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CALL > SEC Filings for CALL > Form 10-K on 15-Mar-2016All Recent SEC Filings

Show all filings for MAGICJACK VOCALTEC LTD

Form 10-K for MAGICJACK VOCALTEC LTD


15-Mar-2016

Annual Report


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

THE FOLLOWING DISCUSSION OF THE COMPANY'S FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH ITS CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS ANNUAL REPORT ON FORM 10-K. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE FUTURE RESULTS TO DIFFER SIGNIFICANTLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED BELOW AND ELSEWHERE IN THIS ANNUAL REPORT, PARTICULARLY THOSE DESCRIBED ABOVE UNDER ITEM 1A, RISK FACTORS.

magicJack VocalTec Ltd. and its Subsidiaries (the "Company") is a cloud communications leader that is the inventor of the magicJack devices and other 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. The Company charges highly competitive rates for the right (the "access right") to access its servers, and the Company's customers then continue to have the ability to obtain free telephone services. The Company also provides additional products and services, which include voice apps on smart phones, as well as the magicJack PLUS, magicJack GO, and magicJack EXPRESS which are updated versions of the magicJack device that have their 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. The Company's 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.

magicJack VocalTec is a vertically integrated group of companies. The Company owns 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 device. The Company also wholesales telephone service to VoIP providers and telecommunication carriers.

The Company's strategy since 2007 has been to vertically integrate its technology, design and suppliers, and the Company has 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. 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 for Android phones. In June 2013, we introduced the New magicJack PLUS. This new device has superior voice quality, expanded memory and enhanced processing power. The New magicJack PLUS included a six-month right to access our servers in order to make and receive telephone calls for free. In July 2014, the Company introduced the magicJack GO which includes a twelve month right to access our servers. In April 2015, we released the magicApp Premium to iOS customers and in July 2015 the magicAPP Premium was made available to Android users. magicAPP Premium offers a US number, unlimited local and long distance calling to the US, Canada, Puerto Rico and the US Virgin Islands, and unlimited text messaging to any US mobile number. The magicAPP Premium offers access to our servers on a monthly or annula basis. In May 2015, we introduced the magicJack EXPRESS which includes a three month right to access our servers.


Basis of Presentation

The Company's consolidated financial statements are prepared in conformity with U.S. GAAP, and are the basis for the discussion and analysis of its results of operations, liquidity and capital resource. References to authoritative accounting literature in this report, where applicable, are based on the Accounting Standards Codification ("ASC"). The Company's functional and reporting currency is the United States Dollar ("U.S. Dollar"), which is the currency of the primary economic environment in which its 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 the Company's consolidated financial statements in the period they occur.

The Company prepares its consolidated financial statements on the basis of being a single reporting entity. Approximately 90% of our revenues in the years ended December 31, 2015, 2014 and 2013 were derived from sales to customers located in the United States. The majority of our revenues were generated from sales of the magicJack device and from the accompanying software access rights, which were $86.8 million, $99.2 million and $124.7 million for the years ended December 31, 2015, 2014 and 2013, respectively. The Company also provides its customers the ability to make prepaid calls using a magicJack device or magicJack APP by purchasing prepaid minutes. Revenues generated from the usage of prepaid minutes were $8.2 million, $10.1 million and $12.6 million for years ended December 31, 2015, 2014 and 2013, respectively.

Basis of Consolidation

The Company's consolidated financial statements include the accounts of magicJack VocalTec Ltd. and its wholly-owned subsidiaries, YMax Corporation, YMax Communications Corp., magicJack Holdings Corporation, magicJack, LP, SJ Labs, Inc., Tiger Jet Network, Inc., and VocalTec Communications, LLC ("VocalTec US", formerly Stratus Telecommunications, LLC). All intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior period financial statement amounts to conform to the current presentation.

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 taxes, income tax valuation allowance, uncertain tax liabilities, 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.

CRITICAL ACCOUNTING POLICIES

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

Net revenues consists of revenue from sales of the magicJack devices to retailers, wholesalers or directly to customers, access rights fees, fees charged for shipping the magicJack devices, 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 Devices and Renewal Access Revenue

The Company recognizes revenues from sales and shipping of direct sales of the magicJack devices over the period associated with the initial access right period. Customers may purchase access rights for continued use of the Company's software to access its 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. Revenue from the sales of magicAPP Premium access rights is recognized ratably over the access right period.

Sales Return Policy

The Company offers some of its direct sales customers a 30-day free trial before they have to pay for their magicJack device. The Company does 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. The Company may offer certain retailers the limited right to return any unsold merchandise from their initial stocking orders. The Company estimates potential returns under these arrangements at point of sale based and re-estimates potential returns on a quarterly basis. For the years ended December 31, 2015, 2014 and 2013, our estimates of returns and actual returns from initial stocking orders have not been materially different.

Prepaid Minutes and Access and Wholesale Charges

Revenue from prepaid minutes and access and wholesale charges are recognized as minutes are used. These revenues are generated from the usage of prepaid minutes, fees charged to telecommunication carriers or providers for origination of their calls to 800-numbers, access fees charged to other telecommunication carriers or providers on a per-minute basis for Interexchange Carriers ("IXC") calls terminated to our end-users. Revenues from access fee charges to other telecommunication carriers are recorded based on rates set forth in the respective state and federal tariffs or negotiated contract rates, less a provision for billing adjustments.

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 primarily of foreign net operating loss carryforwards and timing differences between the recognition of income for book and tax purposes. We record a valuation allowance to reduce the net deferred tax assets to the amount that we estimate is more-likely-than-not to be realized. At December 31, 2013, based on a number of factors, including cumulative profitability over the preceding three years and expected future results, we released $40.5 million of the valuation allowance recorded against net deferred tax assets. We evaluated the valuation allowance as of December 31, 2014, which resulted in adjustments of $1.2 million to bring the allowance to $16.2 million, an amount which reduces the net deferred tax assets to the amount that will more-likely-than-not be realized. We also evaluated the valuation allowance as of December 31, 2015, which resulted in adjustments of $1.3 million to bring the allowance to $17.5 million, an amount which reduces 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 continue to make adjustments if available evidence indicates that it is more-likely-than-not a change in the carrying amounts is required.

We assess our income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where there is a 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. For the year ended December 31, 2015, our provision for uncertain tax positions was reduced by $10.1 million primarily due to the settlement of the IRS audits for tax years 2010 through 2013. For the year ended December 31, 2014, we recorded a provision for uncertain tax positions of $14.2 million. As of December 31, 2015 and 2014, the liability for uncertain tax positions totaled $10.8 million and $18.6 million, respectively. The current portion of such liability, $0.0 million and $7.5 million as of December 31, 2015 and 2014, respectively, has been reflected in income taxes payable. The noncurrent portion of such liability, $10.8 million and $11.4 million as of December 31, 2015 and 2014, respectively, has been reflected in other non-current liabilities.

We file U.S. federal and state and foreign income tax returns in jurisdictions with varying statutes of limitations. During fiscal 2013, we received notice that the IRS was going to examine our tax returns for 2010 and 2011. In October 2014, we were informed that the IRS was going to expand its audit to include our 2012 and 2013 tax returns. During 2015, we reached agreement with the IRS on a settlement of all years under audit. The settlement resulted in an increase to the jurisdictional income of the U.S. The additional tax and interest due to the IRS and various state taxing authorities as a result of the increased U.S. jurisdictional income was $6.8 million and $0.9 million, respectively. The Company was able to utilize approximately $4.2 million of benefits related to other favorable adjustments identified during the exam to satisfy a portion of the federal liability, resulting in net tax and interest paid to the IRS of $2.6 million. The $0.9 million state liability is reflected as a reduction to prepaid income taxes in the Company's December 31, 2015 balance sheet. The increase to the U.S. jurisdictional income resulted in a decrease in our Israeli jurisdictional income. The decrease in Israeli income, in turn, increased our Israeli net operating losses, resulting in a tax benefit of $5.6 million. The tax years 2010 through 2015 remain open to examination by other major taxing jurisdictions to which we are subject.


SHARE-BASED COMPENSATION

Share-based compensation generally consists of option grants or ordinary share and restricted stock units awards to directors, officers, employees or consultants. The Company accounts for share-based compensation in accordance with ASC Topic 718, "Compensation - Stock Compensation" ("ASC 718"). ASC 718 requires companies to estimate the fair value of equity-based payment awards on the date of grant based on the fair value of the award. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in our consolidated statements of operations.

BUSINESS TRENDS

Renewal revenues have remained strong during the year ended December 31, 2015, increasing slightly over the prior year. We remain encouraged by the loyalty of our existing customer base and we continue to undertake efforts to improve our customer renewal rates and limit customer churn. Device sales declined 35% during the year ended December 31, 2015, and other device related revenues declined as well, reflecting the continuing decline in device sales in both our direct and retail channels. In our ongoing efforts to strengthen device sales to new customers, we launched the magicJack EXPRESS in May 2015 which offers customers the same dependable magicJack service at a lower entry price and includes 3 months of service with the initial purchase rather than the year that is included with the magicJack GO. We are maintaining our efforts to expand device sales to new markets, and with the launch of the magicAPP Premium to both iOS and Android customers, we are increasing our efforts to reposition the device with its companion service, the magicAPP Premium. We believe that there will continue to be solid consumer demand for our low priced, unlimited phone service, whether through our magicJack device, our magicAPP, or a combination of both, in the United States and international markets.

With the release of the upgraded magicAPP Premium product to iOS customers in April 2015 and to Android customers in July 2015, we began offering monthly and annual subscription services for the magicAPP Premium and providing our customers the ability to purchase international prepaid minutes directly from the app. We are focused on driving sales growth through monetizing the magicAPP Premium and integrating the full range of our product offerings including the sale of international prepaid minutes. However, there are factors that could materially, adversely affect our growth strategy to integrate the device with the APP and monetize the magicAPP Pemium, including that we have not previously generated any material revenues from the magicAPP as it has been a free service prior to April 2015, and we continue to offer a free version of the app. Additionally, the redeveloped magicAPP Premium competes with other large, well-capitalized global companies in the telecom APP industry who are introducing low priced consumer offers into the marketplace on an ongoing basis. We cannot assure that the features we are offering for monetization of the magicAPP will be attractive to consumers at the price points we are offering, or at all.

Furthermore, though progress on the launch of our relationship with Telefonica has been slower than anticipated, in February 2016 our continuing efforts resulted in the test launch of a new Mexico-based service offering named "Call U.S.". The new service will be offered through Movistar, Telefonica's mobile operator in Mexico, and will be available to Movistar's over 20 million customers, enabling them to purchase a U.S. phone number through which they can receive unlimited inbound calls from friends, relative or business contacts based in the United States. The service is integrated with Telefonica's existing Movistar systems allowing customers to pay through the same channels that they currently use to pay for their core Movistar wireless service. While we are pleased with the launch of the new offering and the progress that we have made in our relationship with Telefonica, there can be no assurance that the launch in Mexico will be successful and the Company cannot predict what impact, if any, the arrangement with Telefonica will ultimately have on its business, results of operations, financial condition or cash flows.

In addition to the Mexico-based service offering with Movistar, the fourth quarter of 2015 marked the start to the next chapter in the company's history as we launched our new SMB subsidiary. We plan on making a significant investment in the new SMB business in 2016 which will leverage our core assets and give us the ability to sell these services at disruptive pricing. While we are not forecasting significant revenue from our SMB business in 2016, we believe that longer-term, our ability to maximize shareholder value will be driven by the execution of these growth initiatives supported by our ongoing free cash flow generation and strong balance sheet.


RESULTS OF OPERATIONS

The following table presents the Company's consolidated results of operations for the periods indicated (in thousands, except per share information). The consolidated statements of operations below have been expanded to show the composition of our net revenues and cost of revenues items to enable a more meaningful discussion of our operations. The components of our operating revenue and cost of revenues as presented in the following table are described below the table.

                                         Year ended                           2015                       2014
                                        December 31,                       Compared to                Compared to
                              2015          2014          2013                2014                       2013
Net Revenues
Sale of magicJack devices   $  15,915     $  24,564     $  54,491     $  (8,649 )     (35.2 )%   $ (29,927 )     (54.9 )%
Access right renewals          65,761        65,542        57,038           219         0.3          8,504        14.9
Shipping and handling             794         2,085         4,399        (1,291 )     (61.9 )       (2,314 )     (52.6 )
magicJack-related
products                        4,289         7,006         8,754        (2,717 )     (38.8 )       (1,748 )     (20.0 )
Prepaid minutes                 8,243        10,083        12,578        (1,840 )     (18.2 )       (2,495 )     (19.8 )
Access and wholesale
charges                         5,953         7,028         6,210        (1,075 )     (15.3 )          818        13.2
Other                               7            14            22            (7 )     (50.0 )           (8 )     (36.4 )
Total Net Revenue             100,962       116,322       143,492       (15,360 )     (13.2 )      (27,170 )     (18.9 )

Cost of Revenues
Cost of magicJack devices
sold                            8,320        11,068        15,341        (2,748 )     (24.8 )       (4,273 )     (27.9 )
Shipping and handling           1,194         1,980         2,452          (786 )     (39.7 )         (472 )     (19.2 )
Credit card processing
fees                            2,260         2,473         2,706          (213 )      (8.6 )         (233 )      (8.6 )
Network and carrier
charges                        15,352        19,694        22,141        (4,342 )     (22.0 )       (2,447 )     (11.1 )
Other                           7,016         7,326         6,454          (310 )      (4.2 )          872        13.5
Total Cost of Revenues         34,142        42,541        49,094        (8,399 )     (19.7 )       (6,553 )     (13.3 )

Gross Profit                   66,820        73,781        94,398        (6,961 )      (9.4 )      (20,617 )     (21.8 )

Operating expenses:
Marketing                       9,409        20,434        14,293       (11,025 )     (54.0 )        6,141        43.0
General and
administrative                 27,547        33,912        26,998        (6,365 )     (18.8 )        6,914        25.6
Research and development        4,521         5,871         5,661        (1,350 )     (23.0 )          210         3.7
Total operating expenses       41,477        60,217        46,952       (18,740 )     (31.1 )       13,265        28.3
Operating income               25,343        13,564        47,446        11,779        86.8        (33,882 )     (71.4 )

Other income (expense):
 Gains (losses) on
investments                         -            37           722           (37 )         *           (685 )         *
Interest and dividend
income                             26           117           318           (91 )         *           (201 )         *
Interest expense                  (57 )        (192 )        (307 )         135           *            115           *
Fair value (loss) gain on
common equity
put options                         -             -        (1,047 )           -           *          1,047           *
Other income, net                   -             4            16            (4 )         *            (12 )         *
Total other (expense)
income                            (31 )         (34 )        (298 )           3           *            264           *
Income before income
taxes                          25,312        13,530        47,148        11,782        87.1        (33,618 )         *
Income tax expense
(benefit)                      11,802         9,745       (23,163 )       2,057        21.1         32,908           *
Net income                     13,510         3,785        70,311         9,725       256.9        (66,526 )         *
Dividends on redeemable
ordinary shares                     -             -             -             -           *              -
Net income attributable
to                                                                                                                   *
ordinary shareholders       $  13,510     $   3,785     $  70,311     $   9,725       256.9      $ (66,526 )         *
Income per ordinary
share:
Basic                       $    0.80     $    0.21     $    3.81     $    0.59       281.0      $   (3.60 )         *
Diluted                     $    0.79     $    0.21     $    3.81     $    0.58       276.2      $   (3.60 )         *


* - Not meaningful.


Components of Net Revenues

Our net revenues are comprised of the following sources:

Sales of the magicJack devices - represent revenues recognized from sales of the magicJack devices to retailers, wholesalers, or direct to customers, net of returns, over the period associated with the initial three, six or twelve months access right period. These revenues are recorded net of sales allowance, chargebacks, retailer discounts and advertising allowances;

Access right renewals - represent revenues from customers purchasing rights to access our servers beyond the initial access right period included with a magicJack device or magicJack service. The extended access right ranges from one to five years. These fees charged to customers are initially deferred and recognized as revenue ratably over the extended access right period. These revenues also include revenues from access rights granted to users of the magicAPP Premium and is recognized ratably over the access right period;

Shipping and handling - represent charges for shipping and handling fees for magicJack devices shipped directly to customers. The fees are initially deferred and recognized as revenues over the initial three, six or twelve months access right period associated with the magicJack device;

magicJack-related products - represent revenues recognized from sale of other items related to the magicJack devices and access right renewals we offer our customers, including: (i) porting fees charged to customers to port their existing phone number to a magicJack device or service, (ii) fees charged for customers to select a custom, vanity or Canadian phone number, (iii) fees charged to customers to change their existing number, (iv) insurance covering the replacement of a damaged or lost device, and (v) the magicJack SLIM power bank battery;

Prepaid minutes - represents revenues recognized primarily from the usage and expiration of international prepaid minutes, net of chargebacks;

Access and wholesale charges - represent revenues generated from: (i) access fees charged to other telecommunication carriers or providers for Inter-exchange Carriers ("IXC") calls terminated to our end-users, and (ii) fees charged to telecommunication carriers or providers for origination of . . .

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