement Bureau released an order providing that the Enforcement Bureau will not pursue enforcement against interconnected VoIP providers that have received affirmative acknowledgement from at least 90% of their subscribers. We have received affirmative acknowledgement from substantially all of our customers, and, therefore, believe that we have effectively satisfied this requirement.

We may be exposed to significant liability based on the differences between our E911 services and those delivered by traditional providers of telephony services.

Lingo’s current E911 services, like those offered by other providers of VoIP services, are more limited than the 911 services offered by traditional wireline telephone companies. These limitations may cause significant delays, or even failures, in callers’ receipt of emergency assistance. Despite the fact that we have notified our customers and received affirmative acknowledgement from substantially all of our customers that they understand the differences between the access Lingo provides to emergency services as compared to those available through traditional wireline telephony providers, affected parties may attempt to hold us responsible for any loss, damage, personal injury or death suffered as a result of certain failures to comply with the FCC mandated E911 service for interconnected VoIP providers. Our resulting liability could be significant.

In July 2008, the “New and Emerging Technologies 911 Improvement Act of 2008” was signed into law. Previously, interconnected VoIP providers, like us, did not have the same protection from potential liability as applied wireline or wireless 911 emergency calling services. This law provides public safety entities, interconnected VoIP providers and others involved in handling 911 calls the same liability protections when handling 911 calls from interconnected VoIP users as from mobile or wired telephone service users. In October 2008, the FCC issued regulations implementing the provisions of the new law that require other entities involved in the provision of E911 services to make the technical capabilities used in such services available to VoIP providers, like us, on reasonable terms. The applicability of the liability protection to 911 calling services that do not conform to the FCC’s rules is unclear. Additionally, any liability associated with 911 call placement and handling prior to the enactment of this new law would not be covered. Therefore, while this law provides significant liability protection to interconnected VoIP providers such as us, we may still face significant and material liability with respect to any past, present or future failures of our E911 service to function properly.

We may be similarly exposed to liability in Canada in connection with emergency services associated with our VoIP services. A description of our regulatory obligations associated with our VoIP services in Canada is set forth under “Government Regulation.”

 

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The Federal Communications Commission may impose additional E911 obligations on VoIP providers, like us, that may increase our cost, decrease our profits, or make our services less competitive with other providers of calling services.

In September 2010, the FCC released a Notice of Proposed Rulemaking considering the imposition of additional E911 obligations on interconnected VoIP providers. Specifically, the FCC is considering requiring interconnected VoIP providers to determine automatically the physical location of their customer rather than allowing customers to manually register their location. Moreover, the Notice includes a tentative conclusion that all interconnected VoIP service providers that allow customers to use their service in more than one location (nomadic VoIP service providers such as us) must utilize automatic location technology that meets the same accuracy standards applicable to providers of mobile phone service providers. At this time, we are unable to predict the outcome of this proceeding or its impact on us.

In September 2010, the FCC released a Further Notice of Inquiry seeking additional comments on a number of issues including, but not limited to, whether nomadic interconnected VoIP providers, like us, should be required to offer automatic location information of their users without customers providing location information. The FCC also seeks comment on how far it can extend E911 obligations to other types of companies including device manufacturers, software developers and others. At this time we cannot predict the outcome of this proceeding nor can we predict its potential impact on our business.

The rates we pay to interconnected telecommunications carriers in the U.S. may increase, which may reduce our profitability or increase the retail price of our service.

The FCC is considering reform of the methodology that regulated telecommunications carriers use to determine the appropriate payments for the exchange of traffic that is necessary to complete telephone calls to the traditional telephone network. In April 2010 the FCC announced its intention to issue a ruling clarifying network operators’ interconnection obligations. The FCC also announced its intention to issue proposed new rules governing the payments carriers make and receive in connection with the exchange of telecommunications traffic. This FCC proposal is now likely to be issued during the first quarter of 2011. The result of these actions, as well as any action the FCC may take in currently pending proceedings bearing on these issues, may be an increase in the rates we pay to such carriers to send traffic to or receive traffic from the traditional telephone network, which would increase our costs. Such a cost increase may result in us increasing the retail price of our service, which may make us less competitive in the communications marketplace, or may reduce our profitability. We cannot predict the outcome of this proceeding.

We may not be able to comply with recent FCC requirements regarding the transfer of telephone numbers to other providers when customers change providers.

In 2008, the FCC clarified that interconnected VoIP providers, such as us, are subject to its rules regarding transferring the telephone numbers of customers that choose to obtain service from other providers, including both interconnected VoIP providers and traditional carriers. In 2009, the FCC released an order that reduces the amount of time within which voice service providers must transfer a telephone number to a new provider. We, along with other VoIP providers, are now required to transfer telephone numbers on the shortened timeframe. We rely on our underlying, third party carriers to comply with these rules. Our third party, underlying carriers are currently in compliance with the FCC’s rules and we expect that they will remain in compliance. But should our underlying carriers fail to comply with the FCC rules, we may be subject to fines, penalties, or cease and desist orders.

States in the U.S. may subject our service to state Universal Service Fund obligations.

Several states have attempted to require nomadic interconnected VoIP providers to contribute to state USFs. One state, Nebraska, engaged in litigation with a provider of interconnected VoIP services similar to us. On July 16, 2009, Kansas and Nebraska filed a petition with the FCC requesting a declaratory ruling that states are

 

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not preempted from requiring nomadic interconnected VoIP providers to contribute to state USFs. The petition also sought a retroactive rule finding that states have been able to collect such contributions for an uncertain time period. On November 5, 2010, the FCC released an order granting the petition in part, clarifying that on a prospective basis states may extend USF contribution requirements to cover intrastate revenues of nomadic VoIP providers, so long as the state’s particular requirements do not conflict with federal law or policies. We cannot predict which states may seek to impose such contributions on us. Decisions by states to collect state USF contributions may result in increased state regulation of our service and increased costs associated with our services, which may lead to either low profits or a less competitively priced service. Typically, state USF fees would be passed on to consumers. At this time, we cannot predict the outcome of individual state decisions or the impact such decisions might have on our business.

We may become subject to state regulation for certain service offerings

A number of states have adopted the position that offerings by VoIP companies like us are subject to state regulation. These states generally base their jurisdiction to regulate such offerings based on whether a VoIP company is able to determine the beginning and end points of communications and whether such communications occur entirely within the boundaries of the respective state. We believe that the Federal Communications Commission has preempted states from regulating VoIP offerings. We cannot predict how this issue will be resolved nor its impact on our business at this time but we could be subject to increased costs, reduced profitability, and fines or penalties.

We require access to the Internet by us and our users in order to offer our services. If Internet access providers or other companies involved in handling Internet traffic are able to block, degrade or charge us so that we can offer quality services, we could incur additional costs or lose customers.

Our service offerings require that customers have access to broadband Internet access at a sufficient bandwidth in order to support call quality and other related services. We and our customers rely on service providers that have significant market power in the broadband Internet access marketplace including incumbent providers of wireline telephone services, cable companies and wireless companies. It is possible that some of these providers could take measures to degrade or disrupt our services, or increase the cost to us or our users to obtain access to certain levels of bandwidth necessary to make our service offerings. The FCC’s jurisdiction to prohibit or regulate these activities is unclear due to a 2009 ruling of the United States Court of Appeals for the D.C. Circuit. The FCC has taken the position that it has sufficient jurisdiction to issue regulations in this area. While interference with access to our products and services seems unlikely such broadband Internet access provider interference has occurred, in very limited circumstances in the U.S., and could result in a loss of existing users and increased costs, and could impair our ability to attract new users, thereby harming our revenue and growth.

We are subject to the requirements of the Federal Trade Commission’s new “Red Flag” identity theft rules.

We must comply with Section 114 of the Fair and Accurate Credit Transactions Act of 2003 (“FACTA”) and rules of the Federal Trade Commission (“FTC”) that require “creditors” to develop and effectuate written internal programs to detect, prevent, and mitigate identity theft in connection with their accounts. The rules became effective on January 1, 2011, and we may be deemed to be a “creditor” as defined in the FACTA. We are taking steps to ensure compliance with the FTC’s rules, but if and to the extent that we are determined to be out of compliance with the rules we may be subject to fines, penalties, compliance orders or any combination of the foregoing.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

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ITEM 2. PROPERTIES

We currently lease our corporate headquarters facility, which is located in McLean, Virginia. Additionally, we lease administrative, technical and sales office space, as well as space for our switches and data centers, in various locations in the countries in which we operate. As of December 31, 2010 total leased space in the United States, Australia, Canada, Brazil and the United Kingdom, as well as other countries in which we operate, approximates 580,000 square feet and the total annual lease costs are approximately $15.2 million. The operating leases expire at various times with the longest commitment expiring in 2019. We believe that our present administrative and sales office facilities are adequate for our anticipated operations and that similar space can be obtained readily as needed, and we further believe that the current leased facilities are adequate to house existing communications equipment.

Certain communications equipment which includes network switches and transmission lines are leased through operating leases, capital leases and vendor financing agreements.

 

ITEM 3. LEGAL PROCEEDINGS

The Company and its subsidiaries are subject to claims and legal proceedings that arise in the ordinary course of its business. Each of these matters is subject to various uncertainties, and it is possible that some of these matters may be decided unfavorably. The Company believes that any aggregate liability that may result from the resolution of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

ITEM 4. (REMOVED AND RESERVED)

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Common Stock

Primus Telecommunications Group, Incorporated (“we” or “us”) common stock has traded on the OTC Bulletin Board under the ticker symbol “PMUG” since July 1, 2009, (the “New Common Stock”). Shares of our common stock issued and outstanding immediately prior to July 1, 2009 (the “Old Common Stock”) traded on the over-the-counter market, both through listings on the OTC Bulletin Board and in the National Quotation Bureau “Pink Sheets.” The ticker symbol “PRTL” was assigned to our Old Common Stock for over the counter quotations. On June 30, 2009 share of our outstanding Old Common Stock were cancelled pursuant to the terms of our Plan of Reorganization and 9,600,000 shares of New Common Stock were issued. We have no continuing obligations with respect to the Old Common Stock.

The following table provides the high and low sale prices for our common stock authorized in connection with our emergence from bankruptcy as reported on the over-the-counter market for the period beginning July 1, 2009 and for our Old Common Stock for the periods through June 30, 2009. These prices do not include retail markups, markdowns or commissions.

 

     Successor             Predecessor  
     New Common Stock (1)             Old Common Stock (2)  

Period

       High              Low                     High              Low      

2010

                

1 st Quarter

   $ 7.25       $ 5.65              

2nd Quarter

   $ 7.54       $ 6.15              

3rd Quarter

   $ 7.70       $ 6.75              

4th Quarter

   $ 14.00       $ 7.00              
 

2009

                

1 st Quarter

              $ 0.09       $ 0.003   

2nd Quarter

              $ 0.04       $ 0.01   

3rd Quarter

   $ 7.75       $ 3.20              

4th Quarter

   $ 7.25       $ 5.60              

 

(1) 9,600,000 Shares of New Common Stock were issued pursuant to the terms of our Plan of Reorganization and trading commenced on July 1, 2009 on a “when issued” basis. The New Common Stock was listed on the OTC Bulletin Board and trades under the ticker symbol “PMUG”.
(2) All outstanding shares of the Old Common Stock were cancelled pursuant to the terms of our Plan of Reorganization and no further trading occurred after June 30, 2009.

Dividend Policy

We have not paid any cash dividends on our common stock to date. The payment of dividends, if any, in the future is within the discretion of the Board of Directors and will depend on our earnings, our capital requirements and financial condition. Dividends are currently restricted by the senior secured notes and the senior subordinated secured notes indentures, and may be restricted by other arrangements entered into in the future by us. It is the present intention of the Board of Directors to retain all earnings, if any, for use in our business operations, and accordingly, the Board of Directors does not expect to declare or pay any dividends in the foreseeable future.

 

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Contingent Value Rights Distribution Agreement

Pursuant to the terms of the Plan, Group issued to holders of Old Common Stock contingent value rights (“Contingent Value Rights” or “CVRs”) to receive up to an aggregate of 2,665,000 shares (the “CVR Shares”) of New Common Stock. In connection with the issuance of the Contingent Value Rights, Group entered into a Contingent Value Rights Distribution Agreement (the “CVR Agreement”), in favor of holders of CVRs thereunder, dated as of the Effective Date.

The CVRs may not be transferred by the holder thereof except in certain limited circumstances. Subject to the terms of the CVR Agreement, holders of CVRs will receive their pro rata share of up to 2,665,000 CVR Shares. A distribution of CVR Shares is required to be made by Group if, as of any determination date (described below), Group’s equity value (assuming cash exercise in full on such date of in-the-money warrants and options of Group) divided by the sum of the number of shares of New Common Stock then issued and outstanding plus the number of shares of New Common Stock underlying warrants, options and similar securities of Group (other than CVRs) that are then in-the-money exceeds $35.95. The aggregate number of such shares of New Common Stock is referred to as the “Applicable Shares;” the price per share of $35.95, subject to adjustment as described below, is referred to as the “CVR Strike Price;” and the per share amount of any such excess over the CVR Strike Price is referred to as the “Excess Equity Value Per Share.” If such a distribution is required, the number of CVR Shares to be distributed by Group equals the product of Excess Equity Value Per Share multiplied by the number of Applicable Shares divided by the CVR Strike Price. Such product of Excess Equity Value Per Share and the number of Applicable Shares is referred to as the “Excess Equity Value.”

Group will determine if and to the extent a distribution of CVR Shares is required on January 1 and July 1 of each year, commencing on the first such date (but in no event later than July 1, 2013) on which data is available to confirm that Group’s adjusted EBITDA for the immediately preceding four fiscal quarters is equal to at least $100 million, and upon a change of control of Group. Distributions of CVR Shares (if any) will be made within 45 calendar days of a determination by Group that a distribution is required. Notwithstanding the foregoing, no distribution of CVR Shares is required to be made by Group unless Excess Equity Value exceeds $1 million as of any determination date.

The number of CVR Shares and the CVR Strike Price will be adjusted from time to time in connection with any stock dividend or distribution, or subdivision, split, combination, reclassification or recapitalization of the New Common Stock. In addition, if Group distributes to holders of New Common Stock any of its assets (including but not limited to cash), securities or rights to purchase securities of Group (other than any regular cash dividend not to exceed in any fiscal year 45% of the consolidated net income of Group for the immediately preceding fiscal year), then the number of CVR Shares will be increased and the CVR Strike Price will be decreased, in each case pursuant to the terms of the CVR Agreement. Additionally, in case of any reclassification, merger, consolidation, capital reorganization or other change in the capital stock of Group (other than in connection with a change of control) in which all or substantially all of the outstanding shares of New Common Stock are converted into or exchanged for stock, other securities or other property, Group shall make appropriate provision so that the holders of Contingent Value Rights shall thereafter be entitled to receive, at such time such holder would have otherwise been entitled to receive a distribution under the CVR Agreement, the kind and amount of stock and other securities and property having a value substantially equivalent to the value of New Common Stock that the holders of Contingent Value Rights would have been entitled to receive in connection with a distribution of CVR Shares immediately prior to such reclassification, merger, consolidation, reorganization or other change in the capital stock of Group at a CVR Strike Price that, in each case, is reasonably determined by the board of directors of Group after consultation with an independent valuation advisor to preserve, to the extent practicable, the intrinsic value of such CVR immediately prior to such event.

The Contingent Value Rights will expire and the CVR Agreement will terminate upon the earliest to occur of: (1) the date upon which no further CVR Shares are available for distribution, (2) the consummation of a change of control (subject to any potential distribution of CVR Shares as a result thereof), and (3) July 1, 2019.

 

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The foregoing description of the CVR Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of such agreement, a copy of which is attached as an exhibit to Group’s Form 8-A filed with the SEC on July 1, 2009 and such exhibit is incorporated herein by reference.

Holders of Common Stock

As of February 28, 2011, the Company had three holders of record of our common stock. The Company believes that this represents approximately 700 beneficial owners.

Recent Sales of Unregistered Securities

There are no unregistered sales of securities for 2010, other than the transactions that have been previously reported in our quarterly report on Form 10-Q for the period ended June 30, 2010, which description is incorporated herein by reference.

Issuer Purchases of Equity Securities

The following shares of Common Stock were withheld to satisfy tax withholding obligations during the year ended December 2010. Upon vesting of restricted stock awarded by the Company to employees, the Company withholds shares to cover employees’ tax withholding obligations, other than for employees who have chosen to satisfy their tax withholding requirements in the form of a cash payment. The table below reflects the only repurchases of equity securities made by the Company in the year 2010. The Company does not have a stock repurchase program.

 

Period

   Total number
of shares
purchased
     Average price
paid per share
     Total number
of shares
purchased as
part of
publicly
announced
plans or
programs
     Maximum
number of
shares (or
approximate
dollar value)
of shares that
may yet be
purchased
under the plan
or programs
 

2010

           

1st Quarter

     56,843       $ 5.88         56,843         —     

2nd Quarter

     —           —           —           —     

3rd Quarter

     —           —           —           —     

4th Quarter

     1,691       $ 9.80         1,691         —     
                       
     58,534       $ 6.16         58,534         —     
                       

 

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Stock Performance Graph

The following graph, furnished voluntarily further to Instruction 6 to Item 201(e) of Regulations S-K, compares the cumulative total returns during the period from July 1, 2009 to December 31, 2010 of our common stock to the Standard & Poor’s Midcap 400 Index and the Standard & Poor’s Telecommunications Index. The comparison assumes $100 was invested on July 1, 2009 in each of the New Common Stock of the Company and the indices and assumes that all dividends were reinvested. The reorganized company’s New Common Stock began trading on the over the counter bulletin board on July 1, 2009. The company’s Old Common Stock, which was actively traded prior to July 1, 2009, does not provide meaningful comparison and the performance of the Old Common Stock has not been provided.

LOGO

 

     July 1, 2009      December 31, 2009      December 31, 2010  

Primus Telecommunications Group Inc. (PMUG)

   $ 100.00       $ 143.75       $ 312.50   

Standard & Poor’s Midcap 400 Index

     100.00         125.69         156.93   

Standard & Poor’s Telecommunications Index

   $ 100.00       $ 115.29       $ 128.67   

The performance graph will not be deemed to be incorporated by reference by means of any general statement incorporating by reference this Form 10-K into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that Primus specifically incorporates such information by reference, and shall not otherwise be deemed filed under such Acts.

 

ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data set forth below should be read in conjunction with (i) Item 7 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview,” (ii) our consolidated audited annual financial statements and the notes thereto, each of which are contained in Item 8 entitled “Financial Statements and Supplementary Data.” and (iii) the information described below under “European Retail Discontinued Operations.”

 

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As of July 1, 2009, the Company adopted fresh-start accounting in accordance with Accounting Standards Codification (ASC) No. 852. The adoption of fresh-start accounting resulted in the Company becoming a new entity for financial reporting purposes. Accordingly, the financial statements on or prior to July 1, 2009 are not comparable with the financial statements for periods after July 1, 2009. The consolidated condensed statements of operations and any references to “Successor” or “Successor Company” for the six months ended December 31, 2009, show the operations of the reorganized Company from and including July 1, 2009, the Effective Date, through December 31, 2009. References to “Predecessor” or “Predecessor Company” refer to the operations of the Company prior to July 1, 2009, except for Predecessor’s July 1, 2009 statements of operations which reflect only the effect of the plan adjustments and fresh-start accounting as of such date and do not reflect any operating results.

In accordance with ASC No. 805, the preliminary allocation of the reorganization value is subject to additional adjustment until the Company has completed its analysis, but not to exceed one year after emergence from bankruptcy, to provide the Company with the time to complete the valuation of its assets and liabilities. The final determination of the fair value of individual assets and liabilities and the final allocation of the reorganization value was finalized during the first six months of 2010.

European Retail Discontinued Operations. Subsequent to its December 31, 2009 year-end, the Company had sold or held for sale its Europe segment, which is also known as European retail operations, and classified the components of these operations as discontinued operations. As a result, the Company has applied retrospective adjustments for 2009, 2008 and 2007 to reflect the effects of the discontinued operations that occurred subsequent to December 31, 2009. Accordingly, revenue, costs, and expenses of the discontinued operations have been excluded from the respective captions in the consolidated statements of operations. The net operating results of the discontinued operations have been reported, net of applicable income taxes as income, or loss, as applicable, from discontinued operations. The Company did not retrospectively adjust its 2009 or 2008 Consolidated Balance Sheet, as held for sale criteria were not met until the third quarter of 2010; as such, financial information for the Europe segment will appear, as applicable, where certain balance sheet information is presented. The following selected financial information has been recast to reflect such retrospective classification of the Company’s European retail operations.

 

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PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

    Successor           Predecessor  
    Year
Ended
December 31,
2010
    Six Months
Ended
December 31,
2009
          Six Months
Ended
July 1,
2009
    Year
Ended
December 31,
2008
    Year
Ended
December 31,
2007
    Year
Ended
December 31,
2006
 

NET REVENUE

  $ 764,947      $ 397,520          $ 365,245      $ 832,837      $ 829,342      $ 907,180   
 

OPERATING EXPENSES

               

Cost of revenue (exclusive of depreciation included below)

    488,612        259,566            236,925        526,435        506,847        594,486   

Selling, general and administrative

    198,201        95,223            88,585        239,123        249,346        240,410   

Depreciation and amortization

    65,279        36,990            11,545        30,356        26,917        41,387   

(Gain) loss on sale or disposal of assets

    196        102            (43     (5,966     241        13,954   

Asset impairment write-down

    —          —              —          —          —          185,952   
                                                   

Total operating expenses

    752,288        391,881            337,012        789,948        783,351        1,076,189   
                                                   

INCOME (LOSS) FROM OPERATIONS

    12,659        5,639            28,233        42,889        45,991        (169,009

INTEREST EXPENSE

    (35,490     (17,278         (14,093     (53,971     (60,709     (53,920

(ACCRETION) AMORTIZATION ON DEBT PREMIUM/DISCOUNT, net

    (183     (3         189        583        (449     (1,732

CHANGE IN FAIR VALUE OF DERIVATIVES EMBEDDED WITHIN CONVERTIBLE DEBT

    —          —              —          —          —          5,373   

GAIN (LOSS) ON EARLY EXTINGUISHMENT OR RESTRUCTURING OF DEBT

    164        (4,146         —          36,872        (7,652     7,409   

GAIN (LOSS) FROM CONTINGENT VALUE RIGHTS VALUATION

    (13,737     (2,804         —          —          —          —     

INTEREST INCOME AND OTHER INCOME (EXPENSE), net

    741        492            378        3,284        6,018        2,652   

FOREIGN CURRENCY TRANSACTION GAIN (LOSS)

    16,413        19,566            20,332        (46,378     32,734        11,873   
                                                   

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE REORGANIZATION ITEMS AND INCOME TAXES

    (19,433     1,466            35,039        (16,721     15,933        (197,354

REORGANIZATION ITEMS, net

    1        (421         424,825        —          —          —     
                                                   

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

    (19,432     1,045            459,864        (16,721     15,933        (197,354

INCOME TAX BENEFIT (EXPENSE)

    9,085        10,180            (4,074     739        9,264        (4,990
                                                   

INCOME (LOSS) FROM CONTINUING OPERATIONS

    (10,347     11,225            455,790        (15,982     25,197        (202,344

INCOME (LOSS) FROM DISCONTINUED OPERATIONS, net of tax

    (11,771     (4,050         15,081        (5,890     (15,593     (44,139

GAIN (LOSS) FROM SALE OF DISCONTINUED OPERATIONS, net of tax

    2,926        (110         251        —          6,132        7,415   
                                                   

NET INCOME (LOSS)

    (19,192     7,065            471,122        (21,872     15,736        (239,068

Less: Net (income) loss attributable to the noncontrolling interest

    105        (333         32        (3,159     —          1,110   
                                                   

NET INCOME (LOSS) ATTRIBUTABLE TO PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED

  $ (19,087   $ 6,732          $ 471,154      $ (25,031   $ 15,736      $ (237,958
                                                   

BASIC INCOME (LOSS) PER COMMON SHARE:

               

Income (loss) from continuing operations attributable to Primus Telecommunications Group, Incorporated

  $ (1.05   $ 1.13          $ 3.19      $ (0.13   $ 0.19      $ (1.79

Income (loss) from discontinued operations, net of tax

    (1.21     (0.42         0.11        (0.05     (0.12     (0.40

Gain (loss) from sale of discontinued operations, net of tax

    0.30        (0.01         —          —          0.05        0.07   
                                                   

Net income (loss) attributable to Primus Telecommunications Group, Incorporated

  $ (1.96   $ 0.70          $ 3.30      $ (0.18   $ 0.12      $ (2.12
                                                   

 

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    Successor           Predecessor  
    Year
Ended
December 31,
2010
    Six Months
Ended
December 31,
2009
          Six Months
Ended
July 1,
2009
    Year
Ended
December 31,
2008
    Year
Ended
December 31,
2007
    Year
Ended
December 31,
2006
 

DILUTED LOSS PER COMMON SHARE:

               

Income (loss) from continuing operations attributable to Primus Telecommunications Group, Incorporated

  $ (1.05   $ 1.11          $ 2.63      $ (0.13   $ 0.14      $ (1.79

Gain (loss) from discontinued operations, net of tax

    (1.21     (0.41         0.09        (0.05     (0.08     (0.40

Gain (loss) from sale of discontinued operations, net of tax

    0.30        (0.01         —          —          0.03        0.07   
                                                   

Net income (loss) attributable to Primus Telecommunications Group, Incorporated

  $ (1.96   $ 0.69          $ 2.72      $ (0.18   $ 0.09      $ (2.12
                                                   

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

               

Basic

    9,721        9,600            142,695        142,643        128,771        112,366   
                                                   

Diluted

    9,721        9,800            173,117        142,643        196,470        112,366   
                                                   

AMOUNTS ATTRIBUTABLE TO COMMON SHAREHOLDERS OF PRIMUS TELECOMMUNICATIONS GROUP, INCORPORATED

               

Income (loss) from continuing operations, net of tax

  $ (10,242   $ 10,892          $ 455,822      $ (19,141   $ 25,197      $ (201,234

Income (loss) from discontinued operations, net of tax

    (11,771     (4,050         15,081        (5,890     (15,593     (44,139

Gain (loss) from sale of discontinued operations, net of tax

    2,926        (110         251        —          6,132        7,415   
                                                   

Net income (loss)

  $ (19,087   $ 6,732          $ 471,154      $ (25,031   $ 15,736      $ (237,958
                                                   

 

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Balance Sheet Data:

 

     Successor             Predecessor  
     As of December 31,             As of December 31,  

(in thousands)

   2010      2009             2008     2007     2006  

Total assets

   $ 514,459       $ 558,914            $ 330,444      $ 460,403      $ 392,250   

Total long-term obligations (including current portion)

   $ 243,891       $ 257,516            $ 604,837      $ 673,903      $ 644,074   

Total liabilities

   $ 431,425       $ 459,005            $ 789,169      $ 907,943      $ 860,506   

Total Primus Telecommunications Group, Inc. stockholders’ equity (deficit)

   $ 83,034       $ 99,909            $ (461,539   $ (447,540   $ (468,255

Discontinued Operations Data:

 

    Successor           Predecessor  
    Year
Ended
December 31,
2010
    Six Months
Ended
December 31,
2009
          Six Months
Ended
July 1,
2009
    Year
Ended
December 31,
2008
    Year
Ended
December 31,
2007
    Year
Ended
December 31,
2006
 

Net revenue

  $ 37,506      $ 26,813          $ 26,271      $ 66,876      $ 76,647      $ 109,939   

Operating expenses

    50,605        29,322            27,408        71,718        91,187        152,606   
                                                   

Income (loss) from operations

    (13,099     (2,509         (1,137     (4,842     (14,540     (42,667

Interest expense

    (8     (45         (42     83        (664     (255

Interest income and other income (expense)

    (396     (160         37        52        (314     (67

Foreign currency transaction gain (loss)

    (137     (1,184         788        (808     (41     (1,196

Reorganization items

    —          (14         15,269        —          —          —     
                                                   

Income (loss) before income tax

    (13,640     (3,912         14,915        (5,515     (15,559     (44,185

Income tax benefit (expense)

    1,869        (138         166        (375     (34     46   
                                                   

Income (loss) from discontinued operations

  $ (11,771   $ (4,050       $ 15,081      $ (5,890   $ (15,593   $ (44,139
                                                   

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with the information in the following paragraph and the information in our consolidated annual audited financial statements and the notes thereto, each of which are contained in Item 8 entitled “Financial Statements and Supplementary Data,” and other financial information incorporated by reference. Some of the information contained in this discussion and analysis includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis

During 2010 we had sold or held for sale our Europe segment, which is also known as European retail operations, and classified the components of these operations as discontinued operations. We applied retrospective adjustments for 2009 and 2008 to reflect the effects of the discontinued operations that occurred during 2010. Accordingly, revenue, costs, and expenses of the discontinued operations have been excluded from the respective captions in the consolidated statements of operations. The net operating results of the discontinued operations have been reported, net of applicable income taxes as income, or loss, as applicable, from discontinued operations. We did not retrospectively adjust our 2009 Consolidated Balance Sheet, as held for sale criteria were not met until the third quarter of 2010; as such, financial information for the Europe segment will appear, as applicable, where certain balance sheet information is presented.

Introduction and Overview of Operations

We are an integrated facilities-based communications services provider offering a portfolio of international and domestic voice, wireless, Internet, VoIP, data and data center services to customers located primarily in Australia, Canada, the United States and Brazil. Our primary markets are Australia and Canada where we have deployed significant network infrastructure. We classify our services into three categories: Growth Services, Traditional Services and International Carrier Services. Our focus is on expanding our Growth Services, which includes our broadband, IP-based voice, local, wireless, data and data center services, to fulfill the demand for high quality, competitively priced communications services. This demand is being driven, in part, by the globalization of the world’s economies, the global trend toward telecommunications deregulation and the migration of communication traffic to the Internet. We manage our Traditional Services, which includes our domestic and international long-distance voice, prepaid cards, dial-up Internet services and Australian off-network local services for cash flow generation that we reinvest to develop and market our Growth Services, particularly in our primary markets of Australia and Canada. We provide our International Carrier Services voice termination services to other telecommunications carriers and resellers requiring IP or time-division multiplexing access.

Generally, we price our services competitively with the major carriers and service providers operating in our principal service regions. We seek to generate net revenue through sales and marketing efforts focused on customers with significant communications needs, including SMEs, multinational corporations, residential customers, and other telecommunications carriers and resellers.

Industry trends have shown that the overall market for domestic and international long-distance voice, prepaid phone cards and dial-up internet services has declined in favor of Internet-based, wireless and broadband communications. Our challenge concerning net revenue in recent years has been to overcome declines in long-distance voice minutes of use per customer as more customers are using wireless devices and the Internet as alternatives to the use of wireline phones. Also, product substitution (e.g., wireless/Internet for fixed line voice) has resulted in revenue declines in our long-distance voice services. Additionally, we believe that because deregulatory influences have begun to affect telecommunications markets outside the United States, the

 

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deregulatory trend is resulting in greater competition from the existing wireline and wireless competitors and from more recent entrants, such as cable companies and VoIP companies, which could continue to affect adversely our net revenue per minute, as well as minutes of use. More recently, adverse global economic conditions have resulted in a contraction of spending by business and residential customers generally which, we believe, has had an adverse affect on our net revenues.

In order to manage our network transmission costs, we pursue a flexible approach with respect to the management of our network capacity. In most instances, we (1) optimize the cost of traffic by using the least expensive cost routing, (2) negotiate lower variable usage based costs with domestic and foreign service providers, (3) negotiate additional and lower cost foreign carrier agreements with the foreign incumbent carriers and others, and (4) continue to expand/reduce the capacity of our network when traffic volumes justify such actions.

Our overall margin may fluctuate based on the relative volumes of international versus domestic long-distance services; international carrier services versus business and residential long-distance services; prepaid services versus traditional post-paid voice services; Internet, VoIP and data services versus fixed line voice services; the amount of services that are resold; and the proportion of traffic carried on our network versus resale of other carriers’ services. Our margin is also affected by customer transfer and migration fees. We generally pay a charge to install and transfer a new customer onto our network and to migrate broadband and local customers. However, installing and migrating customers to our network infrastructure, enables us to increase our margin on such services as compared to resale of services using other carriers’ networks.

Selling, general and administrative expenses are comprised primarily of salaries and benefits, commissions, occupancy costs, sales and marketing expenses, advertising, professional fees, and other administrative costs. All selling, general and administrative expenses are expensed when incurred. Emphasis on cost containment and the shift of expenditures from non-revenue producing expenses to sales and marketing expenses has been heightened since growth in net revenue has been under pressure.

Emergence from Voluntary Reorganization Under Chapter 11 Proceedings

On March 16, 2009, the Holding Companies filed Chapter 11 Cases in the Bankruptcy Court for reorganization relief under Chapter 11 of the Bankruptcy Code. Subsequently, the Holding Companies sought and received an order directing the joint administration of the Chapter 11 Cases under the caption In re: Primus Telecommunications Group, Incorporated, et al., Debtors, Case No. 09-10867. On April 24, 2009, an unsecured creditors’ committee was appointed by the United States Trustee.

On April 27, 2009, the Bankruptcy Court approved the Holding Companies’ use of a disclosure statement dated April 27, 2009 (the “Disclosure Statement”) to solicit votes on the Plan of Reorganization. The Disclosure Statement was distributed to holders of record (as of April 27, 2009) of claims against, and interests in, the Holding Companies who were entitled to vote on the Plan of Reorganization (the “Record Date”).

The Plan was confirmed by the Bankruptcy Court on June 12, 2009 (the “Confirmation Date”). On the Effective Date, the Holding Companies consummated their reorganization under the Bankruptcy Code and the Plan of Reorganization became effective. See “Note 2—Emergence from Voluntary Reorganization under Chapter 11 of the Bankruptcy Code” to our consolidated financial statements for further details.

As of July 1, 2009, we adopted fresh-start accounting in accordance with Financial Accounting Standards Board ASC No. 852, “Reorganizations.” The adoption of fresh-start accounting resulted in the Company becoming a new entity for financial reporting purposes. Accordingly, the financial statements on or prior to July 1, 2009 are not comparable with the financial statements for periods after July 1, 2009. See “Note 4—Fresh-Start Accounting” to our consolidated financial statements for further detail.

 

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Impact of Reorganization on Our Capital Structure, Long-Term Debt and Financial Statements.

Upon our emergence under the Plan of Reorganization on July 1, the Holding Companies’ principal debt was reduced by $316 million, or over 50%, interest payments were reduced by over 50% and certain debt maturities were extended. The significant features of the Plan included the developments summarized below:

 

   

Holding’s $96 million Term Loan facility due February 2011 was reinstated and amended;

 

   

IHC’s $173 million of outstanding 14  1/4% Senior Secured Notes due 2011 were cancelled and the holders thereof received their pro rata portion of $123.5 million of aggregate principal amount of 14 1/4% Senior Subordinated Secured Notes due May 20, 2013 and 4,800,000 shares of the new Common Stock of Group (the “New Common Stock”);

 

   

the $209 million in aggregate outstanding 5% Exchangeable Senior Notes and 8% Senior Notes issued by Holding (collectively, the “Holding Senior Notes”) were cancelled, and the holders thereof received 4,800,000 shares of the New Common Stock and Class A warrants to purchase up to an aggregate of 3,000,000 shares of New Common Stock;

 

   

the 3 3/4% Senior Notes due September 2010, 12 3/4% Senior Notes due October 2009 and Step Up Convertible Subordinated Debentures due August 2009 issued by Group (collectively, the “Group Notes”) were cancelled, and the holders thereof received Class B warrants to purchase up to an aggregate of 1,500,000 shares of the New Common Stock;

 

   

all existing shares of common stock outstanding prior to the Effective Date (the “Old Common Stock”) were cancelled on the Effective Date, and holders thereof received their pro rata share of contingent value rights (“Contingent Value Rights” or “CVRs”) to acquire up to 2,665,000 shares of New Common Stock; and

 

   

all outstanding equity incentive grants of Group were cancelled on the Effective Date, and the Primus Telecommunications Group, Incorporated Management Compensation Plan (the “Management Compensation Plan”) became effective. As of the Effective Date, 400,000 restricted stock units, 400,000 service-based stock options and 100,000 performance-based stock options were granted to certain employees and executive officers under the Management Compensation Plan.

In accordance with the Plan, Group’s certificate of incorporation and bylaws were amended and restated in their entirety. Group’s Second Amended and Restated Certificate of Incorporation (the “Amended Certificate Incorporation”) and Amended and Restated By-Laws (the “Amended By-Laws”) both became effective on the Effective Date. The Amended Certificate of Incorporation provides for 80,000,000 shares of authorized New Common Stock and 20,000,000 shares of authorized new preferred stock, of which 9,600,000 shares of New Common Stock were issued on the Effective Date. A further description of the key provisions of the Amended Certificate of Incorporation and the Amended By-Laws is included in Group’s registration statement on Form 8-A under “Description of Capital Stock” filed with the SEC on July 1, 2009, which description is incorporated herein by reference. This description is qualified in its entirety by reference to the full text of these documents, which are attached as exhibits to such Form 8-A and such text is incorporated herein by reference.

Prior to the Effective Date, Group had approximated 142,695,390 shares of Old Common Stock issued and outstanding, and all of these shares were cancelled in connection with the effectiveness of the Plan. On the Effective Date, Group issued 9,600,000 shares of New Common Stock and had an additional 7,165,000 shares of New Common Stock reserved for future issuance in respect of claims and interests filed and allowed under the Plan, consisting of (1) 3,000,000 shares of new common stock reserved for issuance upon exercise of Class A warrants, (2) 1,500,000 shares of new common stock reserved for issuance upon exercise of Class B warrants, and (3) 2,665,000 shares of new common stock reserved for distribution on account of contingent value rights. The total number of shares of New Common Stock issued and reserved for issuance in respect of claims and interests filed and allowed under the Plan was 16,765,000. Including the shares of New Common Stock reserved

 

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for issuance under the Management Compensation Plan, the total number of shares of New Common Stock issued and reserved for issuance under the Plan was 17,765,000.

Recent Developments

Acquisition of Arbinet Corporation

On February 28, 2011, the Company completed the previously announced merger of PTG Investments, Inc. (“Merger Sub”), a Delaware corporation and a wholly-owned subsidiary of the Company with and into Arbinet Corporation (the “Merger”), pursuant to the Agreement and Plan of Merger dated November 10, 2010, as amended by Amendment No. 1 dated December 14, 2010 (collectively, the “Merger Agreement”) by and among the Company, Merger Sub and Arbinet. As a result of the Merger, Arbinet became a wholly-owned subsidiary of the Company.

In connection with the Merger, each share of Arbinet’s common stock, par value $0.001 per share, issued and outstanding immediately prior to the effective time of the Merger was canceled and converted into the right to receive 0.5817 of a share of Company common stock. The Company intends to integrate Arbinet’s operations into the Company’s International Carrier Services segment.

The value of Primus shares issued as merger consideration is based upon the closing price of Primus common stock as of February 25, 2011 of $15.60 per share. The exchange of 5,557,525 eligible Arbinet shares for 3,232,812 Primus common stock equivalents equated to a purchase value of approximately $50.4 million. This includes the issued and outstanding shares of Arbinet and includes Arbinet’s outstanding warrants, options, stock appreciation rights and other equity awards that were exercised prior to the effective date of the Merger or subject to accelerated vesting features due to a change in control.

The Company intends to integrate Arbinet’s operations into its International Carrier Services segment. The combined company is expected to be ranked among the top 12 leading international telecommunications carrier service providers in the world based on annual revenues, is expected to be well positioned to capitalize on its long established experience in carrier telecom operations and to expand its global voice and data operations to meet the evolving demands of telecom operators worldwide. With its enhanced scale and market position, the combined company is expected to enable international carrier services customers to access additional networks and termination routes at competitive rates. The combined company is expected to have a diversified product portfolio of international voice and data services across all international carrier services customer segments. The combined company would become the only major global provider to offer international carrier services customers options to either acquire direct international connections through traditional interconnect arrangements or manage their access needs through The Exchange.

The Arbinet acquisition will be accounted for under the acquisition method of accounting in accordance with ASC 805, “Business Combinations”. Under the acquisition method of accounting, assets acquired and liabilities assumed are measured at fair value as of February 28, 2011. The fair value of the consideration transferred and the assets acquired and liabilities assumed will be determined by the Company and in doing so management will rely in part upon a third-party valuation report to measure the identifiable intangible assets, property and equipment acquired. The third-party valuation reports are not final at the time of filing this annual report. This means that the assets and liabilities of Arbinet will be recorded, as of the completion of the Merger, at their fair values and added to those of the Company, including an amount for goodwill representing the difference between the purchase price and fair value of the identifiable net assets. Financial statements of the Company issued after the Merger will reflect only the operations of the combined business after the Merger and will not be restated retroactively to reflect the historical financial position or results of operations of Arbinet.

The Company’s acquisition of Arbinet was an all stock transaction and the Merger Agreement was based upon a Primus common stock per share price of $9.5464. The initial purchase price valuation of Arbinet was

based in part upon consultation with a third-party and the total aggregate consideration contemplated in the

 

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Merger Agreement was $28 million and was later augmented as per the terms of Merger Agreement by $3.65 million to include the sale of Arbinet’s intellectual property. The Merger Agreement, though based on a reasonable agreed upon consideration of $31.65 million, provided that increases in the market price of Primus’s common stock would have the effect of increasing the total fair value of the consideration and therefore would increase the amount of the purchase price allocable to goodwill. The base-exchange formula provided by the Merger Agreement established the number of common shares required to consummate the Merger. The number of common shares established by the Merger Agreement remained constant from the inception of the Merger through the closing date, February 28, 2011, and was not affected by the increase in the value of Primus’s stock which occurred after the Merger Agreement date. On February 28, 2011, the final consideration to be allocated to Arbinet’s net assets under ASC No. 805 was valued at approximately $50.4 million and was based upon a Primus common stock per share price of $15.60.

The Company believes that the significant increase in the fair value of the consideration to be allocated to Arbinet’s net assets as compared to the Company’s initial valuation of Arbinet may trigger the requirement for the company to perform a goodwill impairment test upon completion of its acquisition accounting. The Company expects to record its acquisition accounting during the first quarter of 2011.

Given the above, the Company believes that goodwill arising from the acquisition of Arbinet may potentially be considered impaired, fully, or in part, upon completion of the allocation of the consideration to Arbinet’s net assets. The Company will perform a step one test of goodwill impairment during the first quarter of 2011 for the International Carrier Services reporting unit.

Foreign Currency

Foreign currency can have a major impact on our financial results. During 2010, approximately 85% of our net revenue was derived from sales and operations outside the U.S. The reporting currency for our consolidated financial statements is the United States dollar. The local currency of each country is the functional currency for each of our respective entities operating in that country. In the future, we expect to continue to derive the majority of our net revenue and incur a significant portion of our operating costs from outside the U.S., and therefore changes in exchange rates have had and may continue to have a significant, and potentially adverse, effect on our results of operations. Our primary risk of loss regarding foreign currency exchange rate risk is caused primarily by fluctuations in the following exchange rates: USD/Canadian dollar, USD/Australian dollar, USD/British pound (“GBP”), and USD/Euro (“EUR”). Due to the large percentage of our revenue derived outside of the U.S., changes in the USD relative to one or more of the foregoing currencies could have an adverse impact on our future results of operations. We have agreements with certain subsidiaries for repayment of a portion of the investments and advances made to these subsidiaries. As we anticipate repayment in the foreseeable future, we recognize the unrealized gains and losses in foreign currency transaction gain (loss) on the consolidated statements of operations. The exposure of our income from operations to fluctuations in foreign currency exchange rates is reduced in part because a majority of the costs that we incur in connection with our foreign operations are also denominated in local currencies.

We are exposed to financial statement gains and losses as a result of translating the operating results and financial position of our international subsidiaries. We translate the local currency statements of operations of our foreign subsidiaries into USD using the average exchange rate during the reporting period. Changes in foreign exchange rates affect the reported profits and losses and cash flows and may distort comparisons from year to year. By way of example, when the USD strengthens compared to the EUR, there could be a negative or positive effect on the reported results for Europe, depending upon whether Europe is operating profitably or at a loss. It takes more profits in EUR to generate the same amount of profits in USD and a greater loss in EUR to generate the same amount of loss in USD. The opposite is also true. For instance, when the USD weakens there is a positive effect on reported profits and a negative effect on the reported losses for Europe.

 

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In the year ended December 31, 2010, as compared to the year ended December 31, 2009, the USD was weaker on average as compared to the CAD and AUD; the USD was stronger on average as compared to the EUR and GBP. The following tables demonstrate the impact of currency fluctuations on our net revenue for the years ended December 31, 2010 and 2009:

Net Revenue by Location, including Discontinued Operations—in USD (in thousands)

 

     For the Year Ended December 31,  
     2010
Net Revenue
     2009
Net Revenue
     Variance     Variance %  

Canada

   $ 231,185       $ 224,397       $ 6,788        3.0

Australia

   $ 276,722       $ 243,158       $ 33,564        13.8

United Kingdom2

   $ 93,440       $ 93,078       $ 362        0.4

Europe1,2

   $ 60,617       $ 89,182       $ (28,565     (32.0 %) 

Net Revenue by Location, including Discontinued Operations—in Local Currencies (in thousands)

 

     For the Year Ended December 31,  
     2010
Net Revenue
     2009
Net Revenue
     Variance     Variance %  

Canada (in CAD)

     238,229         255,674         (17,445     (6.8 %) 

Australia (in AUD)

     301,324         308,068         (6,744     (2.2 %) 

United Kingdom (in GBP)2

     60,619         59,919         700        1.2

Europe (in EUR)1,2

     42,829         63,633         (20,804     (32.7 %) 

 

1 Europe includes only subsidiaries whose functional currency is the EUR.
2 Table includes revenues from discontinued operations which are subject to currency risk.

In the year ended December 31, 2009, as compared to the year ended December 31, 2008, the USD was stronger on average as compared to the CAD and AUD; the USD was weaker on average as compared to the GBP and the EUR. The following tables demonstrate the impact of currency fluctuations on our net revenue for the years ended December 31, 2009 and 2008:

Net Revenue by Location, including Discontinued Operations—in USD (in thousands)

 

     For the Year Ended December 31,  
     2009
Net Revenue
     2008
Net Revenue
     Variance     Variance %  

Canada

   $ 224,397       $ 260,834       $ (36,437     (14.0 %) 

Australia

   $ 243,158       $ 276,414       $ (33,256     (12.0 %) 

United Kingdom2

   $ 93,078       $ 87,706       $ 5,372        6.1

Europe1,2

   $ 89,182       $ 87,623       $ 1,559        1.8

Net Revenue by Location, including Discontinued Operations—in Local Currencies (in thousands)

 

     For the Year Ended December 31,  
     2009
Net Revenue
     2008
Net Revenue
     Variance     Variance %  

Canada (in CAD)

     255,674         276,294         (20,620     (7.5 %) 

Australia (in AUD)

     308,068         324,724         (16,656     (5.1 %) 

United Kingdom (in GBP)2

     59,919         48,335         11,584        24.0

Europe (in EUR)1,2

     63,633         59,640         3,993        6.7

 

1 Europe includes only subsidiaries whose functional currency is the EUR.
2 Table includes revenues from discontinued operations which are subject to currency risk.

 

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Critical Accounting Policies

To aid in the understanding of our financial reporting, our most critical accounting policies are described below. These policies have the potential to have a more significant impact on our financial statements, either because of the significance of the financial statement item to which they relate, or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events which are continuous in nature.

Revenue Recognition and Deferred Revenue—Net revenue is derived from carrying a mix of business, residential and carrier long-distance traffic, data and Internet traffic, and also from the provision of local, data center and wireless services. For voice and international carrier services VoIP, net revenue is earned based on the number of minutes during a call and is recorded upon completion of a call, adjusted for allowance for doubtful accounts receivable, service credits and service adjustments. Revenue for a period is calculated from information received through our network switches. Customized software has been designed to track the information from the switch and analyze the call detail records against stored detailed information about revenue rates. This software provides us the ability to do a timely and accurate analysis of revenue earned in a period. Separate prepaid services software is used to track additional information related to prepaid service usage such as activation date, monthly usage amounts, fees and charges, and expiration date. Revenue on these prepaid services is recognized as service is provided until expiration, when all unused minutes, which are no longer available to the customers, are recognized as revenue.

Net revenue is also earned on a fixed monthly fee basis for unlimited local and long-distance plans and for the provision of data/Internet (including retail VoIP) and hosting services. Data/Internet and hosting services include monthly fees collected for the provision of dedicated and dial-up access at various speeds and bandwidths and colocation services. These fees are recognized as access and colocation is provided on a monthly basis. Additionally, service activation and installation fees are deferred and amortized over the longer of the average customer life or the contract term. We record payments received in advance for prepaid services and services to be provided under contractual agreements, such as Internet broadband and dial-up access, as deferred revenue until such related services are provided.

A portion of revenue, representing less than 1% of total revenue, is earned from the sale of wireless handsets and VoIP routers. We apply the provisions of ASC No. 605-25, “Revenue Recognition—Multiple Element Arrangements,” which provides guidance on when and how an arrangement involving multiple deliverables should be divided into separate units of accounting. We have concluded that ASC No. 605-25 requires us to account for the sale of wireless handsets and VoIP routers and the related cost of handset and router revenues as a separate unit of accounting when title to the handset or router passes to the customer. Revenue recognized is the portion of the activation fees allocated to the router or handset unit of accounting in the statement of operations when title to the router or handset passes to the customer. We defer the portion of the activation fees allocated to the service unit of accounting and recognize such deferred fees on a straight-line basis over the contract life in the statement of operations.

Net revenue represents gross revenue, net of allowance for doubtful accounts receivable, service credits and service adjustments.

Allowance for doubtful accounts receivable—Determining our allowance for doubtful accounts receivable requires significant estimates. Due to the large number of customers that we serve, it is impractical to review the creditworthiness of each of our customers, although a credit review is performed for larger carrier and retail business customers. We consider a number of factors in determining the proper level of the allowance, including historical collection experience, current economic trends, the aging of the accounts receivable portfolio and changes in the creditworthiness of our customers. Systems to detect fraudulent call activity are in place within our network, but if these systems fail to identify such activity, we may realize a higher degree of uncollectible accounts.

 

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Cost of revenue—Cost of revenue is comprised primarily of costs incurred from other domestic and foreign telecommunications carriers to originate, transport and terminate calls. The majority of our cost of revenue is variable, based upon the number of minutes of use, with transmission and termination costs being the most significant expense. Call activity is tracked and analyzed with customized software that analyzes the traffic flowing through our network switches and calculates the variable cost of revenue with predetermined contractual rates. If the domestic or foreign telecommunications carriers have tracked and invoiced the volume of minutes at levels different than what our activity shows or have invoiced at different rates, we will dispute the charges invoiced. There is no guarantee that we will prevail in such disputes. We use significant estimates to determine the level of success in dispute resolution and consider past historical experience, basis of disputes, financial status, and current relationships with vendors and aging of prior disputes in quantifying our estimates.

Valuation of long-lived assets—We review long-lived assets whenever events or changes indicate that the carrying amount of an asset may not be recoverable. In making such evaluations, we compare the expected undiscounted future cash flows to the carrying amount of the assets. If the total of the expected undiscounted future cash flows is less than the carrying amount of the assets, we are required to make estimates of the fair value of the long-lived assets in order to calculate the impairment loss equal to the difference between the fair value and carrying value of the assets.

We make significant assumptions and estimates in this process regarding matters that are inherently uncertain, such as determining asset groups and estimating future cash flows, remaining useful lives, discount rates and growth rates. The resulting undiscounted cash flows are projected over an extended period of time, which subjects those assumptions and estimates to an even larger degree of uncertainty. While we believe that our estimates are reasonable, different assumptions could materially affect the valuation of the long-lived assets.

We have concluded that we have one asset group: the network. This is due to the nature of our telecommunications network which utilizes all of the POPs, switches, cables and various other components throughout the network to seamlessly form the telecommunications gateway over which our products and services are carried for any given customer’s phone call or data or Internet transmission. Furthermore, outflows to many of the external network providers are not separately assignable to revenue inflows for any phone call or service plan.

We make assumptions about the remaining useful life of our long-lived assets. The assumptions are based on the average life of our historical capital asset additions, our historical asset purchase trend and the fact that our primary assets, our network switches, have an 8-year life. Because of the nature of our industry, we also assume that the technology changes in the industry render all equipment obsolete with no salvage value after their useful lives. In certain circumstances in which the underlying assets could be leased for an additional period of time, we have included such estimated cash flows in our estimate.

Valuation of Goodwill and other intangible assets—Under ASC No.350 “Intangibles—Goodwill and Other’, goodwill and indefinite lived intangible assets are not amortized but are reviewed annually for impairment, or more frequently, if impairment indicators arise. Intangible assets that have finite lives are amortized over their useful lives and are subject to the impairment provisions of ASC 360, “Property Plant and Equipment.”

Goodwill impairment is tested annually using a two-step process that begins with an estimation of the fair value of each reporting unit as of October 1. The first step is a screen for potential impairment by comparing the fair value of a reporting unit with its carrying amount. The second step measures the amount of impairment loss, if any, by comparing the implied fair value of the reporting unit goodwill with its carrying amount. The implied fair value of goodwill shall be determined in the same manner as the amount of goodwill recognized in a business combination is determined, that is through an allocation of the fair value of a reporting unit to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess.

 

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Our reporting units are the same as our operating segments as each segment’s components have been aggregated and deemed a single reporting unit because they have similar economic characteristics. Each component is similar in that they each provide telecommunications services for which all of the resources and costs are drawn from the same pool, and are evaluated using the same business factors by management.

Intangible assets not subject to amortization consist of trade names. Such indefinite lived intangible assets are tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test shall consist of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of the intangible asset exceeds its fair value, an impairment loss shall be recognized in an amount equal to the excess.

Intangible assets subject to amortization consist of certain trade names and customer relationships. These finite lived intangible assets are amortized based on their useful lives. Such assets are subject to the impairment provisions of ASC 360, wherein impairment is recognized and measured only if there are events and circumstances that indicate that the carrying amount may not be recoverable. The carrying amount is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset group. An impairment loss is recorded if after determining that it is not recoverable, the carrying amount exceeds the fair value of the asset.

As disclosed in Note 4—“Fresh Start Accounting” to the Company’s consolidated financial statements, on July 1, 2009, the Company adopted fresh-start accounting in accordance with ASC No. 852, “Reorganizations.” Fresh-start accounting reflects the value of the Company as determined in the confirmed Plan. Under fresh-start accounting, the Company’s asset and liability values are re-measured and allocated in conformity with ASC No. 805, “Business Combinations.” The excess of reorganization value over the fair value of tangible and identifiable intangible assets is recorded as goodwill in the accompanying consolidated balance sheet. Fresh-start accounting also requires that all liabilities, other than deferred taxes, should be stated at fair value.

The carrying values by reporting unit of the goodwill and other indefinite-lived intangible assets are disclosed in Note 6—“Goodwill and Other Intangible Assets,” to the Company’s Consolidated Financial Statements.

To facilitate the first step of the goodwill impairment analysis the Company first determines the fair value of each reporting unit as of October 1, the goodwill measurement date, and compares those amounts to the carrying value of the respective reporting units as of October 1. To the extent the fair value of the reporting unit exceeds the book value, no additional analysis is required and no impairment is recognized. To facilitate the Company’s calculation of the fair value of the reporting units, the valuation methods included (i) a discounted cash flow analysis, considering a range of between 12% and 17% weighted average costs of capital and market-based multiples of projected earnings of between 4.0 and 9.3 times for its terminal value. A key assumption in the fair value calculations is the Company’s future operating performance and resulting cash flow which is inherently subject to significant uncertainties and contingencies, and are based on management’s best estimates at the date of measurement. Potential events which could have a negative effect on the key assumptions include competitive actions, technological developments, regulatory actions and currency movements. For additional risk factors which could affect the assumptions see “Item 1A—Risk Factors” and “Item 7—Special Note Regarding Forward Looking Statements.” Accordingly, the Company cannot provide assurance that the estimates, assumptions, and values reflected in the valuations will be realized, and actual results could vary materially. The goodwill impairment test date of October 1, 2010, was fifteen months after the initial recording of the fair value of our assets under fresh start accounting. After performing step one of the goodwill impairment test no impairment was identified, as the fair value was greater than the carrying value of each reporting unit. Reporting units with significant goodwill balances are the United States and Canada and neither of these reporting units is at risk of failing step one of the goodwill impairment test. The increase in fair value for the reporting units with significant goodwill balances is due primarily to foreign currency translation as the United States dollar has weakened considerably and realizations of cost reduction initiatives which were implemented in the second half of 2010. Additionally, no impairment was recognized based on the analysis of the fair value of the intangible assets not subject to amortization as compared to their carrying value.

 

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In addition to the forgoing, the Company reviews its goodwill and intangible assets for possible impairment whenever events or circumstances indicate that certain carrying amounts of assets may not be recoverable. The factors that the Company considers important, and which could trigger an impairment review, include, but are not limited to: a significant decline in the market value of our common stock or debt securities for a sustained period; a material adverse change in economic, financial market, industry or sector trends; a material failure to achieve operating results relative to historical levels or projected future levels; and significant changes in operations or business strategy.

During the three months ended September 30, 2010, the Company and its Board of Directors ratified a plan to proceed with the disposition of its European retail operations; see Note 19, Discontinued Operations. This triggering event prompted the Company to perform a goodwill impairment test, a two-step test, for the Europe reporting unit. Based on the results of the step one test, the Company determined that the carrying value of the Europe reporting unit was in excess of its respective fair value and a step two test was required for the reporting unit. Based on the testing performed, the Company determined that the carrying value of goodwill exceeded its implied fair value for the Europe reporting unit and recorded a goodwill impairment charge to fully impair the Europe reporting unit’s goodwill; see Note 6, “Goodwill and Other Intangibles,” for further detail.

Accounting for income taxes—We recognize deferred tax assets and liabilities for the expected future tax consequences of transactions and events. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement bases and the tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. If necessary, deferred tax assets are reduced by a valuation allowance to an amount that is determined to be more likely than not recoverable. We must make significant estimates and assumptions about future taxable income and future tax consequences when determining the amount of the valuation allowance. The additional guidance provided by ASC No. 740 “Income Taxes”, clarifies the accounting for uncertainty in income taxes recognized in the financial statements. Expected outcomes of current or anticipated tax examinations, refund claims and tax-related litigation and estimates regarding additional tax liability (including interest and penalties thereon) or refunds resulting therefrom will be recorded based on the guidance provided by ASC No. 740 to the extent applicable.

At present, our subsidiaries in the major jurisdictions in which we operate have significant deferred tax assets resulting from tax loss carryforwards. With the exception of our Canadian companies, these deferred tax assets are fully offset with valuation allowances. The appropriateness and amount of these valuation allowances are based on our assumptions about the future taxable income of each affiliate or available tax planning strategies. Except in the case of our Canadian companies, if our assumptions have significantly underestimated future taxable income with respect to a particular affiliate, all or part of the valuation allowance for the affiliate would be reversed and additional income could result. With the exception of our Canadian affiliates, if our assumptions have significantly overestimated future taxable income with respect to a particular affiliate, there would be no change in the net value of the deferred tax asset and no additional income or tax expense would result. If our assumptions with respect to our Canadian affiliates have significantly overestimated future taxable income, a full or partial valuation allowance would be applied to the corresponding deferred tax assets and additional tax expense would result.

In accordance with ASC No. 852, for periods including and subsequent to the filing of the Chapter 11 petition, prior to the emergence from bankruptcy, all pre-petition liabilities subject to compromise were segregated in the Consolidated Condensed Balance Sheets and classified as liabilities subject to compromise, at management’s estimate of the amount of allowable claims. Liabilities not subject to compromise were separately classified as current and non-current in the Consolidated Condensed Balance Sheet. Revenues, expenses, realized gains and losses, and provisions for losses that result from the reorganization were reported separately as reorganization items, net, in the Consolidated Condensed Statements of Operations. Net cash used for reorganization items was disclosed separately in the Consolidated Condensed Statements of Cash Flows.

After the emergence from bankruptcy on July 1, 2009, the amounts reported on our subsequent financial statements materially changed. We adopted the “fresh start” provisions of ASC No. 852, which requires that all

 

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assets and liabilities except deferred taxes be restated to their fair value. Deferred tax balances have been established as a result of the differences in the basis adjustments from fresh-start accounting. Certain of these fair values differ materially from the values recorded on the Predecessor Consolidated Condensed Balance Sheets. Our emergence from reorganization resulted in a new reporting entity that had no retained earnings or accumulated deficit before the Effective Date. Additionally, we must also adopt any changes in GAAP that are otherwise required to be adopted within twelve months of such date. For all of these reasons, our Successor’s financial statements are not comparable to our Predecessor’s. See “Note 8—Income Taxes,” to the Company’s consolidated financial statements for further details.

Discontinued Operations

2010 Developments—During 2010 the Company classified its Europe segment, which is also known as European retail operations, as discontinued operations. As a result, the Company has applied retrospective adjustments for 2009 and 2008 to reflect the effects of the discontinued operations during 2010. Accordingly, revenue, costs, and expenses of the discontinued operations have been excluded from the respective captions in the consolidated statements of operations. The Company did not retrospectively adjust its 2009 Consolidated Balance Sheet as held for sale criteria was not met until the third quarter of 2010, as such, financial information for the Europe segment will appear, as applicable, where certain balance sheet information is presented, see Note 19, “Discontinued Operations,” for further information.

2008 and 2009 Developments—In the first quarter 2009, the Company sold certain assets of its Japan retail operations. The sale price was $0.4 million (40 million Japanese yen), which included $0.2 million (20 million Japanese yen) in cash and $0.2 million (20 million Japanese yen) receivable. The Company recorded a $0.3 million gain from sale of assets. The Company reported Japan retail operations as a discontinued operation.

In the second quarter 2008, the Company determined it would sell its German retail operations. However, buyers were not found; therefore the Company decided to cease operations of the German retail business during the first quarter of 2009.

As a result of these events, the Company’s consolidated financial statements for all periods presented reflect the Japan retail operations and German retail operations as discontinued operations for the six months ended December 31, 2009, six months ended July 1, 2009, and year ended December 31, 2008. Accordingly, revenue, costs, and expenses of the discontinued operations have been excluded from the respective captions in the consolidated statements of operations. The net operating results of the discontinued operations have been reported, net of applicable income taxes as loss from discontinued operations.

Summarized operating results of the discontinued operations for the year ended December 31, 2010, 2009, and 2008 are as follows:

 

     Successor            Predecessor  
     Year
Ended
December 31,
2010
    Six Months
Ended
December 31,
2009
           Six Months
Ended
July 1,
2009
    Year
Ended
December 31,
2008
 

Net revenue

   $ 37,506      $ 26,813           $ 26,271      $ 66,876   

Operating expenses

     50,605        29,322             27,408        71,718   
                                     

Income (loss) from operations

     (13,099     (2,509          (1,137     (4,842

Interest expense

     (8     (45          (42     83   

Interest income and other income (expense)

     (396     (160          37        52   

Foreign currency transaction gain (loss)

     (137     (1,184          788        (808

Reorganization items

     —          (14          15,269        —     
                                     

Income (loss) before income tax

     (13,640     (3,912          14,915        (5,515

Income tax benefit (expense)

     1,869        (138          166        (375
                                     

Income (loss) from discontinued operations

   $ (11,771   $ (4,050        $ 15,081      $ (5,890
                                     

 

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Explanatory Preliminary Note

In the following presentations and narratives within this Management’s Discussion and Analysis of Financial Condition and Results of Operations, we combine Successor’s results of operations for the period from July 2, 2009 to December 31, 2009 (the “Successor Period”) with Predecessor’s results of operations for the period from January 1, 2009 to July 1, 2009 and we compare these combined results of operations with Predecessor’s results of operations for the year ended December 31, 2008. We also present detailed changes in results, excluding currency impacts, since a large portion of our revenues are derived outside of the U.S., and currency changes can influence or mask underlying changes in foreign operating unit performance. We believe that the comparison of the combined financial results provide management and investors with a meaningful analysis of our performance and trends for comparative purposes. In addition, it should be noted that the application of fresh-start accounting will have a significant non-cash impact on our future results of operations, but will have no impact on the underlying cash flows of the Company.

We have combined the results of operations and the sources and uses of cash for the six months ended July 1, 2009 of the Predecessor and the six months ended December 31, 2009 for the Successor, and compared these combined results with the corresponding periods in 2010 and 2008 to provide a meaningful perspective on our financial and operational performance and trends in order to supplement GAAP data that would not otherwise have been available if we had not combined the results of operations and sources and uses of cash of the Predecessor and the Successor in this manner. The presentation of these combined results for the twelve months ended December 31, 2009 are intended to supplement investors’ understanding of our operating performance and liquidity. However, the combined presentation of the twelve months ended December 31, 2009 are not intended to replace net income (loss), cash flows, financial position or comprehensive income (loss), as determined in accordance with U.S. GAAP for the Predecessor and Successor periods. The Consolidated Financial Statements on or after July 1, 2009 are not comparable to the Consolidated Financial Statements prior to that date. For purposes of calculating constant currency rates between periods in connection with presentations that describe changes in values “excluding currency effects” herein, we have taken results from foreign operations for a given year (that were computed in accordance with GAAP using local currency) and converted such amounts utilizing the same U.S. dollar to applicable local currency exchange rates that were used for purposes of calculating corresponding preceding year GAAP presentations.

In reviewing the results and narratives below, it is important to note that there were significant effects resulting from the adoption of fresh-start accounting that affected our historical presentations and that will impact future results compared to pre-Reorganization results, including significant changes in:

 

   

debt balances and associated interest expense;

 

   

taxes and the adverse cash flow effects of our obligation to pay additional taxes compared to prior periods, given the termination of significant net operating loss carry-forward credits in connection with the Reorganization; and

 

   

depreciation and amortization, as triggered by our requirement to institute a new capital structure and fully re-measure our tangible and identifiable intangible assets.

 

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Results of Operations

The following information for the years ended December 31, 2010, 2009 and 2008 reflects all the items included in consolidated statements of operations as a percentage of net revenue:

 

     Year Ended December 31,  
         2010             2009             2008      

NET REVENUE

     100.0     100.0     100.0

OPERATING EXPENSES

      

Cost of revenue (exclusive of depreciation included below)

     63.9     65.1     63.2

Selling, general and administrative

     25.9     24.1     28.7

Depreciation and amortization

     8.5     6.4     3.6

(Gain) loss on sale or disposal of assets

     0.0     0.0     (0.7 %) 
                        

Total operating expenses

     98.3     95.6     94.9
                        

INCOME FROM OPERATIONS

     1.7     4.4     5.1

INTEREST EXPENSE

     (4.6 %)      (4.1 %)      (6.5 %) 

ACCRETION (AMORTIZATION) ON DEBT PREMIUM/DISCOUNT, net

     0.0     0.0     0.1

GAIN (LOSS) ON EARLY EXTINGUISHMENT OR RESTRUCTURING OF DEBT

     0.0     (0.5 %)      4.4

GAIN (LOSS) FROM CONTINGENT VALUE RIGHTS VALUATION

     (1.8 %)      (0.4 %)      0.0

INTEREST AND OTHER INCOME

     0.1     0.1     0.4

FOREIGN CURRENCY TRANSACTION GAIN (LOSS)

     2.1     5.2     (5.6 %) 

LOSS FROM CONTINUING OPERATIONS BEFORE REORGANIZATION ITEMS AND INCOME TAXES

     (2.5 %)      4.8     (2.0 %) 

REORGANIZATION ITEMS, net

     0.0     55.6     0.0
                        

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

     (2.5 %)      60.4     (2.0 %) 

INCOME TAX BENEFIT (EXPENSE)

     1.2     0.8     0.1
                        

INCOME (LOSS) FROM CONTINUING OPERATIONS

     (1.4 %)      61.2     (1.9 %) 

INCOME (LOSS) FROM DISCONTINUED OPERATIONS, net of tax

     (1.5 %)      1.4     (0.7 %) 

GAIN (LOSS) FROM SALE OF DISCONTINUED OPERATIONS, net of tax

     0.4     0.0     0.0
                        

NET INCOME (LOSS)

     (2.5 %)      62.7     (2.6 %) 
                        

The following information reflects net revenue by product line for the years ended December 31, 2010, 2009 and 2008 (in thousands, except percentages) and is provided for informational purposes and should be read in conjunction with the Consolidated Financial Statements and Notes.

 

     Year Ended December 31,  
     2010     2009     2008  

(in thousands)

   Net Revenue      % of total     Net Revenue      % of total     Net Revenue      % of total  

Retail Voice

   $ 358,599         46.9   $ 345,861         45.3   $ 402,770         48.4

International Carrier Services

     178,631         23.4     212,961         27.9     197,278         23.7

Data/Internet

     194,632         25.4     159,814         21.0     185,483         22.2

Retail VOIP

     33,085         4.3     44,129         5.8     47,306         5.7
                                                   

Total

   $ 764,947         100.0   $ 762,765         100.0   $ 832,837         100.0
                                                   

 

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Results of operations for the year ended December 31, 2010 as compared to the year ended December 31, 2009

Net revenue: Net revenue, exclusive of the currency effect, decreased $59.8 million, or 7.8%, to $703.0 million for the year ended December 31, 2010 from $762.8 million for the year ended December 31, 2009. Inclusive of the currency effect which accounted for an increase of $61.9 million, net revenue increased $2.1 million to $764.9 million for the year ended December 31, 2010 from $762.8 million for the year ended December 31, 2009.

 

     Exclusive of Currency Effect           Inclusive of
Currency Effect
 
     Year Ended                 Year Ended
December 31, 2010
 
     December 31, 2010     December 31, 2009     Year-over-Year     Currency
Effect
   

(in thousands)

   Net
Revenue
     % of
Total
    Net
Revenue
     % of
Total
    Variance     Variance %       Net
Revenue
     % of
Total
 

Canada

   $ 209,369         29.8   $ 224,397         29.4   $ (15,028     (6.7 %)    $ 21,816      $ 231,185         30.2

Australia

     237,629         33.8     243,158         31.9     (5,529     (2.3 %)      39,093        276,722         36.2

International Carrier Services

     180,442         25.7     212,962         27.9     (32,520     (15.3 %)      (1,811     178,631         23.4

United States

     50,724         7.2     67,555         8.9     (16,831     (24.9 %)      —          50,724         6.6

Brazil

     24,838         3.5     14,693         1.9     10,145        69.0     2,847        27,685         3.6
                                                                           

Total Revenue

   $ 703,002         100.0   $ 762,765         100.0   $ (59,763     (7.8 %)    $ 61,945      $ 764,947         100.0
                                                                           

Canada: Canada net revenue, exclusive of the currency effect, decreased $15.0 million, or 6.7%, to $209.4 million for the year ended December 31, 2010 from $224.4 million for the year ended December 31, 2009. The net revenue decrease is primarily attributable to a decrease of $11.8 million in retail voice services, a decrease of $7.6 million in prepaid voice services and a decrease of $0.9 million in wireless services offset, in part, by an increase of $2.3 million in local and VoIP services, an increase of $2.0 million in Internet, an increase of $1.0 million in data and hosting services. Inclusive of the currency effect which accounted for a $21.8 million increase, net revenue increased $6.8 million to $231.2 million for the year ended December 31, 2010 from $224.4 million for the year ended December 31, 2009.

Australia: Australia net revenue, exclusive of the currency effect, decreased $5.6 million, or 2.3%, to $237.6 million for the year ended December 31, 2010 from $243.2 million for the year ended December 31, 2009. The net revenue decrease is primarily attributable to a decrease of $6.6 million in residential voice and a decrease of $3.9 million in Internet services offset, in part, by increases of $2.6 million in business voice services, an increase of $0.9 million in wireless services, and increase of $1.0 million in DSL, VoIP and other services. Inclusive of the currency effect which accounted for a $39.1 million increase, net revenue increased $33.5 million to $276.7 million for the year ended December 31, 2010 from $243.2 million for the year ended December 31, 2009.

International Carrier Services: International Carrier Services net revenue, exclusive of the currency effect, decreased $32.6 million, or 15.3%, to $180.4 million for the year ended December 31, 2010 from $213.0 million for the year ended December 31, 2009. The net revenue decrease is primarily attributable to a decrease in International minutes. Inclusive of the currency effect which accounted for a $1.8 million decrease, net revenue decreased $34.4 million to $178.6 million for the year ended December 31, 2010, from $213.0 million for the year ended December 31, 2009.

United States: United States net revenue decreased $16.9 million, or 24.9%, to $50.7 million for the year ended December 31, 2010 from $67.6 million for the year ended December 31, 2009. The decrease is primarily attributable to a decrease of $9.5 million in retail voice services (for residential and small businesses), a decrease of $6.4 million in VoIP services and a decrease of $1.0 million in Internet services.

 

 

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Brazil: Brazil net revenue, exclusive of the currency effect, increased $10.1 million, or 69.0%, to $24.8 million for the year ended December 31, 2010 from $14.7 million for the year ended December 31, 2009. The revenue increase is due primarily to an increase in VoIP services. Inclusive of the currency effect which accounted for a $2.8 million increase, net revenue increased $13.0 million to $27.7 million for the year ended December 31, 2010 from $14.7 million for the year ended December 31, 2009.

Cost of revenue: Cost of revenue, exclusive of the currency effect, decreased $42.1 million to $454.4 million, or 64.6% of net revenue, for the year ended December 31, 2010 from $496.5 million, or 65.1% of net revenue, for the year ended December 31, 2009. Inclusive of the currency effect, which accounted for a $34.2 million increase, cost of revenue decreased $7.9 million to $488.6 million for the year ended December 31, 2010 from $496.5 million for the year ended December 31, 2009.

 

    Exclusive of Currency Effect     Currency
Effect
    Inclusive of
Currency Effect
 
    Year Ended                   Year Ended
December 31, 2010
 
    December 31, 2010     December 31, 2009     Year-over-Year      

(in thousands)

  Cost of
Revenue
    % of Net
Revenue
    Cost of
Revenue
    % of Net
Revenue
    Variance     Variance %       Cost of
Revenue
    % of Net
Revenue
 

Canada

  $ 96,549        46.1   $ 98,510        43.9   $ (1,961     (2.0 %)    $ 9,963      $ 106,512        46.1

Australia

    145,187        61.1     153,002        62.9     (7,815     (5.1 %)      23,644        168,831        61.0

International Carrier Services

    170,404        94.4     203,865        95.7     (33,461     (16.4 %)      (1,706     168,698        94.4

United States

    22,004        43.4     30,357        44.9     (8,353     (27.5 %)      —          22,004        43.4

Brazil

    20,264        81.6     10,755        73.2     9,509        88.4     2,303        22,567        81.5
                                                                       

Total Revenue

  $ 454,408        64.6   $ 496,489        65.1   $ (42,081     (8.5 %)    $ 34,204      $ 488,612        63.9
                                                                       

Canada: Canada cost of revenue, exclusive of the currency effect, decreased $2.0 million to $96.5 million, or 46.1% of net revenue, for the year ended December 31, 2010 from $98.5 million, or 43.9% of net revenue, for the year ended December 31, 2009. The decrease is primarily attributable to a decrease in net revenue of $15.0 million. Inclusive of the currency effect, which accounted for a $10.0 million increase, cost of revenue increased $8.0 million to $106.5 million for the year ended December 31, 2010 from $98.5 million for the year ended December 31, 2009.

Australia: Australia cost of revenue, exclusive of the currency effect, decreased $7.8 million to $145.2 million, or 61.1% of net revenue, for the year ended December 31, 2010 from $153.0 million, or 62.9% of net revenue, for the year ended December 31, 2009. The decrease is primarily attributable to a $5.6 million decrease in net revenue. Inclusive of the currency effect, which accounted for a $23.6 million increase, cost of revenue increased $15.8 million to $168.8 million for the year ended December 31, 2010 from $153.0 million for the year ended December 31, 2009.

International Carrier Services: International Carrier Services cost of revenue, exclusive of the currency effect, decreased $33.5 million to $170.4 million, or 94.4% of net revenue, for the year ended December 31, 2010 from $203.9 million, or 95.7% of net revenue, for the year ended December 31, 2009. The decrease is primarily attributable to a decrease in net revenue of $32.6 million. Inclusive of the currency effect, which accounted for a $1.7 million decrease, cost of revenues decreased $35.2 million to $168.7 million for the year ended December 31, 2010 from $203.9 million for the year ended December 31, 2009.

United States: United States cost of revenue decreased $8.4 million to $22.0 million, or 43.4% of net revenue, for the year ended December 31, 2010 from $30.4 million, or 44.9% of net revenue, for the year ended December 31, 2009. The decrease is attributable to a decrease in net revenue of $16.8 million.

 

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Brazil: Brazil cost of revenue, exclusive of the currency effect, increased $9.5 million to $20.3 million, or 81.6% of net revenue, for the year ended December 31, 2010 from $10.8 million, or 73.2% of net revenue, for the year ended December 31, 2009. The increase is primarily attributable to an increase in net revenue of $10.1 million and a shift in the revenue product mix to lower margin products. Inclusive of the currency effect, which accounted for a $2.3 million increase, cost of revenue increased $11.8 million to $22.6 million for the year ended December 31, 2010 from $10.8 million for the year ended December 31, 2009.

Selling, general and administrative expenses: Selling, general and administrative expenses (“SG&A”), exclusive of the currency effect, decreased $3.0 million to $180.8 million, or 25.7% of net revenue, for the year ended December 31, 2010 from $183.8 million, or 24.1% of net revenue, for the year ended December 31, 2009. Inclusive of the currency effect, which accounted for a $17.4 million increase, selling, general and administrative expenses increased $14.4 million to $198.2 million for the year ended December 31, 2010 from $183.8 million for the year ended December 31, 2009.

 

    Exclusive of Currency Effect     Currency
Effect
    Inclusive of
Currency Effect
 
    Year Ended                   Year Ended
December 31, 2010
 
    December 31, 2010     December 31, 2009     Year-over-Year      

(in thousands)

  SG&A     % of Net
Revenue
    SG&A     % of Net
Revenue
    Variance     Variance %       SG&A     % of Net
Revenue
 

Canada

  $ 70,624        33.7   $ 79,331        35.4   $ (8,707     (11.0 %)    $ 7,384      $ 78,008        33.7

Australia

    60,998        25.7     58,245        24.0     2,753        4.7     9,715        70,713        25.6

International Carrier Services

    6,423        3.6     6,713        3.2     (290     (4.3 %)      (39     6,384        3.6

United States

    22,203        43.8     25,625        37.9     (3,422     (13.4 %)      —          22,203        43.8

Brazil

    2,961        11.9     3,134        21.3     (173     (5.5 %)      354        3,315        12.0

Corporate

    17,578        —          10,760        —          6,818        63.4     —          17,578        —     
                                                                       

Total SG&A

  $ 180,787        25.7   $ 183,808        24.1   $ (3,021     (1.6 %)    $ 17,414      $ 198,201        25.9
                                                                       

Canada: Canada selling, general and administrative expense, exclusive of the currency effect, decreased $8.7 million to $70.6 million, or 33.7% of net revenue, for the year ended December 31, 2010 from $79.3 million, or 35.4% of net revenue, for the year ended December 31, 2009. The decrease is attributable to a decrease of $3.5 million in advertising expenses, a decrease of $2.8 million in sales and marketing expenses, a decrease of $1.9 million in general and administrative expenses and a decrease of $1.2 million in professional fees offset, in part, by an increase of $0.4 million in salaries and benefits and $0.3 million of other expenses. Inclusive of the currency effect, which accounted for a $7.4 million increase, selling, general and administrative expenses decreased $1.3 million to $78.0 million for the year ended December 31, 2010 from $79.3 million for the year ended December 31, 2009.

Australia: Australia selling, general and administrative expense, exclusive of the currency effect, increased $2.8 million to $61.0 million, or 25.7% of net revenue, for the year ended December 31, 2010 from $58.2 million, or 24.0% of net revenue, for the year ended December 31, 2009. The increase is attributable to an increase of $1.0 million in advertising expenses, an increase of $0.6 million in salaries and benefits, an increase of $0.6 million in occupancy expense, and an increase of $0.4 million in professional fees and an increase of $0.2 million in general and administrative and travel and entertainment expense. Inclusive of the currency effect, which accounted for a $9.7 million increase, selling, general and administrative expense increased $12.5 million to $70.7 million for the year ended December 31, 2010 from $58.2 million for the year ended December 31, 2009.

International Carrier Services: International Carrier Services selling, general and administrative expense decreased $0.3 million to $6.4 million, or 3.6% of net revenue, for the year ended December 31, 2010 from $6.7

 

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million, or 3.2% of net revenue, for the year ended December 31, 2009. The decrease is primarily attributable to $0.2 million in salaries and benefits and a decrease of $0.1 million in occupancy. The impact of currency was minimal.

United States: United States selling, general and administrative expense decreased $3.4 million to $22.2 million, or 43.8% of net revenue, for the year ended December 31, 2010 from $25.6 million, or 37.9% of net revenue, for the year ended December 31, 2009. The decrease is attributable to decreases of $1.8 million in salaries and benefits, $0.7 million decrease in professional fees, $0.6 million decrease in sales and marketing expense, $0.3 million decrease in advertising expenses, and a $0.2 million decrease in travel and entertainment offset, in part, by $0.1 million increase in general and administrative expenses.

Brazil: Brazil selling, general and administrative expense, exclusive of the currency effect, decreased $0.2 million to $2.9 million, or 11.9% of net revenue, for the year ended December 31, 2010 from $3.1 million, or 21.3% of net revenue, for the year ended December 31, 2009. The decrease is attributable to a decrease of $0.3 million in occupancy expense and a decrease of $0.1 million in professional fees offset, in part, by a $0.2 million increase in sales and marketing expenses. Inclusive of the currency effect, which accounted for a $0.4 million increase, selling, general and administrative expense increased $0.2 million to $3.3 million for the year ended December 31, 2010 from $3.1 million for the year ended December 31, 2009.

Corporate: Corporate selling, general and administrative expense increased $6.8 million to $17.6 million for the year ended December 31, 2010 from $10.8 million for the year ended December 31, 2009. The increase is primarily due to a $6.2 million increase in salaries and benefits due to the severance expense for the previous executives and a $0.6 million increase in professional fees.

Depreciation and amortization expense: Depreciation and amortization expense increased $16.8 million to $65.3 million for the year ended December 31, 2010 from $48.5 million for the year ended December 31, 2009. This change occurred as a result of the fair valuing of fixed and intangible assets per Fresh-Start accounting which was implemented effective July 1, 2009. See “Note 4—Fresh-Start Accounting” in our consolidated financial statements for further detail.

Interest expense and accretion (amortization) on debt discount/premium: Interest expense and accretion (amortization) on debt discount/premium, net increased $4.5 million to $35.7 million for the year ended December 31, 2010 from $31.2 million for the year ended December 31, 2009. During first half of 2009, the Company did not record interest expense on certain compromised indebtedness as a result of the Company’s filing for a plan of reorganization. This resulted in higher interest expense for the year ended December 31, 2010 compared to the year ended December 31, 2009.

Gain (loss) from contingent value rights valuation. The loss from the change in fair value of the contingent value rights increased $10.9 million to $13.7 million loss for the year ended December 31, 2010 from $2.8 million loss for the year ended December 31, 2009. The Company determined these contingent value rights to be derivative instruments to be accounted for as liabilities and were marked to fair value, (and in future periods will be marked to fair value), at each balance sheet date. Upon issuance of the contingent value rights, the Company recorded a liability of $2.6 million in other liabilities as part of fresh-start accounting, and we will adjust this liability quarterly to its then estimated fair value, (which in future periods potentially could be substantially greater than the initial recorded liability balance). The change in fair value of the liability is reflected in our Statements of Operations as other income (expense). Estimates of fair value represent the Company’s best estimates based on a Black-Scholes pricing model.

Interest income and other (expense). Interest income and other (expense) decreased $0.2 million to $0.7 million for the year ended December 31, 2010 from $0.9 million expense for the year ended December 31, 2009.

 

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Foreign currency transaction gain (loss): Foreign currency transaction gain decreased $23.5 million to a gain of $16.4 million for the year ended December 31, 2010 from a gain of $39.9 million for the year ended December 31, 2009. The gains are attributable to the impact of foreign currency exchange rate changes on intercompany debt balances and on receivables and payables denominated in a currency other than the subsidiaries’ functional currency.

Reorganization items, net. Reorganization items, exclusive of discontinued operations reflect the favorable impact of $424.4 million, and inclusive of discontinued operations reflect the unfavorable impact of $439.5 million for the year ended December 31, 2009 due to fresh-start accounting and revaluation of assets and liabilities ($188.6 million), gain on extinguishment of debt ($243.2 million), and reversal of future interest payments recorded as long-term obligations ($20.4 million), offset in part principally by the incurrence of professional fees as a result of the Chapter 11 Cases ($12.6 million).

Income tax benefit (expense): Income tax benefit (expense) is a $9.1 million benefit for the year ended December 31, 2010 compared to a $6.1 million benefit for the year ended December 31, 2009. The benefit includes expenses consisting of foreign withholding tax on intercompany interest, the release of certain “ASC 740” liabilities as a result of the expiration of the statute of limitations and charges for uncertain tax positions under ASC No. 740, “Income Taxes.” The foreign tax expense was offset by a significant benefit from the release of valuation allowances related to deferred tax assets. Refer to “Note 8—Income Taxes,” to our consolidated audited financial statements.

Results of operations for the year ended December 31, 2009 as compared to the year ended December 31, 2008

Net revenue: Net revenue, exclusive of the currency effect, decreased $14.4 million, or 1.7%, to $818.4 million for the year ended December 31, 2009 from $832.8 million for the year ended December 31, 2008. Inclusive of the currency effect, which accounted for a decrease of $55.6 million, net revenue decreased $70.1 million to $762.8 million for the year ended December 31, 2009 from $832.8 million for the year ended December 31, 2008.

 

    Exclusive of Currency Effect     Currency
Effect
    Inclusive of
Currency  Effect
 
    Year Ended                   Year Ended
December 31, 2009
 
    December 31, 2009     December 31, 2008     Year-over-Year      

(in thousands)

  Net
Revenue
    % of
Total
    Net
Revenue
    % of
Total
    Variance     Variance %       Net
    Revenue    
    % of
    Total    
 

Canada

  $ 241,603        29.5   $ 260,834        31.3   $ (19,231     (7.4 %)    $ (17,206   $ 224,397        29.4

Australia

    262,917        32.1     276,413        33.2     (13,496     (4.9 %)      (19,759     243,158        31.9

International Carrier Services

    230,285        28.1     197,278        23.7     33,007        16.7     (17,323     212,962        27.9

United States

    67,555        8.3     88,181        10.6     (20,626     (23.4 %)      —          67,554        8.9

Brazil

    16,040        2.0     10,131        1.2     5,909        58.3     (1,347     14,694        1.9
                                                                       

Total Revenue

  $ 818,400        100.0   $ 832,837        100.0   $ (14,437     (1.7 %)    $ (55,635   $ 762,765        100.0
                                                                       

Canada: Canada net revenue, exclusive of the currency effect, decreased $19.2 million, or 7.4%, to $241.6 million for the year ended December 31, 2009 from $260.8 million for the year ended December 31, 2008. The net revenue decrease is primarily attributable to a decrease of $16.3 million in retail voice services, a decrease of $3.8 million in prepaid voice services, a decrease of $1.1 million in wireless services and a decrease of $0.3 million in local services offset, in part, by an increase of $2.3 million in Internet, data and hosting services. Inclusive of the currency effect, which accounted for a $17.2 million decrease, net revenue decreased $36.4 million to $224.4 million for the year ended December 31, 2009 from $260.8 million for the year ended December 31, 2008.

 

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Australia: Australia net revenue, exclusive of the currency effect, decreased $13.5 million, or 4.9%, to $262.9 million for the year ended December 31, 2009 from $276.4 million for the year ended December 31, 2008. The net revenue decrease is primarily attributable to a decrease of $13.5 million in Internet services, a decrease of $3.1 million in residential voice and a decrease of $2.6 million in broadband services offset, in part, by increases of $3.9 million in business voice services and $1.9 million in wireless services. Inclusive of the currency effect, which accounted for a $19.8 million decrease, net revenue decreased $33.2 million to $243.2 million for the year ended December 31, 2009 from $276.4 million for the year ended December 31, 2008.

International Carrier Services: International Carrier Services net revenue, exclusive of the currency effect, increased $33.0 million, or 16.7%, to $230.3 million for the year ended December 31, 2009 from $197.3 million for the year ended December 31, 2008. The net revenue increase is primarily a result of expanded routed capabilities and enhanced traffic volumes from existing customers and the obtainment of new customers. Inclusive of the currency effect which accounted for a $17.3 million decrease, net revenue increased $15.7 million to $213.0 million for the year ended December 31, 2009, from $197.3 million for the year ended December 31, 2008.

United States: United States net revenue decreased $20.6 million, or 23.4%, to $67.6 million for the year ended December 31, 2009 from $88.2 million for the year ended December 31, 2008. The decrease is primarily attributable to a decrease of $13.2 million in retail voice services (for residential and small businesses), a decrease of $5.6 million in VoIP services and a decrease of $1.8 million in Internet services.

Brazil: Brazil net revenue, exclusive of the currency effect, increased $5.9 million, or 58.4%, to $16.0 million for the year ended December 31, 2009 from $10.1 million for the year ended December 31, 2008. The revenue increase is due primarily to an increase in VoIP services. Inclusive of the currency effect, which accounted for a $1.3 million decrease, net revenue increased $4.6 million to $14.7 million for the year ended December 31, 2009 from $10.1 million for the year ended December 31, 2008.

Cost of revenue: Cost of revenue, exclusive of the currency effect, increased $7.7 million to $534.1 million, or 65.3% of net revenue, for the year ended December 31, 2009 from $526.4 million, or 63.2% of net revenue, for the year ended December 31, 2008. Inclusive of the currency effect, which accounted for a $37.6 million decrease, cost of revenue decreased $29.9 million to $496.5 million for the year ended December 31, 2009 from $526.4 million for the year ended December 31, 2008.

Canada: Canada cost of revenue, exclusive of the currency effect, decreased $8.4 million to $106.0 million, or 43.9% of net revenue, for the year ended December 31, 2009 from $114.4 million, or 43.9% of net revenue, for the year ended December 31, 2008. The decrease is primarily attributable to a decrease in net revenue of $19.2 million. Inclusive of the currency effect, which accounted for a $7.5 million decrease, cost of revenue decreased $15.9 million to $98.5 million for the year ended December 31, 2009 from $114.4 million for the year ended December 31, 2008.

Australia: Australia cost of revenue, exclusive of the currency effect, decreased $4.0 million to $165.4 million, or 62.9% of net revenue, for the year ended December 31, 2009 from $169.4 million, or 61.3% of net revenue, for the year ended December 31, 2008. The decrease is primarily attributable to a $13.5 million decrease in net revenue, offset in part by a $5.8 million reduction to cost of revenue in 2008 as the result of rulings by the Australian regulatory authority. Inclusive of the currency effect, which accounted for a $12.4 million decrease, cost of revenue decreased $16.4 million to $153.0 million for the year ended December 31, 2009 from $169.4 million for the year ended December 31, 2008.

International Carrier Services: International Carrier Services cost of revenue, exclusive of the currency effect, increased $30.4 million to $220.6 million, or 95.8% of net revenue, for the year ended December 31, 2009 from $190.2 million, or 96.4% of net revenue, for the year ended December 31, 2008. The increase is primarily attributable to an increase in net revenue of $33.0 million offset, in part, by lower costs, as a percentage of net

 

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revenues. Inclusive of the currency effect, which accounted for a $16.7 million decrease, cost of revenues decreased $13.7 million to $203.9 million for the year ended December 31, 2009 from $190.2 million for the year ended December 31, 2008.

United States: United States cost of revenue decreased $15.8 million to $30.3 million, or 44.9% of net revenue, for the year ended December 31, 2009 from $46.1 million, or 52.5% of net revenue, for the year ended December 31, 2008. The decrease is attributable to a decrease in net revenue of $20.6 million, a cost recovery of $1.5 million from a dispute settlement and lower costs resulting from our cost control initiatives.

Brazil: Brazil cost of revenue, exclusive of the currency effect, increased $5.3 million to $11.7 million, or 73.1% of net revenue, for the year ended December 31, 2009 from $6.4 million, or 62.8% of net revenue, for the year ended December 31, 2008. The increase is primarily attributable to an increase in net revenue of $5.9 million and a shift in the revenue product mix to lower margin products. Inclusive of the currency effect, which accounted for a $1.0 million decrease, cost of revenue increased $4.4 million to $10.8 million for the year ended December 31, 2009 from $6.4 million for the year ended December 31, 2008.

Selling, general and administrative expenses: Selling, general and administrative expenses, exclusive of the currency effect, decreased $44.1 million to $195.0 million, or 23.8% of net revenue, for the year ended December 31, 2009 from $239.1 million, or 28.7% of net revenue, for the year ended December 31, 2008. Inclusive of the currency effect, which accounted for a $11.2 million decrease, selling, general and administrative expenses decreased $55.3 million to $183.8 million for the year ended December 31, 2009 from $239.1 million for the year ended December 31, 2008.

Canada: Canada selling, general and administrative expense, exclusive of the currency effect, decreased $12.9 million to $85.0 million, or 35.2% of net revenue, for the year ended December 31, 2009 from $97.9 million, or 37.5% of net revenue, for the year ended December 31, 2008. The decrease is attributable to a decrease of $7.0 million in salaries and benefits, a decrease of $7.1 million in sales and marketing expenses and a decrease of $0.7 million in general and administrative expenses offset, in part, by an increase of $0.8 million in advertising expenses and $1.1 million of other expenses. Inclusive of the currency effect, which accounted for a $5.7 million decrease, selling, general and administrative expenses decreased $18.6 million to $79.3 million for the year ended December 31, 2009 from $97.9 million for the year ended December 31, 2008.

Australia: Australia selling, general and administrative expense, exclusive of the currency effect, decreased $18.9 million to $63.3 million, or 24.1% of net revenue, for the year ended December 31, 2009 from $82.2 million, or 29.7% of net revenue, for the year ended December 31, 2008. The decrease is attributable to a decrease of $6.1 million in salaries and benefits, a decrease of $8.4 million in sales and marketing expense, a decrease of $2.0 million in advertising expenses, a decrease of $1.7 million in general and administrative and a decrease of $0.7 million in all other expenses. Inclusive of the currency effect, which accounted for a $4.7 million decrease, selling, general and administrative expense decreased $23.6 million to $58.6 million for the year ended December 31, 2009 from $82.2 million for the year ended December 31, 2008.

International Carrier Services: International Carrier Services selling, general and administrative expense, exclusive of the currency effect, decreased $1.2 million to $7.2 million, or 3.1% of net revenue, for the year ended December 31, 2009 from $8.4 million, or 4.3% of net revenue, for the year ended December 31, 2008. Inclusive of the currency effect, which accounted for a $0.5 million decrease, selling, general and administrative expense decreased $1.7 million to $6.7 million for the year ended December 31, 2009 from $8.4 million for the year ended December 31, 2008.

United States: United States selling, general and administrative expense decreased $10.0 million to $25.6 million, or 37.9% of net revenue, for the year ended December 31, 2009 from $35.6 million, or 40.4% of net revenue, for the year ended December 31, 2008. The decrease is attributable to decreases of $4.0 million in salaries and benefits, $2.1 million in general and administrative expenses, $1.6 million in advertising expenses, $1.1 million in sales and marketing expense, $0.7 million in occupancy, and $0.5 million in other expenses.

 

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Brazil: Brazil selling, general and administrative expense, exclusive of the currency effect, decreased $0.5 million to $3.5 million, or 21.6% of net revenue, for the year ended December 31, 2009 from $4.0 million, or 39.8% of net revenue, for the year ended December 31, 2008. The decrease is attributable to a $0.6 million decrease in salaries and benefits and a $0.3 million decrease in sales and marketing offset in part by a $0.3 million increase in all other expenses. Inclusive of the currency effect, which accounted for a $0.3 million decrease, selling, general and administrative expense decreased $0.9 million to $3.1 million for the year ended December 31, 2009 from $4.0 million for the year ended December 31, 2008.

Corporate: Corporate selling, general and administrative expense decreased $0.3 million to $10.8 million for the year ended December 31, 2009 from $11.1 million for the year ended December 31, 2008. The decrease is primarily due to a decrease in salaries and benefits.

Depreciation and amortization expense: Depreciation and amortization expense was $48.5 and $30.4 million for the years ended December 31, 2009 and 2008, respectively. This change occurred as a result of the fair valuing of fixed and intangible assets per Fresh-Start accounting which was implemented effective July 1, 2009. See “Note 4—Fresh-Start Accounting” in our consolidated financial statements for further detail.

Interest expense and accretion (amortization) on debt discount/premium: Interest expense and accretion (amortization) on debt discount/premium, net decreased $22.2 million to $31.2 million for the year ended December 31, 2009 from $53.4 million for the year ended December 31, 2008. The decrease was due to the lower debt levels primarily resulting from the cancellation of certain indebtedness through the Plan of Reorganization, effective as of July 1, 2009.

Gain (loss) from contingent value rights valuation. The value of the contingent value rights decreased $2.8 million during 2009 due to the change of the fair market value. The Company determined these contingent value rights to be derivative instruments to be accounted for as liabilities and were marked to fair value, (and in future periods will be marked to fair value), at each balance sheet date. Upon issuance of the contingent value rights, the Company recorded a liability of $2.6 million in other liabilities as part of fresh-start accounting, and we will adjust this liability quarterly to its then estimated fair value, (which in future periods potentially could be substantially greater than the initial recorded liability balance). The change in fair value of the liability is reflected in our Statements of Operations as other income (expense). Estimates of fair value represent the Company’s best estimates based on a Black-Scholes pricing model.

Interest income and other (expense). Interest income and other (expense) decreased $2.4 million to $0.9 million for the year ended December 31, 2009 from $3.3 million expense for the year ended December 31, 2008.

Foreign currency transaction gain (loss): Foreign currency transaction gain increased $86.3 million to a gain of $39.9 million for the year ended December 31, 2009 from a loss of $46.4 million for the year ended December 31, 2008. The gains are attributable to the impact of foreign currency exchange rate changes on intercompany debt balances and on receivables and payables denominated in a currency other than the subsidiaries’ functional currency.

Reorganization items, net. Reorganization items, exclusive of discontinued operations reflect the favorable impact of $424.4 million, and inclusive of discontinued operations reflect the favorable impact of $439.5 million for the year ended December 31, 2009 due to fresh-start accounting and revaluation of assets and liabilities ($188.6 million), gain on extinguishment of debt ($243.2 million), and reversal of future interest payments recorded as long-term obligations ($20.4 million), offset in part principally by the incurrence of professional fees as a result of the Chapter 11 Cases ($12.6 million).

Income tax benefit (expense): Income tax benefit (expense) is a $6.1 million benefit for the year ended December 31, 2009 compared to a $0.7 million benefit for the year ended December 31, 2008. The benefit includes expenses consisting of foreign withholding tax on intercompany interest, the release of certain

 

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“ASC 740” liabilities as a result of the expiration of the statute of limitations and charges for uncertain tax positions under ASC No. 740, “Income Taxes.” The foreign tax expense was offset by a significant benefit from the release of deferred tax liabilities related to amortization of certain fresh-start adjustments to fixed assets and intangibles as discussed in “Note 8—Income Taxes,” to our consolidated audited financial statements.

Liquidity and Capital Resources

Important Long-Term Capital Structure Developments:

Terminated Exchange Offers. In the first quarter of 2011, we announced the commencement of private offers to exchange (the “Exchange Offers”) up to $240 million of new 9.50% Senior Secured Notes due 2019 issued by Primus Telecommunications Holding, Inc. for our outstanding 13% Notes and 14 1/4% Notes. As of the expiration time of the Exchange Offers at 5:00 p.m. New York City Time on March 23, 2011 the minimum participation condition with respect to the Exchange Offers was not fully met and we therefore elected to terminate the Exchange Offers.

Debt Redemption. On March 16, 2011 we sent a notice of redemption to holders of the 14 1/4% Notes, pursuant to which Primus Telecommunications IHC, Inc. elected to redeem $24,014,974 aggregate principal amount of our outstanding 14 1/4% Notes, with an April 15, 2011 redemption date (the “Redemption Date”) at a redemption price of 100.00% of the principal amount thereof (the “Redemption Price”), plus accrued and unpaid interest to, but excluding the Redemption Date on the redeemed 14 1/4% Notes. On the Redemption Date, the Redemption Price (together with accrued and unpaid interest to, but excluding the Redemption Date of $1,283,300 on the redeemed 14 1/4% Notes) will become due and payable on 14 1/4% Notes called for redemption and, unless Primus Telecommunications IHC, Inc. shall default in the payment of the Redemption Price and accrued interest, interest on 14 1/4% Notes called for redemption shall cease to accrue on and after the Redemption Date.

2009 13% Notes Offering. In the fourth quarter 2009, we completed a private offering of $130 million in 13% Senior Secured Notes due 2016. Net proceeds, after deducting underwriting and transactional expenses, of $123.5 million were used principally to fully repay and terminate our $94.8 million senior secured term loan facility and $27.0 million Canadian credit facility, each of which were due in 2011. In connection with the July 2009 Reorganization and our December 2009 issuance of 13% Notes, we significantly adjusted our capital structure, our debt agreements’ covenants and terms, our debt service obligations and our long-term debt maturities. We believe these efforts have better aligned our capital structure with our business’s cash flow and liquidity expectations.

Changes in Cash Flows

Our principal liquidity requirements arise from cash used in operating activities, purchases of network equipment including switches, related transmission equipment and capacity, development of back-office systems, expansion of data center facilities, interest and principal payments on outstanding debt and other obligations and income taxes. We have financed our growth and operations to date through public offerings and private placements of debt and equity securities, vendor financing, capital lease financing and other financing arrangements.

Net cash provided by operating activities was $36.5 million for the year ended December 31, 2010 as compared to net cash provided by operating activities of $29.0 million for the year ended December 31, 2009. For the year ended December 31, 2010, net income, net of non-cash operating activity, provided $54.4 million of cash. In addition, cash was increased by a reduction in accounts receivable of $3.4 million and an increase in accrued interest of $0.1 million. For the year ended December 31, 2010, we used $8.5 million to reduce our accounts payable, $6.2 million to reduce our accrued interconnection costs, $2.6 million to reduce our accrued income taxes, $2.5 million to increase other assets, $0.3 million to reduce our accrued expenses, deferred

 

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revenue, other current liabilities and other liabilities, net, and $1.2 million to increase our prepaid expenses and other current assets. Cash effect of reorganization items was $0.1 million.

Net cash provided by operating activities was $29.0 million for the year ended December 31, 2009 as compared to net cash provided by operating activities of $8.8 million for the year ended December 31, 2008. For the year ended December 31, 2009, net income, net of non-cash operating activity, provided $61.6 million of cash. In addition, cash was increased by a reduction in accounts receivable of $12.5 million, a reduction in prepaid expenses and other current assets of $2.3 million, a reduction in other assets of $4.3 million and an increase in accrued interest of $0.4 million. For the year ended December 31, 2009, we used $20.5 million to reduce our accounts payable, $9.0 million to reduce our accrued income taxes, $2.6 million to reduce our accrued expenses, deferred revenue, other current liabilities and other liabilities, net, and $7.8 million to reduce our accrued interconnection costs. Cash effect of reorganization items was $12.2 million.

Net cash used in investing activities was $21.2 million for the year ended December 31, 2010 compared to $15.1 million for the year ended December 31, 2009. Net cash used in investing activities during the year ended December 31, 2010 included $26.4 million of capital expenditures and was primarily offset by $5.7 million from the sale of certain European retail operations, primarily Belgium, United Kingdom and France.

Net cash used in investing activities was $15.1 million for the year ended December 31, 2009 compared to $18.7 million for the year ended December 31, 2008. Net cash used in investing activities during the year ended December 31, 2009 included $15.1 million of capital expenditures.

Net cash used in financing activities was $13.9 million for the year ended December 31, 2010 compared to $12.7 million for the year ended December 31, 2009. During the year ended December 31, 2010, $13.9 million was used to reduce the principal amounts outstanding on capital leases, leased fiber capacity, financing facilities and other long-term obligations.

Net cash used in financing activities was $12.7 million for the year ended December 31, 2009 compared to $28.1 million for the year ended December 31, 2008. During the year ended December 31, 2009, $35.0 million was used to retire in full our Canadian Credit Facility, $96.3 million was used to retire in full the Senior-Secured Term Loan Facility, $4.9 million was used to reduce the principal amounts outstanding on capital leases, leased fiber capacity, financing facilities and other long-term obligations. Net cash proceeds received from the issuance of the Senior Secured Notes was $123.5 million.

Short- and Long-Term Liquidity Considerations and Risks

As of December 31, 2010, we had $41.5 million of unrestricted cash and cash equivalents. We believe that our existing cash and cash equivalents will be sufficient to fund our debt service requirements, other fixed obligations (such as capital leases, vendor financing and other long-term obligations), and other cash needs for our operations for at least the next twelve months.

As of December 31, 2010, we have $45.6 million in future minimum purchase obligations, $68.5 million in future operating lease payments and $245.7 million of indebtedness. At December 31, 2010, approximately $88.3 million of unrecognized tax benefits have been recorded as liabilities in accordance with ASC No. 740; however, we are uncertain as to if or when such amounts may be settled, so we have not included these amounts in the table below.

 

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The obligations reflected in the table below reflect the contractual payments of principal and interest that existed as of December 31, 2010:

 

(in thousands)

Year Ending December 31,

   Capital Leases
and Other
    13% Senior
Secured
Notes
    14 1/4% Senior
Subordinated
Secured  Notes
    Purchase
Obligations
     Operating
Leases
     Total  

2011

   $   1,228      $ 16,900      $ 16,247      $   34,142       $   15,706       $ 84,223   

2012

     340        16,900        16,247        7,115         13,886         54,488   

2013

     168        16,900        122,139        3,162         11,038         153,407   

2014

     20        16,900        —          1,162         7,119         25,201   

2015

     —          16,900        —          54         5,695         22,649   

Thereafter

     —          146,947        —          —           15,102         162,049   
                                                  

Total Minimum Principal & Interest Payments

     1,756        231,447        154,633        45,635         68,546         502,017   

Less: Amount Representing Interest

     (89     (101,447     (40,618     —           —           (142,154
                                                  

Total Long-Term Obligations

   $ 1,667      $ 130,000      $ 114,015      $ 45,635       $ 68,546       $ 359,863   
                                                  

The foregoing table assumes that the 14 1/4% Notes are refinanced before January 21, 2013 and holders of 13% Notes do not accept any Excess Cash Flow Offer to purchase 13% Notes. In this regard, the Company must extend an offer to repurchase to the holders of the 13% Notes an applicable amount, (equal to 50% of Excess Cash Flow), of the 13% Notes at par, in the event the Company and certain subsidiaries have excess cash flow (as defined in Note 7—Long Term Obligations.) for any fiscal year commencing with the fiscal year ending December 31, 2010. See Item 1A. “Risks Associated with our Liquidity Needs and Debt Securities.” for certain risks and uncertainties related thereto.

We have contractual obligations to utilize network facilities from certain carriers with terms greater than one year. We generally do not purchase or commit to purchase quantities in excess of normal usage or amounts that cannot be used within the contract term.

Newly Adopted Accounting Principles

Effective July 1, 2009, the Company adopted ASC No. 105, “Generally Accepted Accounting Principles.” ASC No. 105 establishes the FASB Accounting Standards Codification as the source of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements. The adoption did not have a material impact on its results of operations, financial position and cash flows.

Effective April 1, 2009, the Company adopted ASC No. 855, “Subsequent Events.” ASC No. 855 establishes principles and requirements for evaluating and reporting subsequent events and distinguishes which subsequent events should be recognized in the financial statements versus which subsequent events should be disclosed in the financial statements. The adoption did not have a material effect on the Company’s results of operations, financial position or cash flows.

Effective January 1, 2009, the Company adopted ASC No. 810, “Consolidation.” Reconciliations at the beginning and the end of the period of the total equity, equity attributable to the Company and equity attributable to the noncontrolling interest for Successor’s six months ended December 31, 2009 and Predecessor’s six months ended July 1, 2009 and year ended December 2008 are included in the Company’s consolidated statement of stockholders’ equity (deficit).

Effective January 1, 2009, the Company adopted ASC No. 805, “Business Combinations.” ASC No. 805 establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the

 

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acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. The Company applied this standard on July 1, 2009 to the Fresh Start Balance Sheet, (See Note 4 “Fresh Start Accounting” for further detail).

In February 2008, the FASB issued ASC No. 820, “Fair Value Measurements.” The provisions of ASC No. 820 provide guidance for, among other things, the definition of fair value and the methods used to measure fair value, were adopted January 1, 2008 for financial instruments. The provisions adopted in 2008 did not have a material impact on the Company’s financial statements. ASC No. 820 delayed the effective date for all nonrecurring fair value measurements of nonfinancial assets and liabilities (except for those that are recognized or disclosed at fair value in the financial statements on a recurring basis) until financial years beginning after November 15, 2008, and changed the scope of ASC No. 820. On January 1, 2009, the Company adopted the remaining provisions of ASC No. 820 for nonrecurring fair value measurements of nonfinancial assets and liabilities. The provisions adopted in the first quarter 2009 were applied by the Company in the fair value measurements as part of the fresh start accounting adoption upon emergence from bankruptcy on July 1, 2009 and the goodwill impairment analysis performed as of October 1, 2009.

The valuation techniques required by ASC No. 820 are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. These two types of inputs create the following fair value hierarchy:

 

   

Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date;

 

   

Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability; and

 

   

Level 3: Unobservable inputs for the asset or liability. These unobservable inputs reflect the entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability, and are developed based on the best information available in the circumstances (which might include the reporting entity’s own data).

The Company had a cross-currency principal and interest rate agreement with Lehman Brothers Special Financing, Inc., who entered bankruptcy in October 2008 and ceased performing on the agreement. The Company estimated the value to be zero, requiring a write-off of $1.2 million in 2008, and moved the instrument from Level 2 to Level 3 because the counter party’s credit risk is not observable.

In March 2008, the FASB issued ASC No. 815, “Derivatives and Hedging.” ASC No. 815 amends and expands the disclosure requirements with the intent to provide users of financial statements with an enhanced understanding of the use of derivative instruments, how derivative instruments and related hedged items are accounted for, and how derivative instruments and related hedged items affect an entity’s financial statements. ASC No. 815 is effective for financial statements issued for fiscal years interim periods beginning after November 15, 2008. In addition the Company accounted for the Contingent Value Rights Distribution Agreement in accordance with ASC No. 815, “Derivatives and Hedging” as well as related interpretations of this standard. The change in value of the Contingent Value Rights Distribution Agreement is reflected in our Statements of Operations as other income (expense), (see Note 2—Emergence from Voluntary Reorganization Under Chapter 11 of the Bankruptcy Code,” for further detail). The adoption of ASC No. 815 on January 1, 2009 did not have a material impact on the Company’s results of operations, financial position and cash flows.

New Accounting Pronouncements

In June 2009, the FASB issued ASC No. 810-10, “Consolidation,” which amends the definition of the primary beneficiary of a variable interest entity and will require the Company to assess each reporting period if

 

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any of the Company’s variable interests give it a controlling financial interest in the applicable variable interest entity. The provisions of ASC No. 810-10 will become effective for financial statements issued for fiscal years and interim periods begin after November 15, 2009. The Company is currently evaluating the impact the provisions of ASC No. 810-10 on its financial statements.

In April 2008, the FASB issued ASC No. 852-10, “Reorganizations”. ASC No. 852-10 nullifies certain requirements regarding changes in accounting principles that will be applicable to the financial statements of an entity emerging from bankruptcy. Any changes in accounting principles required within the twelve months following the implementation of fresh start accounting by such an entity are no longer required to be adopted at the time fresh start accounting is implemented. Entities emerging from bankruptcy that implement fresh start accounting should only follow accounting standards in effect at the date fresh start accounting is implemented, including any standards eligible for early adoption.

Recently Issued Accounting Standards Updates

In January 2010, an update was issued to the Fair Value Measurements and Disclosures Topic, ASC 820, which requires new disclosures for fair value measurements and provides clarification for existing disclosures requirements. More specifically, this update requires (a) an entity to disclose separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately (i.e., present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This update clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and requires disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. This update was effective for us on January 1, 2010, except for Level 3 reconciliation disclosures which will be effective for us on January 1, 2011. The update did not have a material impact on our disclosures to our consolidated and combined financial statements.

In December 2010, an update was made to the Intangibles—Goodwill and Other Topic, ASC 350, which provides guidance for all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative. The update modifies Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This update will become effective for us on January 1, 2011. We do not expect the adoption of this update to have a material impact on our consolidated and combined financial statements.

Special Note Regarding Forward Looking Statements

Certain statements in this Report on Form 10-K and elsewhere concerning strategic objectives and initiatives, Arbinet merger synergies and strategies, our overall prospects, our prospects for the International Carrier Services business after giving effect to the Arbinet acquisition, future liquidity, cost savings initiatives and related matters constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are based on current expectations, and are not strictly historical statements. In some cases, you can identify forward-looking statements by terminology such as “if,” “may,” “should,” “believe,” “anticipate,” “future,” “forward,” “potential,” “estimate,” “reinstate,” “opportunity,” “goal,” “objective,” “exchange,” “growth,” “outcome,” “could,” “expect,” “intend,” “plan,” “strategy,” “provide,” “commitment,” “result,” “seek,” “pursue,” “ongoing,” “include” or in the negative of such terms or comparable terminology. These forward-looking statements

 

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inherently involve certain risks and uncertainties, although they are based on our current plans or assessments which are believed to be reasonable as of the date of this filing. Forward-looking statements include, without limitation, statements set forth in this document and elsewhere regarding, among other things:

 

   

our financial condition, Arbinet business integration and synergy efforts, financing requirements, prospects and cash flow;

 

   

expectations of future growth, creation of shareholder value, revenue, foreign revenue contributions and net income, as well as income from operations, margins, earnings per share, cash flow and cash sufficiency levels, working capital, network development, customer migration and related costs, spending on and success with growth products, including broadband Internet, VOIP, wireless, local, data and hosting services, traffic development, capital expenditures, selling, general and administrative expenses, income tax and withholding tax expense, fixed asset and goodwill impairment charges, service introductions, cash requirements and potential asset sales;

 

   

increased competitive pressures, declining usage patterns, and our growth products, bundled service offerings, the pace and cost of customer migration onto our networks, the effectiveness and profitability of the growth products;

 

   

financing, refinancing, debt extension, de-leveraging, restructuring, exchange or tender plans or initiatives, and potential dilution of existing equity holders from such initiatives;

 

   

liquidity and debt service forecast;

 

   

assumptions regarding currency exchange rates;

 

   

timing, extent and effectiveness of cost reduction initiatives and management’s ability to moderate or control discretionary spending;

 

   

management’s plans, goals, expectations, guidance, objectives, strategies, and timing for future operations, acquisitions, synergies, asset dispositions, product plans, performance and results;

 

   

management’s assessment of market factors and competitive developments, including pricing actions and regulatory rulings; and

 

   

ability to generate net cash proceeds from the disposition of selective assets without material impairment to profitability.

Factors and risks that could cause actual results or circumstances to differ materially from those set forth or contemplated in forward looking statements include those set forth in “Risk Factors” as well as, without limitation:

 

   

the occurrence of a default or event of default under our indentures or other financing agreements;

 

   

our inability to generate sufficient liquidity and working capital;

 

   

an inability to fully fund and repurchase holder acceptances of offers to repurchase 13% Notes that we are obligated to make annually, subject to certain limitations, in connection with Excess Cash Flow Offers;

 

   

fluctuations in the exchange rates of currencies, particularly of the USD relative to foreign currencies of the countries where we conduct our foreign operations;

 

   

an inability to fully fund and repurchase holder acceptances of offers to repurchase debt securities that we may be obligated to make following certain change in control developments affecting Group and certain of its subsidiaries;

 

   

changes in business conditions causing changes in the business direction and strategy by management;

 

   

heightened competitive pricing and bundling pressures in the markets in which we operate;

 

   

the ability to service substantial indebtedness;

 

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accelerated decrease in minutes of use on wireline phones;

 

   

difficulty in maintaining or increasing customer revenues and margins through our product initiatives and bundled service offerings, and difficulties in migrating and provisioning broadband and local customers to digital subscriber line (DSL) networks;

 

   

inadequate financial resources to promote and to market product initiatives, whether due to acceptances of Excess Cash Flow Offers or otherwise;

 

   

fluctuations in prevailing trade credit terms or revenues due to the adverse impact of, among other things, further telecommunications carrier bankruptcies or adverse bankruptcy related developments affecting our large carrier customers;

 

   

the possible inability to raise additional capital when needed, on attractive terms, or at all;

 

   

adverse changes in the credit markets or in the ratings given to Primus’s debt securities by nationally accredited ratings organizations, which could limit or restrict the availability, or increase the cost, of financing;

 

   

possible claims under our existing debt instruments which could impose constraints and limit our flexibility;

 

   

the inability to service substantial indebtedness and to reduce, refinance, extend, exchange, tender for or restructure debt significantly, or in amounts sufficient to conduct regular ongoing operations;

 

   

further changes in the telecommunications or Internet industry, including rapid technological changes, regulatory and pricing changes in our principal markets and the nature and degree of competitive pressure that we may face;

 

   

adverse tax or regulatory rulings from applicable authorities;

 

   

enhanced broadband, DSL, Internet, wireless, VOIP, date and hosting and local and long distance voice telecommunications competition;

 

   

changes in financial, capital market local and international and economic conditions;

 

   

changes in service offerings or business strategies, including the need to modify business models if performance is below expectations;

 

   

the effects of greater than anticipated competition requiring new pricing, marketing strategies or new product or service offerings and the risk that the combined company, following the Arbinet merger, will not respond on a timely or profitable basis;

 

   

difficulty in retaining existing long distance wireline and dial-up ISP customers;

 

   

difficulty in migrating or retaining customers associated with acquisitions of customer bases, or integrating other assets;

 

   

the effects of changes in both general and local economic conditions on the markets served by Primus or Arbinet, which can affect demand for its products and services, customer purchasing decisions, collectability of revenues and required levels of capital expenditures;

 

   

changes in the regulatory schemes or requirements and regulatory enforcement in the markets in which we operate;

 

   

restrictions on our ability to execute certain strategies or complete certain transactions as a result of our inexperience with new products, or limitations imposed by available cash resources, our capital structure or debt covenants;

 

   

aggregate margin contribution from the new products is not sufficient in amount or timing to offset the margin decline in our legacy long distance voice and dial-up ISP businesses;

 

   

the ability to integrate successfully Arbinet’s operations into the existing operations of Primus;

 

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the effects of increased expenses due to activities related to the Arbinet merger;

 

   

the risk that the growth opportunities and cost synergies (or other efficiencies) from the Arbinet merger may not be fully realized or may take longer to realize than expected;

 

   

the ability to manage effectively, after the Arbinet merger, the combined company’s operations, operating expenses and capital expenditures;

 

   

the effect of various buyers and sellers on the Arbinet Exchange, or members, not trading on the Arbinet Exchange or utilizing the Arbinet business’s new and additional services;

 

   

volatility in the volume and mix of trading activity on Arbinet’s Exchange;

 

   

uncertain and long member enrollment cycle in the Arbinet business;

 

   

the failure to manage Arbinet’s carrier services;

 

   

decreased trading volumes due to Arbinet’s efforts to increase call quality on the Arbinet Exchange;

 

   

the possible inability to hire and/or retain qualified executive management, sales, technical and other personnel;

 

   

risks and costs associated with our effort to locate certain activities and functions off-shore;

 

   

risks associated with international operations;

 

   

dependence on effective information and billing systems;

 

   

possible claims for patent infringement on products or processes employed in providing our services;

 

   

dependence on third parties for access to their networks to enable us to expand and manage our global network and operations and to offer broadband, DSL, local, VOIP and wireless services, including dependence upon the cooperation of incumbent carriers relating to the migration of customers;

 

   

dependence on the performance of our global standard asynchronous transfer mode and Internet-based protocol (ATM+IP) communications network; risks associated with maintaining and upgrading networks; and

 

   

adverse regulatory rulings or actions affecting our operations, including the imposition of taxes and fees, the imposition of obligations upon VOIP providers to provide enhanced 911 (E911) services and restricting access to broadband networks owned and operated by others, including the development of a national broadband network in Australia.

As such, actual results or circumstances may vary materially from such forward looking statements or expectations. Readers are also cautioned not to place undue reliance on these forward looking statements which speak only as of the date these statements were made. We are not obligated to update or revise any forward looking statements, whether as a result of new information, future events or otherwise.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our primary market risk exposures relate to changes in foreign currency exchange rates, valuations of derivatives and to changes in interest rates.

Foreign currency can have a major impact on our financial results. As of December 31, 2010, about 85% of our net revenue is derived from sales and operations outside the U.S. The reporting currency for our consolidated financial statements is the USD. The local currency of each country is the functional currency for each of our respective entities operating in that country. In the future, we expect to continue to derive the majority of our net revenue and incur a significant portion of our operating costs from outside the U.S., and therefore changes in exchange rates have had and may continue to have a significant, and potentially adverse, effect on our results of operations. Our primary risk of loss regarding foreign currency exchange rate risk is caused primarily by fluctuations in the following exchange rates: USD/CAD and USD/AUD. Due to the large percentage of our revenue derived outside of the U.S., changes in the USD relative to one or more of the foregoing currencies could have an adverse impact on our future results of operations. We have agreements with certain subsidiaries for repayment of a portion of the investments and advances made to these subsidiaries. As we anticipate repayment in the foreseeable future, we recognize the unrealized gains and losses in foreign currency transaction gain (loss) on the consolidated statements of operations. We historically have not engaged in hedging transactions.

We are exposed to financial statement gains and losses as a result of translating the operating results and financial position of our international subsidiaries. We translate the local currency statements of operations of our foreign subsidiaries into USD using the average exchange rate during the reporting period. Changes in foreign exchange rates affect the reported profits and losses and cash flows and may distort comparisons from year to year. By way of example, when the USD strengthens compared to the AUD, there could be a negative or positive effect on the reported results for Australia, depending upon whether our Australia unit is operating profitably or at a loss. It takes more profits in AUD to generate the same amount of profits in USD and a greater loss in AUD to generate the same amount of loss in USD. The opposite is also true. For instance, when the USD weakens there is a positive effect on reported profits and a negative effect on reported losses for Australia.

In the year ended December 31, 2010, as compared to the year ended December 31, 2009, the USD was stronger on average as compared to the AUD, CAD, and GBP; and weaker on average to the EUR. As a result, our revenue of the subsidiaries whose local currency is AUD, CAD, GBP