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CALL > SEC Filings for CALL > Form 10-Q on 10-May-2016All Recent SEC Filings

Show all filings for MAGICJACK VOCALTEC LTD

Form 10-Q for MAGICJACK VOCALTEC LTD


10-May-2016

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited condensed consolidated financial statements as of March 31, 2016 and for the three month period ended March 31, 2016 and 2015, as well as our Annual Report on Form 10-K for the year ended December 31, 2015. This Management's Discussion and Analysis of Financial Condition and Results of Operations contains 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 titled "Risk Factors" of our Form 10-K for the year ended December 31, 2015 filed on March 15, 2016.

Overview

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. magicJack devices weigh about one ounce and plug into the USB port on a computer or into a power adapter and high speed Internet source and provide users with complete phone service for home, enterprise and while traveling. We charge our customers highly competitive rates for the right (the "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, 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. 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.

magicJack VocalTec is 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 also wholesale telephone services to VoIP providers and telecommunications 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. 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 includes a six-month right to access our servers in order to make and receive telephone calls for free. In July 2014, we introduced the magicJack GO which includes a twelve month right to access our servers. In April 2015, we released an update to the magicAPP to iOS customers and in July 2015 the updated magicAPP was made available to Android users. The magicAPP 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 offers access to our servers on a monthly or annual basis. In May 2015, we introduced the magicJack EXPRESS which includes a three month right to access our servers.

In March 2016, we acquired substantially all of the assets of North American Telecommunications Corporation (dba "Broadsmart"). Broadsmart is a leading hosted UCaaS (Unified Communication as a Service) provider for medium-to-large multi-location enterprise customers. Broadsmart has a track record of designing, provisioning and delivering complex UCaaS solutions to blue chip corporate customers on a nationwide basis. Broadsmart has expertise in servicing enterprises with hundreds-to-thousands of locations. With the acquisition of Broadsmart, we have diversified our operations into UCaaS targeting high end SMB and enterprise customers. This acquisition has positioned us to compete long-term in the UCaaS market.

During the first quarter of 2016, we created a new subsidiary, magicJack SMB, Inc. Through this subsidiary, we intend to provide easy-to-buy, simple-to-use VOIP services to small businesses at disruptive prices. We are currently in the final stages of product development for our first SMB product offering and expect to begin sales in Q2 2016.


Basis of Presentation

Our unaudited condensed 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-X. Accordingly, our unaudited condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements that are included in our Annual Report on Form 10-K for the year ended December 31, 2015. The balance sheet at December 31, 2015 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.

Our unaudited condensed 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 U.S. dollars are presented at their original amounts. Transactions and balances in currencies other than U.S. dollars, including Israeli New Shekel ("NIS"), are re-measured in U.S. dollars and any gains or losses are recognized in our consolidated financial statements in the period they occur.

We have historically prepared our consolidated financial statements on the basis of being a single reporting entity. Approximately 90% of our revenues in the three months ended March 31, 2016 and 2015 were derived from sales to customers located in the United States. Going forward, with the acquisition of Broadsmart and the internal development of our SMB division, we will be reporting the results of operations for these new business lines as separate business segments.

Basis of Consolidation

Our consolidated financial statements include the accounts of magicJack VocalTec and its wholly-owned subsidiaries. The results of Broadsmart Global, Inc. have been included since March 17, 2016. Refer to Note 14 - "Acquisition of Business," for further details. 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, 2016 may not be indicative of the results for the entire year ending December 31, 2016. The interim unaudited condensed 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, 2015 filed on March 15, 2016.

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 our 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

We recognize 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 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. Revenue from the sales of magicAPP access rights is recognized ratably over the 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 device. 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 and re-estimate potential returns on a quarterly basis. For the three months ended March 31, 2016 and 2015, 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 telecommunications carriers or providers for origination of their calls to 800-numbers and access fees charged to other telecommunications 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 telecommunications 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 of primarily foreign net operating loss carry-forwards 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 we estimate is more-likely-than-not to be realized. We periodically review the composition of our net deferred tax assets and related valuation allowances and make adjustments if available evidence indicates that it is more-likely-than-not a change in the carrying amounts is required. We increased the valuation allowance by $0.5 million during the three months ended March 31, 2016.

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 that we estimate 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 that we estimate there is a 50% or less likelihood that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. We revised our liability for uncertain tax positions by an increase of $1.2 million during the three months ended March 31, 2016, due primarily to an increase in uncertain tax positions related to various state issues and the revaluation impact of previously recorded Israeli uncertain tax positions.

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 carry-forwards expected to be realized through 2016 and changes in other deferred tax assets and liabilities are recognized during interim periods based on annual forecasts as of the interim reporting date. At March 31, 2016, the estimated annual effective income tax rate is expected to approximate 34.9%, excluding discrete tax items, which includes federal, foreign, and state and local taxes. This rate may fluctuate due to changes in our jurisdictional income and due to the timing of other discrete period transactions during the remainder of the year.


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. We account 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 unaudited condensed consolidated statements of operations.

RESULTS OF OPERATIONS

The following table presents our unaudited condensed consolidated results of
operations for the periods indicated (in thousands). The unaudited condensed
consolidated statements of operations below have been expanded to show the
composition of our net revenues and cost of revenues to enable a more meaningful
discussion of our operations.

                                 Three Months Ended                2016
                                      March 31,                 Compared to
                                  2016          2015               2015
Net Revenues
Sale of magicJack devices      $    3,565     $  3,384     $    181          5.3 %
Access right renewals              15,217       17,075       (1,858 )      (10.9 )
Shipping and handling                 209          188           21         11.2
magicJack-related products          1,120        1,217          (97 )       (8.0 )
Prepaid minutes                     1,690        2,234         (544 )      (24.4 )
Access and wholesale charges        1,418        1,410            8          0.6
Broadsmart                            480            -          480        100.0
Other                                   -            4           (4 )     (100.0 )
Total Net Revenue                  23,699       25,512       (1,813 )       (7.1 )

Cost of Revenues
Cost of magicJack devices           2,006        2,147         (141 )       (6.6 )
Shipping and handling                 436          296          140         47.3
Credit card processing fees           515          677         (162 )      (23.9 )
Network and carrier charges         3,526        4,339         (813 )      (18.7 )
Other                               1,726        2,008         (282 )      (14.0 )
Total Cost of Revenues              8,209        9,467       (1,258 )      (13.3 )

Gross Profit                       15,490       16,045         (555 )       (3.5 )

Operating expenses:
Marketing                           1,221        2,750       (1,529 )      (55.6 )
General and administrative          8,935        7,700        1,235         16.0
Research and development            1,100        1,162          (62 )       (5.3 )
Total operating expenses           11,256       11,612         (356 )       (3.1 )
Operating income                    4,234        4,433         (199 )       (4.5 )

Other income (expense):
Interest and dividend income            7           11           (4 )          *
Interest expense                        -          (34 )         34            *
Other income (expense), net            (7 )          -           (7 )          *
Total other income (expense)            -          (23 )         23            *
Income before income taxes          4,234        4,410         (176 )       (4.0 )
Income tax expense                  3,500        3,102          398         12.8
Net income                     $      734     $  1,308     $   (574 )      (43.9 )


Components of Net Revenues

Our net revenues are comprised of the following sources:

Sales of the magicJack devices - represents 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 - represents 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 paid subscribers of the magicAPP and are recognized ratably over the access right period;

Shipping and handling - represents 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 - represents revenues recognized from the 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, and (iv) insurance covering the replacement of a damaged or lost device;

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

Access and wholesale charges - represents revenues generated from: (i) access fees charged to other telecommunication carriers or providers for IXC calls terminated to our end-users, and (ii) fees charged to telecommunications carriers or providers for origination of calls to their 800-numbers. These revenues are recorded based on rates set forth in the respective state and federal tariffs or negotiated contract rates, less provisions for billing adjustments; and

Other - represents primarily revenues generated by ancillary revenue sources.

Components of Cost of Revenues

Our cost of revenues is comprised of the following components:

Cost of magicJack devices sold - represents the costs of components and manufacturing of the magicJack devices, as well as broker commissions, production, packaging and other inventory-related costs. The cost of components and manufacturing of the magicJack devices is recognized from sales of the magicJack devices to retailers, wholesalers, or direct to customers over the period associated with the initial three, six or twelve months access right period;

Shipping and handling - represents freight, postage and other transportation costs related to: (i) transportation of the magicJack devices from the manufacturer to our warehouse and distribution center, and (ii) freight, shipping and handling fees incurred to ship the magicJack devices to retailers and directly to customers. These costs are expensed as incurred;

Credit card processing fees - represents transaction and other fees incurred as a result of accepting credit card payments for sales of magicJack devices, access right renewals, shipping and handling charges, magicJack related products and prepaid minutes sold directly to customers through our website. These fees are expensed as incurred;

Network and carrier charges - represents facilities charges to establish and maintain our network as well as network usage fee charges from other telecommunications carriers. These rates or charges are based upon commercial agreements or applicable state and/or federal tariffs. These charges are expensed as incurred; and

Other cost of revenues - represents allocation of personnel-related costs, amortization and depreciation expense related to assets employed in generating our revenues, as well as costs from discontinued revenue sources.


THREE MONTHS ENDED MARCH 31, 2016 COMPARED TO THREE MONTHS ENDED MARCH 31, 2015

Net Revenues

Total net revenue was $23.7 million and $25.5 million for the three months ended March 31, 2016 and 2015, respectively, representing a decrease of $1.8 million, or 7.1%. The decrease in the components of net revenues was primarily attributable to the following:

$1.9 million decrease in access right renewal revenues;

$0.5 million decrease in revenues from prepaid minutes resulting from lower usage levels; and

$0.1 million decrease in magicJack related product revenue reflecting lower volumes.

These decreases in components of net revenue were partially offset by a $0.2 million increase in revenues from the sale of magicJack devices and $0.5 million for the 15 days of revenue for Broadsmart in March 2016.

For the three months ended March 31, 2016 and 2015, sales of the magicJack devices through retail outlets represented approximately 59% and 66%, respectively, of sales of all magicJack devices sold. For the same periods, direct sales represented approximately 41% and 34%, respectively, of magicJack devices sold. For the three months ended March 31, 2016 and 2015, no retailer accounted for more than 10% of the Company's total net revenue.

Cost of Revenues

Total cost of revenues was $8.2 million and $9.5 million for the three months ended March 31, 2016 and 2015, respectively, representing a decrease of approximately $1.3 million, or 13.3%. This decrease in cost of revenues was primarily attributable to: (i) a $0.8 million decrease in network and carrier charges primarily as a result of lower traffic and better negotiated rates with other carriers, (ii) a $0.2 million decrease in credit card processing fees,
(iii) a $0.1 million decrease in the cost of magicJack devices, and (iv) a $0.3 million decrease in other cost of revenues primarily attributable to a decrease in overhead allocation reflecting lower personnel related costs. These decreases in components of cost of revenues was partially offset by a $0.1 million increase in shipping and handling costs. In total, cost of revenues for Broadsmart were $0.3 million for the partial month of operations in March 2016.

Operating Expenses

Total operating expenses were $11.3 million and $11.6 million for three months ended March 31, 2016 and 2015, respectively, representing a decrease of $0.3 million, or 3.1%. This decrease in operating expenses is primarily attributable to a $1.5 million decrease in marketing expense reflecting reduced media buys and marketing related spends as well as lower personnel related costs. This decrease was partially offset by a $1.2 million increase in General and Administrative ("G&A") expense primarily reflecting increased legal, accounting and professional fees associated with the acquisition of Broadsmart totaling approximately $0.8 million and a partial month of Broadsmart related costs totaling $0.2 million.

Income Taxes

Total income tax expense was $3.5 million and $3.1 million for the three months
ended March 31, 2016 and 2015, respectively. The principal components of our
income taxes for the three months ended March 31, 2016 and 2015 are the
following (in thousands):

                                                  Three Months Ended
                                                      March 31,
                                                   2016         2015

                Income before income taxes     $   4,234      $ 4,410
                Income tax expense (benefit)       3,500        3,102
                Effective income tax rate          82.66 %      70.34 %

We primarily operate in the U.S. and Israel, and our Israeli operations are subject to a statutory income tax rate of 25.0% that is lower than our U.S. . . .

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