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CALL > SEC Filings for CALL > Form 10-K on 16-Mar-2017All Recent SEC Filings

Show all filings for MAGICJACK VOCALTEC LTD

Form 10-K for MAGICJACK VOCALTEC LTD


16-Mar-2017

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. We charge highly competitive rates for the right to access our servers ("access right"), and our customers then continue to have the ability to obtain free telephone services. We currently offer the 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 magicJack mobile apps are applications that allow users to make and receive telephone calls through their smart phones using their magicJack account. Currently, consumers that do not have a magicJack account can purchase and download the magicJack mobile apps to make telephone calls from anywhere in the world into the U.S. or Canada for free. The mobile apps include the magicApp and the magicJack Connect App, which are available for both iOS and Android. 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 device. 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.

From 2011 through 2015, we have offered several versions of the magicJack device and mobile apps. The device has been progressively upgraded to include superior voice quality, expanded memory and enhanced processing power. The initial access right period for the different versions of the device ranged from three to twelve months.

In March 2016, we acquired substantially all of the assets of North American Telecommunications Corporation (dba "Broadsmart"). Broadsmart is a leading hosted Unified Communication as a Service ("UCaaS") provider for medium-to-large multi-location enterprise customers. Broadsmart has a track record of 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 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. ("SMB"). Through this subsidiary, we provide easy-to-buy, simple-to-use VoIP services to small to medium sized businesses at competitive prices. We began sales of our SMB product in the third quarter of 2016.

In May 2016, we launched the magicJack Connect App for iOS and Android. The magicJack Connect App offers users free worldwide Wi-Fi App-to-App calling & messaging. The magicJack Connect App also offers an unlimited U.S. calling plan which allows subscribers to call the U.S. from anywhere in the world plus receive a U.S. phone number for only $9.99 per year.


Basis of Presentation

Our consolidated financial statements are prepared in conformity with U.S. GAAP, and are the basis for the discussion and analysis of our 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"). 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 have historically prepared our consolidated financial statements on the basis of being a single reporting entity. Beginning in the first quarter of 2016, with the acquisition of Broadsmart and the internal development of our SMB division, we have been reporting the results of operations for these new business lines as separate Reportable Segments. Refer to Note 16, "Segment Reporting," in the Notes to our Consolidated Financial Statements included in Item 8 herein for further details.

Approximately 87% of our consolidated revenues in the year ended December 31, 2016 and 90% of our revenues in the years ended December 31, 2015 and 2014 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 $77.6 million, $86.8 million and $99.2 million for the years ended December 31, 2016, 2015 and 2014, respectively. We also provide our 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 $5.7 million, $8.2 million and $10.1 million for years ended December 31, 2016, 2015 and 2014, respectively.

The majority of our Enterprise segment revenues recognized were generated from Broadsmart hosted UCaaS services and sales of hardware and equipment which were $9.0 million post acquisition for the year ended December 31, 2016. We had no UCaaS revenue from Broadsmart for the years ended December 31, 2015 and 2014, prior to acquisition.

Our SMB segment did not generate significant revenue for the year ended December 31, 2016. There was no revenue for SMB for the years ended December 31, 2015 and 2014.

Basis of Consolidation

Our 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, Tiger Jet Network, Inc., VocalTec Communications, LLC ("VocalTec US", formerly Stratus Telecommunications, LLC), Broadsmart Global, Inc., and magicJack SMB, Inc.. The results of Broadsmart Global, Inc. have been included since March 17, 2016. Refer to Note 15, "Acquisition of Business," in the Notes to our Consolidated Financial Statements included in Item 8 herein for further details. The results of SMB have been included since the first quarter of 2016. 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 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

We recognize revenue in accordance with ASC Topic 605, "Revenue Recognition" ("ASC 605"), which provides authoritative guidance on revenue recognition. For arrangements that include more than one product or service ("deliverables"), we apply Section 25 of ASC 605, "Multiple-Element Arrangements". ASC 605-25 establishes criteria for separating deliverables into different units of accounting and allocating consideration to those units of accounting.

Core Consumer Segment

For the Core Consumer business, net revenues consist of revenues 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 related products and services. Revenues are recorded net of sales returns and allowances.

magicJack Devices and Access Right Renewals

magicJack devices include an initial access right, which qualify as multiple deliverables per ASC 605-25. Since the device and initial access right are interdependent and not sold separately, they are accounted for as a combined unit of accounting. Direct sales of devices include shipping charges and 30 days to return the device and cancel the service. For retail sales of devices, there is a delay between shipment to the retailer and the ultimate sale to a customer (end-user). Based on sales and inventory data provided by retail partners, our estimate of the delay for the year ending December 31, 2016 was 90 days. We defer revenue recognition on direct sales for the 30 day return period and on retail sales for the delay period, after which we recognize the revenue from device sales and shipping charges, if applicable, ratably over the remaining initial access right period.

Customers may renew access rights for periods ranging from one month to five years. The revenue associated with access right renewals is deferred and recognized ratably over the extended access right period. Revenue from mobile apps is included as part of Access Right Renewals and 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 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 also accept returns of battery powerbanks for mobile devices within 30 days of sale. We estimate potential returns under these arrangements at point of sale and re-estimate them on a quarterly basis. For the years ended December 31, 2016, 2015 and 2014, our estimates of returns and actual returns from initial stocking orders have not been materially different.

Other magicJack-Related Products

We offer customers other optional products related to their magicJack devices and services, such as insurance, custom or vanity phone numbers, Canadian phone numbers, the ability to either change their existing phone numbers or port them to a magicJack device, and battery powerbanks for mobile devices. These revenues are recognized at the time of sale, with the exception of sales of the battery powerbank which are recognized when shipped.

Prepaid Minutes and Access and Wholesale Charges

We generate revenues from sales of prepaid international minutes to customers, fees charged to telecommunication carriers or providers for origination of their calls to 800-numbers, and access fees charged to other telecommunication carriers or providers on a per-minute basis for 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. Revenues from prepaid minutes and access and wholesale charges are recognized as minutes are used.


Enterprise Segment

For the Enterprise segment, net revenues consist of revenues from the sale of hosted services, usage charges, hardware and network equipment sales, and other one-time miscellaneous service charges.

UCaaS services and equipment provided by our Broadsmart subsidiary qualify as multiple deliverables per ASC 605-25. Since the equipment and services are sold separately and can be used with other products and services, they are accounted for as separate units of accounting. We recognize revenues from sales of our hosted services in the period the services are provided over the term of the respective customer agreements. Customers are billed monthly in advance for these recurring services and in arrears for one time service charges and other certain usage charges. Revenues from sales of hardware and network equipment are recognized in the period that the equipment is delivered. Revenues from the sale of equipment purchased but not yet delivered and installed is deferred and recognized in the period that the hardware or equipment is put into service.

SMB Segment

SMB provides phone equipment and services that are interdependent and not sold separately. As such, they are accounted for as a combined unit of accounting under ASC 605-25. Some agreements include a refund period or a promotion for free introductory service. Revenue recognition is deferred for either period, after which we recognize the revenue for the combined unit ratably over the remaining service period. Revenues from this segment were not significant for the year ended December 31, 2016.

GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets acquired. Goodwill and other identifiable intangible assets with indefinite lives are not amortized to operations, but are instead reviewed for impairment at least annually, or more frequently if there is an indicator of impairment. Indicators include, but are not limited to: sustained operating losses or a trend of poor operating performance and a decrease in our market capitalization below its book value.

The valuation methodology we use for assessing potential impairment requires management to make judgments and assumptions based on historical experience and projections of future operating performance. If these assumptions differ materially from actual future results, we may record impairment charges in the future.

As part of our annual impairment review for goodwill and other identifiable intangible assets with indefinite lives, performed as of October 1, 2016 (the "Measurement Date"), management determined that there were impairment indicators at the Enterprise Segment. Based on these indicators and the new reporting units for goodwill, we engaged an independent third party to perform a valuation of Broadsmart's intangible assets and a two-step goodwill impairment test for each of our reporting units.

The third party valuation as of October 1, 2016 was used to test the Enterprise segment's identified intangible assets subject to amortization for impairment. Management summed the undiscounted cash flows expected to result from the use of these assets and their eventual disposition used in the third party valuation report and noted that the sum exceeded the carrying amount of the assets, indicating no further impairment testing was necessary for these assets as of October 1, 2016. Refer to Note 6, "Intangible Assets" in the Notes to our Consolidated Financial Statements included in Item 8 herein for further details.

The third party valuation as of October 1, 2016 determined the fair value of Broadsmart's identified intangible assets not subject to amortization based on the relief from royalty method, which requires an estimate of a reasonable royalty rate, identification of relevant projected revenues and expenses, and selection of an appropriate discount rate. This valuation yielded an estimated fair value of $1.7 million for the Broadsmart tradename. This tradename was recorded as an identifiable intangible asset with an indefinite life at a carrying value of $2.2 million. As a result, an impairment loss of $0.5 million was recognized in General and Administrative expense for the fourth quarter of 2016 under the Enterprise segment in the statement of operations related to the tradename.

Under the first step of the goodwill test as of October 1, 2016, the fair value of each reporting unit was compared with its carrying value (including goodwill). The fair value was determined based on a discounted future cash-flows approach. The Core Consumer reporting unit passed the first step with fair value in excess of carrying value by approximately 227% and no further testing was required. The SMB segment had no goodwill and no further testing was required. The Enterprise reporting unit did not pass the first step and further testing was required.

Under the second step of the goodwill test as of October 1, 2016, the carrying amount of the Enterprise reporting unit's (Broadsmart's) goodwill was compared to its implied fair value. The implied fair value of goodwill was determined by allocating the fair value of the reporting unit's assets and liabilities in a manner similar to a purchase price allocation with the residual fair value being the implied fair value of goodwill. The fair value of the reporting unit was determined using a discounted cash flow analysis. The Enterprise segment passed the second step with implied fair value of goodwill exceeding carrying value by approximately 35%.


Based on this testing, we determined that there was no impairment of goodwill as of our annual goodwill impairment test date of October 1, 2016 . Refer to Note 7, "Goodwill" in the Notes to our Consolidated Financial Statements included in Item 8 herein for further details.

Management continued to monitor the performance of the Enterprise segment/reporting unit (Broadsmart) and updated its impairment analysis of intangible assets not subject to amortization, goodwill and the identified intangible assets subject to amortization as of December 31, 2016. No further impairment charges were required as a result of this analysis.

Although the acquired Broadsmart business has underperformed compared to our expectations, we believe that the underlying fundamentals of the Broadsmart business and the exhibited market opportunities for growth remain consistent with our understanding and analysis of the business at the time of acquisition. Subsequent to the year ended December 31, 2016, we implemented steps to improve the operating results and bolster integration efforts for the Broadsmart business. In February 2017, we hired a new Chief Operating Officer for Broadsmart to reduce the administrative and organizational duties of Broadsmart's original founders, who continue to be employed by us and are integral to its success, so that they can focus on expanding the customer base. We have also begun to hire additional sales and marketing personnel dedicated to obtaining new business. We believe that the Enterprise reporting unit will eventually perform at originally expected levels but more time is needed to give these integration efforts an opportunity to be successful. If these efforts are not successful, we will need to re-evaluate our forecasts for the Enterprise reporting unit. Further impairments could ensue if Broadsmart continues to perform below expectations.

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. We evaluated the valuation allowance as of December 31, 2016, 2015 and 2014 which resulted in adjustments of ($1.2 million) to bring the allowance to $16.3 million, $1.3 million to bring the allowance to $17.5 million, and $1.2 million to bring the allowance to $16.2 million, respectively. These amounts adjust 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, 2016, we recorded a provision for uncertain tax positions of ($0.3) million. 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. As of December 31, 2016 and 2015, the liability for uncertain tax positions totaled $10.4 million and $10.8 million, respectively. The current portion of such liability, if any, has been reflected in income taxes payable. There was no current portion of uncertain tax positions as of December 31, 2016 and 2015, respectively. The noncurrent portion of such liability, $10.4 million and $10.8 million as of December 31, 2016 and 2015, respectively, has been reflected in other non-current liabilities.

In November 2015, the FASB issued ASU No. 2015-17, "Balance Sheet Classification of Deferred Taxes". ASU 2015-17 requires deferred tax liabilities and assets to be classified as noncurrent in the consolidated balance sheet. The standard is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for financial statements that have not been previously issued. The ASU may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company adopted ASU 2015-17 on a prospective basis in the fourth quarter of 2015. Prior periods were not retrospectively adjusted.

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. We were 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 our December 31, 2015 consolidated balance sheets. 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. For year ended December 31, 2016, we recorded income tax expense of $8.7 million, which is higher than the expected tax provision of $4.7 million, using the statutory rate of 34%, due, in part, to the net impact of a decrease in the Israeli corporate tax rate from 26.5% to 23.0% which was effective in December 2016. The decrease in the rate resulted in the need to reduce our Israeli deferred tax assets, primarily net operating loss carryforwards, which resulted in deferred tax expense and a reduction in the value of related deferred tax assets of $5.2 million. Additionally, the effective tax rate was impacted by decreases to uncertain tax positions of ($0.8 million), decreases in valuation allowances of ($1.2 million), and other items of $0.8 million. The discrete items noted above were partially offset by the lower jurisdictional tax rate charged on the operating income of our Israeli operations. The tax years 2011 through 2016 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. We account for share-based compensation in accordance with ASC . . .

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