Why being No. 1 on the Inc. 500 and selling more cell phones on the Internet than anyone else wasn't enough.
In retrospect, the high point for InPhonic might have been the day it went public -- the day when its potential was supposed to just begin to be realized.
Founded in 1999 by an up-and-coming entrepreneur named David Steinberg, the Washington-based business was one of the first online sellers of mobile phones, plans, and activation services. At the time, Steinberg, a salesman at heart, had already made an imprint in the industry. In 1993, he had started Sterling Cellular, a third-party distributor for Cellular One, and within six years, the company had expanded to 58 locations. In 1999, Steinberg split Sterling into three parts -- a retail chain, a telemarketing company, and a back-office operation that activated and shipped phones, according to a feature in the March 2005 issue of Inc. Then, when he decided to move the activation and distribution unit onto the Web, he used a chance encounter with former Pepsi and Apple CEO John Sculley to pitch his idea and get him on board. The new company, InPhonic, started out selling phones and plans through sites it created and managed for online businesses, national retailers, member-based organizations and associations. Companies like BestBuy and Amazon would eventually become partners. In 2003, it launched its signature site, Wirefly.com, which earned immediate praise as a one-stop comparison-shopping destination for cell phone plans, phones, and accessories. In Steinberg's words, he had created "the Expedia of the mobile phone industry."
By the end of 2003, InPhonic had achieved a three-year growth rate of more than 23,000 percent, earning it the No. 1 ranking on the 2004 Inc. 500 list of the nation's fastest-growing private companies. With a board that included Sculley, venture-capital heavyweight Jay Hoag, and 1996 vice presidential candidate Jack Kemp, InPhonic didn't exactly lack for star power either. Even surrounded by this all-star cast, it was clear from the start that Steinberg was the main catalyst for success. In a story published in October 2004, Sculley told Inc. that Steinberg reflected the best traits of Steve Jobs and Bill Gates. Steinberg, Sculley said, had "the ability to motivate people to believe in what he believes in" and was "one of the best deal creators, negotiators, and closers I've ever worked with."
Early on, Steinberg had been able to raise $85 million in venture capital. That helped the company's annual revenue skyrocket from $499,000 in 2000 to $136 million in 2003, but it was the potential for continued growth that allowed InPhonic to go public in November 2004 without ever having turned a profit. Its dominant status in the online wireless marketplace was enough to raise more than $100 million in the IPO and its market cap would climb as high as $850 million -- which Steinberg figured to put to use, continuing a strategy of buying up smaller competitors. In 2002, InPhonic had purchased Simplexity for $20 million. In May 2003, when InPhonic had acquired Avesair for $7 million, it had marked the company's seventh acquisition in the preceding 14 months, according to an article at the time in RCR Wireless News.
But with the growth came additional pressures, and buried in the company's IPO prospectus was a caveat that would ultimately prove prophetic. "We have grown rapidly," a heading on page 13 reads, "and we must manage additional growth and the demands on our resources and personnel in order to be successful."
It was almost three years to the day after that Nov. 16, 2004, filing that the company would make news with a filing of a different sort. On Nov. 8, 2007, InPhonic filed for Chapter 11 bankruptcy protection after learning that an affiliate of the private-equity firm Versa Capital Management was interested in buying the beleaguered company. InPhonic said the bankruptcy would help facilitate the sale. Under Chapter 11, a company gets a chance to reorganize its business and debts. In late December 2007, a judge approved the sale after Versa had worked out an agreement with the company's creditors. Claudia Springer, attorney for the official committee of unsecured creditors, says the sale to Versa was the best -- and really only -- result that would allow some creditors to recover their debt. "There was not really any other interest from someone that actually put an offer on the table," Springer says.
Throughout the bankruptcy process, InPhonic continued to do business, but not with great success. According to spokesman Tripp Donnelly, the company is still "the largest online retailer of cell phones and products." While this may be true, lawyers for Versa said in court papers that the company has been losing more than $3 million a week.
Thus far, none of InPhonic's principals have been willing to discuss publicly what went wrong. Most of the all-star management team, including Steinberg and Sculley, did not return calls seeking comment or declined comment for this story. But by talking to competitors and industry experts, it is possible to piece together some of what happened.
Looking back, one of the first public indications that the company was suffering growing pains -- and might have a flaw in its business model -- came in 2006, when InPhonic found itself at the center of several lawsuits. In June of that year, the District of Columbia's Attorney General's Office sued InPhonic, claiming that its rebate practices violated the district's consumer protection law. The lawsuit alleged that InPhonic "imposed restrictive conditions on the rebates on their cellular phones that prevented many consumers from receiving the promised savings." Substantial rebate offers are common on InPhonic's websites and offer consumers a way to save substantially more than they could at brick-and-mortar stores.
This was not just a minor dispute. "Their track record is deplorable," says Edward Johnson III, president and CEO of the Better Business Bureau of Washington D.C., which logged thousands of complaints about the company's practices. "This company is one of the single most-complained about companies in the BBB system."
In February 2007, InPhonic and the AG's office settled, with InPhonic agreeing to pay the district $100,000, to reimburse thousands of customers, and to begin advertising rebate restrictions clearly. As of Nov. 14, 2007, the company had issued 2,088 checks to consumers for a total of $214,555. The Federal Trade Commission also levied similar charges against the company, and that case was resolved in a similar manner. "The type of rebate program that InPhonic designed was very complicated and contained some very unusual terms that consumers don't ordinarily see in rebate programs," says Matthew Gold, an FTC staff attorney. "InPhonic's problem was that they failed to adequately disclose those terms prior to sale."
InPhonic spokesman Donnelly says the company learned from its mistakes and has since improved its practices. "Our growth did come with growing pains -- growing beyond the capacity of the third-party rebate processor we then used and not having the necessary protocols to quickly help customers," Donnelly wrote in an e-mail to Inc.com. "InPhonic was never nor today content with any customer unrest, and we believe we have demonstrated action and change where necessary in pursuit of a quality customer experience."
Nonetheless, the company's troubles continued to mount. In April 2007, InPhonic revealed in an SEC filing that it was going to have to restate its financial statements for the second and third quarters of 2006. The problem originated with the company's improper recording of disputed carrier commissions as revenue before they had actually been collected. With the filing, investors discovered that the company's net loss for 2006 would increase by $5 million to $7 million. InPhonic also recognized three "material weaknesses in its internal controls over financial reporting," mostly stemming from the lack of a "sufficient number of employees with appropriate levels of knowledge, expertise, and training in the application of generally accepted accounting principles." If the company had serious concerns about the viability of its continued operations, though, it didn't say it. In fact, it said the opposite: "The Company does not believe that this will negatively affect the 2007 business outlook."
In May 2007, the news grew worse with an update of the previous filing, in which the company revealed more accounting problems: "In 2006, the Company recorded net activation and services revenue of approximately $16 million related to certain carrier commissions and bonuses which it had deemed collectible. The Company now believes that it was inappropriate to have recorded revenue associated with these matters until such collections are received." And there was more: $2.5 million in revenue that had been recorded improperly and $4.9 million in expenses that had failed to be reported.
When InPhonic finally filed its 2006 restated financial report in May, it reported a loss of $63.7 million -- more than three and a half times the initially reported $17.5 million loss. The numbers were staggering, but the restatements proved to be recognition of what at least one analyst had been wondering about all along. "I initiated with a SELL rating when the stock was over $10 because there was a massive differential between what the company said they were 'earning' on the income statement and how they were shedding cash on the cash flow statement," Brad Maniulow, an analyst with American Technology Research, wrote in an e-mail to Inc.com. "Ultimately, it came down to a massive decline in the quality of the balance sheet -- they were recognizing revenues that weren't being collected, and their accounts payable and accounts receivable were growing two to four times as fast as revenues."
When the restatements were over, CFO Larry Winkler was gone. The reason for his resignation? "Personal reasons," the company said. Winkler could not be reached for comment.
In July 2007, Kenneth Schwarz was named to replace Winkler, and then in August, InPhonic announced that it was forming a strategic alliance with Brightstar, the cell phone industry's leader in distribution and supply chain management, which ranked second in revenue on the 2007 Inc. 5000 list and 1,840th in growth. The company also held the No. 154 spot on the 2003 Inc. 500.
Under the agreement, Brightstar was to acquire the distribution, inventory, and fulfillment assets of InPhonic and make an equity investment of $5 million in the company. Brightstar was also slated to become InPhonic's sole provider of wireless handsets, SIM cards, and accessories. "This strategic partnership with Brightstar will allow us to focus on our core competencies as an online wireless leader in customer acquisition," Steinberg said in a statement at the time. "This new alliance would provide an initial cash infusion, and we believe a significant positive impact to InPhonic's working capital and cash flow as well."
If there was hope that the company might be able to regain its financial footing by spinning off its distribution responsibilities, it would prove short-lived. A few weeks later, Steinberg handed off his CEO title to Andy Zeinfeld, who was president of the company at the time. (Zeinfeld declined comment through a company spokesman.) Then, on Oct. 5, InPhonic defaulted on its secured-lender loans and announced that its agreement with Brightstar had been terminated. Marcelo Claure, Brightstar's founder, president, and CEO, says a non-disclosure agreement prohibits him from discussing the termination in detail, but notes that the decision was his. "I personally made the decision that I didn't want to move forward with a transaction," he says.
What followed next, was the beginning of the end for InPhonic -- at least the company that Steinberg had envisioned. COO Brian Curran was fired on Oct. 10, the company hired Lazard Middle Market as a financial advisor on Oct. 11 to "explore strategic alternatives to increase the company's cash liquidity and to maximize shareholder value," and John Sculley resigned from the board one week later. (Curran could not be reached for comment.) On Nov. 7, Steinberg resigned as chairman of the board, a position he had kept after relinquishing the chief executive post.
Delly Tamer, founder and CEO of privately held LetsTalk.com, a major competitor of InPhonic, has kept tabs on the company from its beginning. When news arose of the bankruptcy filing, Tamer says, it became obvious that financial discipline had not been a substantial enough priority at InPhonic. "With how much money they raised, the question is where is this money going? " he says, taking note of their IPO and an additional $100 million in debt financing received from Goldman Sachs and Citigroup. "You want to be a public company, you have to really abide by and follow GAAP [Generally Accepted Accounting Principles] guidelines. It's not a walk in the park."
But the numbers beneath the accounting errors may have been indicators of more deep-set flaws in InPhonic's business model. InPhonic had tried to grow "too much, too quickly," Tamer says. "When any Internet company does an acquisition… in my view, 80 percent of the work is what you do after you acquire it -- the integration of the acquisition and assimilation of cultures," he says. "It's unclear to me that they did that."
In addition, the fast-paced growth seems to have come at the expense of profitability. Even while InPhonic's revenue jumped from $154.9 million in 2004 to $320.5 million in 2005, its net loss increased from $10.2 million to $38.2 million. "Going public before profitability is not [necessarily] an error," Tamer says. "But when they went public in 2004, Wall Street probably expected profitability soon after the public offering. The question is: Did they try hard enough to be profitable?"
CFO Schwarz declined comment through a spokesman, but in court papers he offered the following factors as contributing to the bankruptcy: "increased spending on marketing that proved to be unprofitable, insufficient improvement in revenue assurance and collection efforts, inability to maintain adequate inventory of the most popular wireless devices, increasing general and administrative expenses, and declining gross margin in revenue generated by customer activations."
In May, Steinberg, InPhonic and Winkler, the former CFO, were named in a shareholder class-action complaint filed in the District of Columbia's U.S. District Court. The complaint argues that the defendants "engaged in a scheme to deceive the market and engaged in a course of conduct that artificially inflated InPhonic's share price and operated as a fraud or deceit on purchasers of InPhonic shares by misrepresenting the Company's financial condition and business prospects." InPhonic has not yet filed a response, but in an SEC filing in June the company said, "We believe that the allegations… are without merit and intend to vigorously defend the litigation."
Not long after the suit was filed -- and the company's financial restatements were finally over -- Steinberg told a conference call of analysts, according to a transcript, "You know, you hate to say this, but at the end of the day, if anything good came out of this process, it was learning how to better manage our financial operations on a going-forward basis and save money."
"If we can make some lemonade out of lemons," he added, "we have learned a lot about how to better operate this business."
But whatever lessons Steinberg may have learned, they apparently came too late. Now, InPhonic is Versa Capital's problem. The company declined to be interviewed for this story, other than providing this prepared statement: "We believe the business holds great promise and look forward to working with Andy Zeinfeld and his management team as they complete the upcoming transition and closing, and return their full focus to executing the newly restructured and viable business plan."
Versa seems to be starting fresh in at least one respect. The name InPhonic can no longer be found anywhere on the homepage of the company's website; the name Simplexity has replaced it.