TMCnet News
MAGICJACK VOCALTEC LTD - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This Management's Discussion and Analysis of Operations and Financial Condition should be read in conjunction with our unaudited condensed consolidated financial statements as of March 31, 2013 and for the three month periods ended March 31, 2013 and 2012, as well as our Annual Report on Form 10-K for the year ended December 31, 2012. This Management's Discussion and Analysis of Operations and Financial Condition contain forward-looking statements, the accuracy of which involves risk and uncertainties. We use words such as "anticipates," "believes," "plans," "expects," "future," "intends," "estimates," "projects," and similar expressions to identify forward-looking statements. Readers should not place undue reliance on these forward-looking statements, which apply only as of the date of this report. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons. Factors that might cause or contribute to such differences include, but are not limited to those discussed under the section entitled "Risk Factors" of our Form 10-K for the year ended December 31, 2012 filed on April 2, 2013. Overview magicJack VocalTec Ltd. and its Subsidiaries (the "Company") is a cloud communications leader that is the inventor of VoIP, the softphone, the magicJack, the magicJack PLUS and other award winning magicJack products and services. magicJacks weigh about one ounce and plug into the USB port on a computer or into a power adapter and high speed Internet source, providing users with complete phone service for home, enterprise and while traveling. We charge as low as $20 a year for an access right to access our servers, and our customers then continue to have the ability to obtain free telephone services. We also provide additional products and services, which include voice apps on smart phones, as well as the magicJack PLUS, which is a standalone magicJack that has its own CPU and can connect a regular phone directly to the user's broadband modem/router and function as a standalone phone without using a computer. Our products and services allow users to make and/or receive free telephone calls to and from anywhere in the world where the customer has broadband access to the Internet, and allow customers to make free calls back to the United States and Canada from anywhere legally permitted in the world. We are a vertically integrated group of companies. We own a micro processor chip design company, an appserver and session border controller company, a wholesale provider of VoIP services, a softphone company, and the developer and provider of the magicJack product line. We intend to expand these existing platforms to allow its customers to use search, shopping, click-to-call and other services via the Internet through intellectual property right pending and proprietary technologies. We also wholesale telephone service to VoIP providers and telecommunication carriers. Our strategy since 2007 has been to vertically integrate our technology, design and suppliers, and we have completed four acquisitions between 2007 and 2010, including a merger with the company that invented VoIP, in order to implement this strategy. During September 2011, we began promoting the magicJack APP that can be used to make or receive telephone calls between two computers or between the customer's computer and a public switch telephone network ("PSTN"). The customer can use a headphone or a computer's speakers and microphone to make and receive telephone calls. In September 2011, the magicJack APP also became available for the iPhone, iPad and iPod Touch. In August 2012, the magicJack APP became available to Android phones. Basis of Presentation Our consolidated financial statements are prepared in conformity with United States generally accepted accounting principles ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of regulation S-K. Accordingly, our consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements that are included in the Company's Annual report on Form 10-K for the year ended December 31, 2012. The balance sheet at December 31, 2012 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. Management believes, however, that all adjustments of a normal, recurring nature considered necessary for a fair presentation have been included. The Company's consolidated financial statements are the basis for the discussion and analysis of our results of operations, liquidity and capital resources. References to authoritative accounting literature in this report, where applicable, are based on the Accounting Standards Codification ("ASC"). Our functional and reporting currency is the United States Dollar ("U.S. Dollar"), which is the currency of the primary economic environment in which our consolidated operations are conducted. Transactions and balances originally denominated in dollars are presented at their original amounts. Transactions and balances in currencies other than dollars, including Israeli New Shekel ("NIS"), are re-measured in dollars and any gains or losses are recognized in our consolidated financial statements in the period they occur. We prepare our consolidated financial statements on the basis of being a single reporting entity. Over 90% of our revenues in the three months ended March 31, 2013 and 2012 were derived from sales to customers located in the United States. 20 -------------------------------------------------------------------------------- Basis of Consolidation Our consolidated financial statements include the accounts of magicJack VocalTec and its wholly-owned subsidiaries, YMax Corporation, YMax Communications Corp., magicJack Holdings Corporation, magicJack, LP, SJ Labs, Inc., Tiger Jet Network, Inc., VocalTec Communications LLC and Predictive Marketing, LLC and B Kruse and Associates, LLC (collectively, "Dialmaxx"). All intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications may have been made to prior period financial statement amounts to conform to the current presentation. The results for the three months ended March 31, 2013, may not be indicative of the results for the entire year. The interim unaudited consolidated financial statements should be read in conjunction with our financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this report and in our Annual Report on Form 10-K for the year ended December 31, 2012 filed on April 2, 2013. Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Such estimates and judgments are revised periodically as required. Actual results could differ from those estimates. Significant estimates include allowances for billing adjustments and doubtful accounts, the recoverability of long-lived assets and goodwill, income tax valuation allowance (and related matters), the value of ordinary shares issued in business combinations or underlying the Company's ordinary share options, the expected forfeitures of ordinary share options and estimates of likely outcomes related to certain contingent liabilities. We evaluate our estimates on an ongoing basis. Our estimates and assumptions are based on factors such as historical experience, trends within the Company and the telecommunications industry, general economic conditions and on various other assumptions that we believe to be reasonable under the circumstances. The results of such assumptions form the basis for making judgments about the carrying values of assets and liabilities that are not readily available. Actual results may differ from our estimates and assumptions as a result of varying market and economic conditions, and may result in lower revenues and lower operating income. We have identified below our critical accounting policies. These policies are both the most important to the portrayal of our financial condition and results of operations and require our management's most difficult, subjective and complex judgments and estimates. Actual results may differ from these estimates under different assumptions or conditions. REVENUE RECOGNITION Revenues consists of revenue from sales of the magicJack and magicJack PLUS to retailers, wholesalers or directly to customers, access rights fees, fees charged for shipping the magicJack and magicJack PLUS, usage of prepaid minutes, access charges to other carriers and other miscellaneous charges for telecommunication usage. Revenue is recorded net of sales returns and allowances. magicJack and magicJack PLUS Revenue We recognize revenues from sales and shipping of direct sales of the magicJack and magicJack PLUS over the period associated with the initial 12-month access right period. Customers may purchase access rights for continued use of our software to access our servers for additional years either when the original purchase is made, or at any time thereafter. The revenue associated with the access right for additional years is deferred and recognized ratably over the extended access right period. Sales Return Policy We offer some of our direct sales customers a 30-day free trial before they have to pay for their magicJack or magicJack PLUS unit. We do not record or recognize revenue until the 30-day trial period has expired and a customer's credit card has been charged. Returns from retailers are accepted on an authorized basis for devices deemed defective. We may offer certain retailers the limited right to return any unsold merchandise from their initial stocking orders. We estimate potential returns under these arrangements at point of sale based and re-estimate potential returns on a quarterly basis. For the three months ended March 31, 2013 and 2012, our estimates of returns and actual returns from initial stocking orders have not been materially different. 21 -------------------------------------------------------------------------------- Telephony Services Revenue Telephony revenue is recognized as minutes are used. Telephony revenue is generated from the usage of prepaid minutes, fees for origination of calls to 800-numbers, access fees charged to other telecommunication carriers on a per-minute basis for Interexchange Carriers ("IXC") calls terminated on our servers, and wholesaling telephone service to VoIP providers and telecommunication carriers. We have estimated and provided allowances for billing adjustments of access charges to carrier customers. INCOME TAXES We recognize deferred tax assets and liabilities for the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their book basis using enacted tax rates. Any changes in enacted rates or tax laws are included in the provision for income taxes in the year of enactment. Our net deferred tax assets consist of primarily foreign net operating loss carryforwards and timing differences between recognition of income for book and tax purposes. We record a valuation allowance to reduce the net deferred tax assets to the amount that it estimates is more-likely-than-not to be realized. At December 31, 2012, we, based on cumulative profitability over the preceding three years and expected 2013 results, released $10.9 million of the valuation allowance recorded against its net deferred tax assets and determined that a remaining valuation allowance of $55.4 million was necessary to reduce the net deferred tax assets to the amount that will more-likely-than-not be realized. We periodically review the composition of our net deferred tax assets and related valuation allowances and will make adjustments if available evidence indicates that it is more-likely-than-not a change in the carrying amounts is required. No adjustments were made during the three months ended March 31, 2013, We assess our income tax positions and record tax benefits for all years subject to examination based upon its evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where there is greater than 50% likelihood that a tax benefit will be sustained, we have recorded the largest amount of tax benefit that may potentially be realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where there is 50% or less likelihood that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. We record our income tax expense for interim financial statements by using an estimated annual effective income tax rate based on our expected annual results after elimination of nontaxable items. The tax benefits of net operating loss carryforwards expected to be realized through 2013 and certain other deferred tax assets were recognized are for financial reporting purposes at December 31, 2012. At March 31, 2013, the estimated annual effective tax rate is expected to approximate 35.2%, which includes state and local taxes. This rate may fluctuate due to the timing of other discrete period transactions during the remainder of the year. 22 -------------------------------------------------------------------------------- RESULTS OF OPERATIONS The following table presents our consolidated results of operations for the periods indicated (in thousands). The condensed consolidated statements of operations below have been expanded to show the composition of our net revenue and cost of revenues items to enable a more meaningful discussion of our operations. Three Months Ended 2013 March 31, Compared to 2013 2012 2012 Net Revenues Sale of magicJack and magicJack PLUS $ 15,021 $ 14,970 $ 51 0.3 % Access right renewals 13,520 10,263 3,257 31.7 Shipping and handling 980 1,190 (210 ) (17.6 ) magicJack-related products 2,617 2,485 132 5.3 Prepaid minutes 3,233 5,847 (2,614 ) (44.7 ) Access and wholesale charges 1,543 1,907 (364 ) (19.1 ) Other (37 ) 925 (962 ) (104.0 ) Total Net Revenue 36,877 37,587 (710 ) (1.9 ) Cost of Revenues Cost of magicJack and magicJack PLUS sold 2,280 4,850 (2,570 ) (53.0 ) Shipping and handling 584 1,009 (425 ) (42.1 ) Credit card processing fees 768 1,112 (344 ) (30.9 ) Network and carrier charges 5,997 7,609 (1,612 ) (21.2 ) Other 1,514 980 534 54.5 Total Cost of Revenues 11,143 15,560 (4,417 ) (28.4 ) Gross Profit 25,734 22,027 3,707 16.8 Operating expenses: Advertising 2,814 8,704 (5,890 ) (67.7 ) General and administrative 6,818 6,834 (16 ) (0.2 ) Research and development 862 658 204 31.0 Total operating expenses 10,494 16,196 (5,702 ) (35.2 ) Operating income 15,240 5,831 9,409 161.4 Other income (expense): Gains on investments 527 597 (70 )* Interest and dividend income 156 251 (95 )* Interest expense (93 ) (119 ) 26 * Fair value (loss) gain on common equity put options (1,047 ) 1,656 (2,703 )* Other income, net 1 10 (9 )* Total other (expense) income (456 ) 2,395 (2,851 )* Income before income taxes 14,784 8,226 6,558 79.7 Income tax expense 5,198 30 5,168 * Net income $ 9,586 $ 8,196 $ 1,390 17.0 23-------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, 2013 COMPARED TO THREE MONTHS ENDED MARCH 31, 2012 Net Revenues Total net revenue was $36.9 million and $37.6 million for the three months ended March 31, 2013 and 2012, respectively, representing a decrease of $0.7 million, or 1.9%. The decrease in the components of net revenues was primarily attributable to the following: · $2.6 million decrease in revenues from prepaid minutes primarily as a result of the Company making an operational change in the three months ended March 31, 2012 which allowed it to identify the point in time when prepaid minutes expire under the terms of service, resulting in approximately $3.0 million attributable to prepaid minutes that expired between February 2008 and February 2012 being recognized as revenue; · a $1.0 million decrease in non-core other revenues as a result of discontinuing sales of telecommunications hardware and our proprietary software in late 2012 in order to focus on our internal needs; and · a $0.4 million decrease in revenues from access and wholesale charges. These decreases in components of net revenue were partially offset by a $3.3 million increase in access right renewal revenues as a result of the impact of price increases effective in early 2012 and higher number of active devices beyond its first year of service. For the three months ended March 31, 2013 and 2012, sales of the magicJack and magicJack PLUS units through retail outlets represented approximately 74% and 60%, respectively, of sales of all magicJack and magicJack PLUS units sold. For the same periods, direct sales represented approximately 26% and 40%, respectively, of magicJack and magicJack PLUS units sold. For the three months ended March 31, 2013 and 2012, no retailer accounted for more than 10% of the Company's total net revenue. Cost of Revenues Total cost of revenues was $11.1 million and $15.6 million for the three months ended March 31, 2013 and 2012, respectively, representing a decrease of approximately $4.4 million, or 28.4%. This decrease in cost of revenues was primarily attributable to: (i) a $2.6 million decrease driven by the favorable impact of a settlement with a retail sales broker and lower inventory cost of magicJack PLUS units sold, (ii) a $1.6 million reduction in network and carrier charges as we discontinued selling to certain high-cost wholesalers and continued effort to negotiate better rates with other carriers, and (iii) a combined $0.8 million decrease in shipping and handling costs and credit card processing fees primarily as a result of fewer units sold in the three months ended March 31, 2013 as we started preparing to launch a new product in mid 2013. These decreases in cost of revenues were partially offset by a $0.5 million net increase in cost of other revenues primarily due to higher personnel-related costs and higher amortization expense due to certain intangible assets purchased in mid 2012 and a $0.2 million impairment of certain technology and customer relationships related to the VocalTec legacy products, which we discontinued selling in 2013, offset in part by reduced costs of non-core other revenues as a result of discontinuing sales of telecommunications hardware and our proprietary software in late 2012. Operating Expenses Total operating expenses was $10.5 million and $16.2 million for three months ended March 31, 2013 and 2012, respectively, representing a decrease of $5.7 million, or 35.2%. This decrease in operating expenses was primarily due to a $5.9 million decrease in advertising-related expenses driven by a reduction in long-form and short-form advertising for the magicJack PLUS as we started preparing to launch a new product in mid 2013. Our combined advertising-related expenses decreased by approximately 67.7% for the quarter ended March 31, 2013 as compared to the quarter ended March 31, 2012 in part because the legacy value of our short and long-form advertising has not required continued reinforcement. Advertising-related expenses have varied, and may continue to vary from quarter to quarter. Other Income (Expense) Total other income (expense) for the three months ended March 31, 2013 was ($0.5) million, as compared to $2.4 million for the three months ended March 31, 2012, representing a decrease of $2.9 million. This decrease in other income (expense) was primarily due to changes in the item discussed below. Fair Value (Loss) Gain on Common Equity Put Options Fair value (loss) gain on common equity put options for three months ended March 31, 2013 and 2012, was ($1.0) million and $1.7 million, respectively. We sold common equity put option contracts in connection with our share repurchase program in order to attempt to lower the average share price paid for ordinary shares we purchase. 24 -------------------------------------------------------------------------------- Income Taxes Total income tax expense was $5.2 million and $30 thousand for the three months ended March 31, 2013 and 2012, respectively. Income taxes for the three months ended March 31, 2013 and 2012 are the following (in thousands): Three Months Ended March 31, 2013 2012 Income before taxes $ 14,784 $ 8,226 Income tax expense 5,198 30 Effective income tax rate 35.16 % 0.36 % Income tax expense for the three months ended March 31, 2012 was offset primarily by the utilization of net operating loss carryforwards. At December 31, 2012, we released $10.9 million of our valuation allowance against certain deferred tax assets related primarily to foreign net operating loss carryforwards and deferred revenue of that are expected to be realized in 2013, 2014 and 2015. These benefits are expected to reduce income taxes payable as realized and will not affect our effective tax rate. The actual effective tax rate may fluctuate in the future as a result of the realization of previously unrecognized deferred tax assets, discrete period transactions which may have different tax consequences and changes in enacted tax rates. Refer to Note 11, "Income Taxes," in the Notes to our unaudited condensed consolidated financial statements included in Item 1 herein for further details. Net income As a result of the foregoing items, net income increased to $9.6 million in the three months ended March 31, 2013, as compared to $8.2 million in the three months ended March 31, 2012. Net income per diluted share increased to $0.51 per ordinary share the three months ended March 31, 2013, as compared to $0.39 per ordinary share in the prior year comparable period as a result of increased profitability and a decrease of approximately 2.5 million (or 12%) in the weighted average number of diluted ordinary shares outstanding in the three months ended March 31, 2013 as compared to the prior year comparable period due to our share repurchase program. LIQUIDITY AND CAPITAL RESOURCES Our primary sources of liquidity are cash generated from operations and cash on hand and investments. As of March 31, 2013, we had cash and cash equivalents of $40.2 million, available-for-sale marketable securities of $8.6 million and accounts receivables of $5.0 million. Our accounts payable at March 31, 2013 was $7.8 million. During the three months ended March 31, 2013, we generated positive operating cash flows of $16.6 million, as compared to $24.2 million for three months ended March 31, 2012. The $7.5 million decrease was primarily due to higher sales of access right renewals in the three months ended March 31, 2012 in anticipation of a price increase, offset in part by increased profitability. Net income was $9.6 million for the three months ended March 31, 2013 as compared to $8.2 million for the three months ended March 31, 2012. We currently believe that available funds and cash flows generated by operations will be sufficient to fund our working capital and capital expenditure requirements for at least the next twelve months. If we decide to make future acquisitions, we may require new sources of funding, including additional debt, equity financing or some combination thereof. There can be no assurances that we will be able to secure additional sources of funding or that such additional sources of funding will be available to us on acceptable terms. Cash Flow - Operating Activities Net cash provided by operating activities was $16.6 million and $24.2 million for the three months ended March 31, 2013 and 2012, respectively. During the three months ended March 31, 2013, net cash provided by operating activities was primarily attributable to: (i) a $9.6 million net income, (ii) $4.1 million increase in accounts payable due to the estimated federal income tax payable, (iii) $2.8 million increase in deferred revenues primarily attributable to higher sales of access right renewals, and (iv) $3.4 million in non-cash items consisting of a $1.2 million provision for billing adjustments, $1.2 million for depreciation and amortization expense, a $0.5 million combined net loss on common equity put options and investments and $0.4 million in treasury stock issued to settle a liability. These items were partially offset by a $3.6 million decrease in accrued expenses and other current liabilities primarily as a result of previously outstanding put option contracts being assigned to us and the favorable impact of a settlement with a retail sales broker. 25 -------------------------------------------------------------------------------- During the three months ended March 31, 2012, net cash provided by operating activities was primarily attributable to: (i) a $19.7 million increase in deferred revenues attributable to strong initial sales of the magicJack PLUS since its launch in September 2011 and higher sales of access right renewals in anticipation of a price increase, (ii) a $2.5 million increase in accrued expenses and other current liabilities as a result of the Company holding short position in certain investments and timing of bills received from vendors, (iii) a $1.4 million decrease in inventories as a result of strong sales of the magicJack PLUS since its introduction in September 2011, which resulted in depletion of inventory built up in late 2011, as well as a $0.4 million write down of obsolete inventories, (iv) $1.4 million in non-cash expenses primarily as a result of a provision for billing adjustments, depreciation and amortization expense, offset in part by a combined $2.3 million in fair value gains on common equity put options and investments. These items were partially offset by: (i) a $3.7 million decrease in accounts payable primarily due to timing of payments to our vendors, (ii) a $3.5 million increase in accounts receivables due to the strong sales of the magicJack PLUS to retailers, and (iii) a $1.4 million increase in deferred costs. Cash Flow - Investing Activities Net cash provided by (used in) investing activities was $10.5 million and ($2.3) million for the three months ended March 31, 2013, and 2012, respectively. Net cash provided by investing activities during the three months ended March 31, 2013 was primarily attributable to $10.6 million proceeds from sale of investments, offset in part by $0.1 million used to purchase certain intangible assets and $0.1 million used to purchase equipment. Net cash used in investing activities during the three months ended March 31, 2012 was primarily attributable to: (i) $6.4 million net purchase of marketable securities, and (ii) $1.0 million used to purchase certain intangible assets. These used of cash were partially offset by $5.2 million net proceeds from sale of short investment positions. Cash Flow -Financing Activities Net cash used in financing activities was $5.7 million and $2.7 million for the three months ended March 31, 2013 and 2012, respectively. Net cash used in financing activities during the three months ended March 31, 2013 consisted of $5.7 million in cash used to purchase ordinary shares as part of our stock repurchase program. Net cash used in financing activities during the three months ended March 31, 2012 primarily consisted of $4.9 million in cash used to purchase ordinary shares as part of our stock repurchase program, partially offset by: (i) $1.6 million in premiums received from the sale of common equity put options in connection with our share repurchase program, and (ii) $0.7 million in cash received from the exercise of ordinary share options. Refer to the section below for additional information on our stock repurchase program. Stock Repurchase Program Our Board of Directors authorized a stock repurchase program to enable us to purchase our ordinary shares at such times as management deems appropriate. In January 2012, the Board of Directors increased our stock repurchase program by $20 million to $55 million. In April 2012, the Board of Directors authorized the repurchase an additional $20 million of our ordinary shares. In June 2012, the Board of Directors further authorized the repurchase of an additional $25 million of our ordinary shares. The objective of our stock repurchase program is to improve stockholders' returns. We expended $91.3 million under our repurchase program through March 31, 2013. At March 31, 2013, there was $8.7 million authorized to purchase ordinary shares pursuant to the stock repurchase program. All shares purchased, not yet retired, are recorded as treasury stock. We have sold put option contracts and purchased call option contracts in connection with our share repurchase program in order to lower the average share price paid for ordinary shares we purchase. Taking into consideration the proceeds received from the sale of put option contracts exercised, put option contracts that expired unexercised and purchase price of call option contracts exercised during the three months ended March 31, 2013 and 2012, we expended approximately (i) $3.3 million purchasing 190,000 shares of outstanding ordinary shares at an average price of $17.27 during the three months ended March 31, 2013, and (ii) $3.0 million purchasing 313,100 shares of outstanding ordinary shares at an average price of $9.43 during the three months ended March 31, 2012. Other Liabilities As of March 31, 2013, we had outstanding indebtedness in connection with an agreement entered during June 2011 for the purchase of certain intangible assets, and secured only by such intangible assets, under which we are required to make three non-interest bearing future annual payments of $1.5 million beginning May 31, 2013. The liability for such payments has been discounted at a rate of 10% to a net present value of $4.0 million at March 31, 2013. Refer to Note 8, "Other Liabilities," in the Notes to our unaudited condensed consolidated financial statements included elsewhere herein for further details. 26 -------------------------------------------------------------------------------- RECENT ACCOUNTING PRONOUNCEMENTS In February 2013, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2013-02, Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income ("ASU 2013-02"). ASU 2013-02 requires an entity to present, either on the face of the statement where net income is presented or in the notes to the financial statements, significant amounts reclassified out of accumulated other comprehensive income (loss) by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. Amounts that are not required to be reclassified in their entirety to net income must be cross-referenced to other disclosures that provide additional detail. This guidance was effective on a prospective basis for the annual and interim reporting periods for the Company beginning January 1, 2013. Our adoption of this standard did not have a significant impact on our consolidated financial statements. Our accumulated other comprehensive loss is comprised of one item pertaining to unrealized gains and losses on marketable securities. Reclassification of the gains or losses occurs when the specific investments are sold. |