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United States
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 000-26763
NET2PHONE, INC.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 22-3559037
--------------------------------- ----------------------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
520 Broad Street, Newark, New Jersey 07102
(Address of Principal Executive Offices) (Zip Code)
(973) 438-3111
(Registrant's Telephone Number, Including Area Code)
----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
As of March 6, 2003, the registrant had outstanding 30,776,684 shares of
common stock, $.01 par value and 28,986,750 shares of Class A stock, $.01 par
value.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) Yes X No
----- -----
NET2PHONE, INC.
TABLE OF CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of January 31, 2003 and July 31, 2002................ 3
Condensed Consolidated Statements of Operations for the three months and six months ended
January 31, 2003 and 2002.................................................................... 4
Condensed Consolidated Statement of Stockholders' Equity for the six months ended
January 31, 2003............................................................................ 5
Condensed Consolidated Statements of Cash Flows for the six months ended January 31, 2003
and 2002..................................................................................... 6
Notes to Condensed Consolidated Financial Statements.......................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................... 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................... 21
Item 4. Controls and Procedures....................................................................... 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................. 22
Item 2. Changes in Securities and Use of Proceeds..................................................... 22
Item 3. Defaults Upon Senior Securities............................................................... 23
Item 4. Submission of Matters to a Vote of Security Holders........................................... 23
Item 5. Other Information............................................................................. 23
Item 6. Exhibits and Reports on Form 8-K.............................................................. 23
Signatures.............................................................................................. 24
Certifications.......................................................................................... 25
2
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
NET2PHONE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
January 31, July 31,
(In thousands, except per share data) 2003 2002
------------- -------------
(unaudited) (note 1)
ASSETS:
Current assets:
Cash and cash equivalents........................................................... $ 65,380 $ 64,216
Marketable securities - current..................................................... 46,197 25,771
Notes receivable from employees - current........................................... 840 855
Due from IDT........................................................................ - 682
Other current assets................................................................ 13,045 15,690
----------- ----------
Total current assets........................................................... 125,462 107,214
Property and equipment, net.............................................................. 29,376 32,875
Marketable securities - long term........................................................ - 18,704
Notes receivable from employees - long term.............................................. 6,150 6,924
Other assets............................................................................. 5,635 5,979
----------- ----------
Total assets................................................................... $ 166,623 $ 171,696
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable.................................................................... $ 3,031 $ 7,727
Accrued expenses.................................................................... 20,325 27,266
Capital lease obligations - short term.............................................. 3,452 3,003
Due to IDT.......................................................................... 3,944 -
Other current liabilities........................................................... 15,118 15,821
---------- ----------
Total current liabilities...................................................... 45,870 53,817
Other liabilities........................................................................ 3,197 1,973
Capital lease obligations - long term.................................................... 1,620 2,670
---------- ----------
Total liabilities.............................................................. 50,687 58,460
Minority interests....................................................................... 7,976 46,881
Redeemable common stock, $.01 par value; 294 and 294 shares outstanding.................. 9,717 9,753
Stockholders' equity:
Common stock, $.01 par value; 200,000 shares authorized including redeemable
shares; 34,022 and 33,871 shares issued 340 339
Class A stock, $.01 par value, 37,924 shares authorized;
28,987 and 28,995 shares issued................................................... 290 290
Additional paid-in capital.......................................................... 885,416 885,165
Accumulated deficit................................................................. (739,006) (773,266)
Accumulated other comprehensive income ............................................ 608 240
Deferred compensation............................................................... (9,304) (12,919)
Loans to stockholders............................................................... (2,040) (2,040)
Treasury stock, at cost; 3,575 and 3,751 shares................................... (38,061) (41,207)
---------- ---------
Total stockholders' equity ................................................... 98,243 56,602
---------- ---------
Total liabilities and stockholders' equity ................................... $ 166,623 $ 171,696
=========== =========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
NET2PHONE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Six months ended Three months ended
(In thousands, except per share data) January 31, January 31,
---------------------- ------------------------
2003 2002 2003 2002
-------- -------- --------- ----------
Revenue $ 46,999 $ 80,730 $ 23,051 $ 37,839
Costs and expenses:
Direct cost of revenue (exclusive of items shown below) ....... 26,228 46,581 12,286 22,503
Selling, general and administrative.................................. 28,223 74,564 14,563 36,459
Depreciation and amortization........................................ 4,856 14,070 2,375 7,331
Restructuring, severance, impairment and other items................. 5,876 21,197 703 15,287
Settlement of Cisco litigation....................................... (58,034) - 395 -
Acquired in-process research and development......................... - 13,850 - -
Non-cash compensation................................................ 4,349 11,184 2,693 6,295
-------- --------- --------- ---------
Total costs and expenses................................ 11,498 181,446 33,015 87,875
-------- --------- --------- ---------
Income (loss) from operations............................................. 35,501 (100,716) (9,964) (50,036)
Interest income, net...................................................... 1,405 2,750 589 815
-------- --------- --------- ---------
Income (loss) before minority interests................................... 36,906 (97,966) (9,375) (49,221)
Minority interests........................................................ 24 (10,297) (134) (2,907)
-------- --------- --------- ---------
Net income (loss)......................................................... 36,882 (87,669) (9,241) (46,314)
Redeemable common stock accretion......................................... - (133) -. -
-------- --------- --------- ---------
Net income (loss) available to common stockholders........................ $ 36,882 $ (87,802) $ (9,241) $ (46,314)
======== ========= ========= =========
Net income (loss) per common share-basic & diluted........................ $ 0.62 $ (1.52) $ (0.15) $ (0.80)
======== ========= ========= =========
Weighted average number of common shares used in the calculation of
basic & diluted net income (loss) per common share:... 59,574 57,736 59,804 57,799
======== ========= ========= =========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
Net2Phone, Inc.
Condensed Consolidated Statement of Stockholders' Equity
Six months ended January 31, 2003
(in thousands)
Accumulated
Common Stock Class A Stock Additional Other
----------------- ---------------- Paid-In Accumulated Comprehensive
Shares Amount Shares Amount Capital (Deficit)/Profit Income (Loss)
-------- ------- ------- ------ ---------- ---------------- ------------
Balance at July 31, 2002 33,871 $ 339 28,995 $ 290 $ 885,165 $ (773,266) $ 240
Net loss for the three months ended January 31, 2003 - - - - - 36,882 -
Foreign currency translation - - - - - - (355)
Unrealized equity securities gain, net - - - - - - 723
Comprehensive income
Treasury share funding of 401K Plan - - - - - (2,622) -
Conversion of Class A stock to common stock 8 - (8) - - - -
Exercise of stock options 143 1 - - 133 - -
Issuance of Restricted Share grant to executive - - - - 394 - -
Forfeiture of stock options - - - - (729) - -
Repricing of stock options - - - - 453 - -
Amortization of deferred compensation - - - - - - -
------- ------- ------- ------ ---------- ----------- ------
Balance at January 31, 2003 34,022 $ 340 28,987 $ 290 $ 885,416 $ (739,006) $ 608
======= ======= ======= ====== ========== =========== ======
[RESTUBBED TABLE]
Treasury Stock Total
Deferred Loans to ---------------------------- Stockholders'
Compensation Stockholders Shares Amount Equity (Deficit)
-------------- -------------- ----------- --------------- ------------------
Balance at July 31, 2002 $ (12,919) $ (2,040) 3,751 $ (41,207) $ 56,602
Net loss for the three months ended January 31, 2003 - - - - 36,882
Foreign currency translation - - - - (355)
Unrealized equity securities gain, net - - - - 723
---------
Comprehensive income 37,250
Treasury share funding of 401K Plan - - (176) 3,146 524
Conversion of Class A stock to common stock - - - - -
Exercise of stock options - - - - 134
Issuance of Restricted Share grant to executive - - - - 394
Forfeiture of stock options 729 - - - -
Repricing of stock options (453) - - - -
Amortization of deferred compensation 3,339 - - - 3,339
--------- --------- ------ ---------- ---------
Balance at January 31, 2003 $ (9,304) $ (2,040) 3,575 $ (38,061) $ 98,243
========= ========= ====== ========== =========
See accompanying notes.
5
NET2PHONE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended
(In thousands) January 31,
--------------------------------------
2003 2002
--------------------------------------
Operating activities:
Net income (loss).................................................................. $ 36,882 $ (87,669)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization...................................................... 4,856 14,070
Non-cash compensation.............................................................. 4,349 11,083
Write-off of acquired in-process research and development.......................... - 13,850
Restructuring, severance, impairment, and other non-cash items..................... 6,429 23,956
Charitable contribution............................................................ - 2,952
Non-cash litigation settlement..................................................... (38,929) -
Minority interests................................................................. - (10,297)
Changes in assets and liabilities: - -
Other assets.................................................................... 729 3,413
Accounts payable and accrued expenses........................................... (11,833) (14,995)
Deferred revenue................................................................ (619) (2,560)
Net advances from (repayments to) IDT Corporation.............................. 4,536 (11,941)
---------- ---------
Net cash provided by (used in) operating activities..................................... 6,400 (58,138)
Investing activities:
Purchases of property and equipment................................................ (3,428) (13,385)
Purchases of marketable securities ................................................ (30,002) (67,722)
Proceeds from the sale of marketable securities ................................... 28,641 80,445
Acquisitions, net of cash acquired......... ....................................... - (27,583)
Payments of long-term obligations.................................................. - (6,563)
Other.............................................................................. 18 (775)
---------- ---------
Net cash used in investing activities................................................... (4,771) (35,583)
Financing activities:
Proceeds from the issuance of subsidiary preferred stock........................... - 13,998
Payments of capital lease obligations.............................................. (474) (627)
Purchases of redeemable common stock............................................... - (3,306)
Repurchase of common stock......................................................... - (510)
Other.............................................................................. 9 176
---------- ---------
Net cash (used in) provided by financing activities..................................... (465) 9,731
Effect of exchange rate on cash......................................................... - (219)
---------- ---------
Net increase (decrease) in cash and cash equivalents.................................... 1,164 (84,209)
Cash and cash equivalents at beginning of period........................................ 64,216 195,141
---------- ---------
Cash and cash equivalents at end of period.............................................. $ 65,380 $ 110,932
========== =========
Supplemental disclosure of cash flow information:
Cash payments made for interest......................................................... $ 102 $ -
========== =========
Cash payments made for income taxes..................................................... $ - $ -
========== =========
Supplemental disclosure of non-cash investing activities:
Liabilities incurred to acquire fixed assets............................................ $ - $ 6,969
========== =========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
6
NET2PHONE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Net2Phone, Inc. and its subsidiaries (collectively "the Company" or "Net2Phone")
have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally
accepted in the United States for annual financial statements. In the opinion of
management, all adjustments considered necessary for a fair presentation,
including normal recurring accruals and other items, have been included. Certain
reclassifications have been made to the prior year's unaudited condensed
consolidated financial statements to conform to the current year's presentation.
The results for the interim periods presented are not necessarily indicative of
the results that may be expected for any future period. The balance sheet at
July 31, 2002 has been derived from the audited financial statements at that
date but does not include all of the information and footnotes required by
accounting principles generally accepted in the United States for complete
audited financial statements. For further information, refer to the audited
financial statements and notes thereto included in Net2Phone's Annual Report on
Form 10-K for the year ended July 31, 2002.
The Company's fiscal year ends on July 31 of each calendar year. Each
reference below to a Fiscal Year refers to the Fiscal Year ending in the
calendar year indicated (e.g., fiscal 2002 refers to the Fiscal Year ended July
31, 2002).
2. Recent Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities ("SFAS 146"). SFAS 146 requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Previous accounting guidance was provided by Emerging Issues Task Force ("EITF")
Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring) ("EITF 94-3"). SFAS 146 replaces EITF 94-3 and is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The adoption of SFAS 146 did not have a material impact on our consolidated
financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure, An Amendment of FASB Statement No. 123.
This statement provides alternative methods of transition for a voluntary change
to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
Statement No. 123 to require more prominent and more frequent disclosures in
financial statements about the effects of stock-based compensation. The
provisions of SFAS No. 148 are effective for fiscal years ending after December
15, 2002, and the interim disclosure provisions are effective for financial
reports containing financial statements for interim periods beginning after
December 15, 2002. We will adopt the disclosure provisions of SFAS No. 148
beginning with the three and nine months ending April 30, 2003. The adoption of
SFAS No. 148 will not have an impact on our results of operations or financial
position as we currently do not plan to change our method of accounting for
stock-based compensation.
3. Earnings Per Share
The shares issuable upon the exercise of stock options and warrants are
excluded from the calculation of earnings per share as their effect would be
antidilutive. Stock options for 10.4 million shares for the three and six months
ended January 31, 2003 and 9.9 million shares for the three and six months ended
January 31, 2002, were not included in the computation of diluted earnings per
share.
4. Related Party Transactions
IDT Corporation
We continue to maintain significant business relationships with IDT
Corporation ("IDT") and its affiliates, and IDT maintains a controlling
ownership interest in us. In the three and six months ended January 31, 2003, we
provided carrier services to IDT of $1.7 million and $2.8 million, respectively
and sold disposable calling cards to IDT affiliates totaling $1.4 million and
$3.5 million, respectively. In the three and six months ended January 31, 2003,
we purchased wholesale carrier services from IDT of $2.8 million and $6.0
million, respectively.
7
NET2PHONE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
In the three and six months ending January 31, 2002, we provided carrier
services to IDT of $3.9 million and $8.2 million, respectively, and sold
disposable calling cards to IDT affiliates totaling $5.9 million and $11.9
million, respectively. In the three and six months ended January 31, 2002, we
purchased wholesale carrier services from IDT of $7.9 million and $15.2 million,
respectively.
Our corporate headquarters and several other facilities are leased from
IDT. In the three and six months ended January 31, 2003 we paid IDT $0.4 million
and $0.8 million, respectively, in facilities lease payments. In the three and
six months ended January 31, 2002 we paid IDT $1.5 million and $2.7 million,
respectively, in facilities lease payments. In January 2003, we entered into
negotiations with IDT to relinquish, effective February 2003, one floor of three
that we lease from IDT. It is our intention to assess the sublease market value
of this floor space during the third quarter of 2003.
The due from (to) IDT balances represent net amounts due from (to) IDT to
(by) us principally for wholesale carrier services and facilities lease
payments. The average balance we owed to IDT during the three and six months
ended January 31, 2003 was $2.3 million and $1.6 million, respectively.
5. Marketable Securities
Prior to August 1, 2002, we classified our investments in marketable
securities as held-to-maturity since we had the intent and ability to hold the
securities to maturity. During the first quarter of fiscal 2003, we arranged for
IDT's treasury function to provide investment management services relating to
our portfolio of marketable securities. As a result of this change, we
reevaluated our prior determination that our investments in marketable
securities are held-to-maturity, and concluded that they should be characterized
as available-for-sale to be consistent with IDT treasury function's intent with
respect to management of these securities. Accordingly, during the first quarter
of fiscal 2003, held-to-maturity securities with an amortized cost of $44.5
million and gross unrealized gains of $0.5 million were transferred to the
available-for-sale category.
6. Other Comprehensive Income
The Company's other comprehensive income (loss) consists of the following:
Six Months Ended January 31, Three Months Ended January 31,
---------------------------- ------------------------------
2003 2002 2003 2002
---------- ----------- ------------ -------------
(in thousands) (in thousands)
Net income (loss) $ 36,882 $ (87,669) $ (9,241) $ (46,314)
-------- --------- -------- ---------
Other Comprehensive Income (Loss):
Foreign currency translation adjustments (355) (219) (355) (219)
Unrealized gains (losses) on available-for-sale
securities 723 359 223 7,030
-------- --------- -------- ---------
368 140 (132) 6,811
-------- --------- -------- ---------
Total comprehensive income (loss) $ 37,250 $ (87,529) $ (9,373) $ (39,503)
======== ========= ======== =========
7. Option Repricing
On December 18, 2001, the Board of Directors approved the repricing of
options to purchase shares of Net2Phone's common stock granted on or before
December 18, 2001. There were options to purchase 6,373,863 shares of common
stock outstanding and eligible to be repriced.
The exercise price per share of the repriced options ranged from $3.50 per
share to $7.00 per share. The repriced options are subject to variable
accounting treatment and, therefore, must be marked-to-market each quarter.
Based on Net2Phone's stock price at January 31, 2003, the Company recorded $1.0
million and $0.4 million, respectively, of compensation expense for the three
and six months ended January 31, 2003. For the three and six months ended
January 31, 2002, the Company recorded compensation expense of $1.7 million
relating to this repricing. As our share price increases, we will continue to
incur charges until the options are exercised.
All of our non-cash compensation is attributable to selling, general and
administrative expense.
8
8. Legal Proceedings
Multi-Tech
On February 15, 2000, Multi-Tech Systems, Inc. filed suit against
Net2Phone and other companies in the United States Federal District Court in
Minneapolis, Minnesota. Multi-Tech alleged that "the defendant companies are
infringing because they are providing the end users with the software necessary
to simultaneously transmit voice and data on their computers in the form of
making a phone call over the Internet." On August 16, 2002, following an initial
hearing, the Court issued an order construing the claims of all the patents in
suit that we consider favorable to our non-infringement defenses. On October 31,
2002, the Court entered a consent judgment dismissing the patent infringement
claims asserted by Multi-Tech Systems, Inc. On November 19, 2002, Multi-Tech
filed an appeal with the United States Court of Appeals for the Federal Circuit.
We continue to defend the lawsuit vigorously.
Class-Actions
Four substantially similar class-action lawsuits were filed in the
United States District Court for the Southern District of New York on behalf of
all persons who acquired our stock between July 29, 1999 and December 6, 2000.
Net2Phone, certain of our executive officers, directors and underwriters
involved in our initial public offering are named as defendants in these
complaints. The complaints allege, in part, that certain underwriters of our
initial public offering violated federal securities laws by failing to disclose
that they had solicited and received undisclosed commissions and allocated
shares in our initial public offering to those investors in exchange for their
agreement to purchase our shares in the after-market at pre-determined prices.
The complaints also allege that, whether or not Net2Phone and the named
executives were aware of the underwriters' arrangements, Net2Phone and the named
executives have statutory liability under the federal securities laws for
issuing a registration statement in connection with our initial public offering
that failed to disclose that these allegedly undisclosed arrangements existed.
The suits against us are substantially the same as suits asserting the same
allegations that have been filed against several hundred other companies that
closed their initial public offerings at or about the same time. The deadline
for all defendants to respond to the complaints has been extended by the court
to which the various cases have been assigned. We recently have been able to
secure the voluntary dismissal of all claims against those executive officers
and directors named in the lawsuits. In addition, our underwriting agreement
with our underwriters provides for indemnification of Net2Phone and its
executives and directors for liabilities arising out of misstatements in our
registration statement attributable to material non-disclosures by the
underwriters. We intend to pursue our indemnification claims against the
underwriters. In addition, we maintain directors and officers liability
insurance coverage which should substantially cover the costs of defending the
various suits. However, an unfavorable decision in these areas could have a
material adverse effect on our business operations, financial condition, results
of operations and cash flows.
9. Settlement of CISCO Litigation
On March 19, 2002, we filed suit in the United States District Court
for the District of New Jersey against Cisco Systems, Inc. and a Cisco executive
who had been a member of the board of directors of ADIR Technologies, Inc., a
majority-owned subsidiary of the Company. The suit arose out of the
relationships that had been created in connection with Cisco's and Net2Phone's
original investments in ADIR and out of ADIR's subsequent purchase of NetSpeak,
Inc. in August 2001. In July 2002, Net2Phone and ADIR agreed to settle the suit.
The parties settled the suit and all related claims against Cisco and the Cisco
executive in exchange for: (i) the transfer, during the first quarter of fiscal
2003, to Net2Phone of Cisco's and Softbank Asia Infrastructure Fund's respective
11.5% and 7.0% interests in ADIR, and (ii) the payment by Cisco, during such
quarter, of $19.5 million to Net2Phone and ADIR. As a result of this settlement,
we recognized during the quarter ended October 31, 2002, a gain of $58.4 million
consisting of a $38.9 million reduction in minority interests as a result of the
transfer of the ADIR shares and receipt of settlement proceeds of $19.5 million
less $1.6 million of legal and other expenses related to the settlement that
were recorded in fiscal 2002. No income taxes have been reported on the gain as
the Company has sufficient net operating loss carryforwards to offset the gain.
During the second quarter 2003, we approved and therefore recorded an
additional $0.4 million in compensation expense directly related to the Cisco
litigation settlement.
9
10. Restructuring, Severance, Impairment and Other Items
The following table summarizes the charges included in Restructuring,
severance, impairment and other items in the statements of operations:
Six Months Ended January 31, Three Months Ended January 31,
2003 2002 2003 2002
----------------------------------------------------------------------------
(in thousands) (in thousands)
Workforce reductions $3,649 $ 6,164 $ - $ 6,164
Reserve adjustments (3,406) - (250) -
Exit costs 1,787 1,879 (113) 1,879
Impairment of long-lived assets 1,851 2,324 408 2,284
Separation agreements of former CEO
and CFO 1,995 10,830 658 4,960
-------- -------- ------ --------
Total $ 5,876 $ 21,197 $ 703 $ 15,287
======== ======== ====== ========
o First Quarter 2003 Restructuring
On October 24, 2002, we announced that we were consolidating the
development and support of our products for both our core business and our
broadband effort within one unit working on standards-based solutions that will
service the entire organization. This consolidation reduced our staff by
approximately 20%, or about 55 employees. As a result of this restructuring, for
the six months ended January 31, 2003, there was a charge of $3.6 million
related to terminated employees, $0.9 million related to the reduction of
operations at various locations, and $1.4 million related to elimination of
various equipment and network build-outs. As of January 31, 2003 approximately
$1.7 million of involuntary termination benefits have been paid and charged
against the reserve.
o Reserve Adjustments
During the three months ended April 30, 2002, we recognized a charge of
$4.7 million related to the elimination of specific connectivity and network
related costs. During the three-months ended October 31, 2002, we reversed $2.9
million of those previously recognized charges as a result of successful
settlement negotiations with vendors regarding cancellation charges and $0.3
million of previously recognized severance expense as a result of the subsequent
retention of several individuals whose employment had been terminated.
For the three months ended January 31, 2003 there was a $0.2 million
reduction in the charge related to terminated employees. This reduction reflects
our decision to retain certain employees whose employment had been scheduled for
termination.
o Other Exit Costs & Impairment Charges
We recognized, during the first quarter of fiscal 2003, an additional $0.5
million charge relating to the sale of our web-based banner advertising business
in fiscal 2002. For the three months ended January 31, 2003, we incurred exit
charges of $0.7 million. These include the following: $0.4 million relating to a
lease termination of one our New Jersey locations; $0.4 million for the
write-off of capitalized software relating to the de-emphasis of our carrier
services business; and $0.1 million in severance for a former employee of
Net2Phone following a short term of employment at IDT. Also, during the second
quarter of fiscal 2003, we recorded a favorable mark-to-market adjustment of
$0.6 million relating to the proceeds owed to former shareholders of an
operation we purchased in fiscal 2000 and discontinued during fiscal 2001. For
the six months ended January 31, 2003, there was a favorable mark-to-market
adjustment of $0.1 million.
10
o Separation Agreements of Former CEO and CFO
In October 2001, Howard Balter resigned as our Chief Executive Officer.
Pursuant to an agreement between Mr. Balter and the Company, Mr. Balter waived
various rights under his employment agreement, entered into a 30 month
restrictive non-compete covenant and agreed to provide consulting services for a
15 month period, all in exchange for settlement of various loans from the
Company and the guarantee of continued benefits for a similar period. In
addition, Mr. Balter's options were repriced at the conclusion of the first
three months of the consultancy period. Mr. Balter waived all rights to assert
any claims against Net2Phone and ADIR relating to his employment agreement with
Net2Phone. The aggregate principal amount of Mr. Balter's borrowing from
Net2Phone and ADIR was $4.4 million. In addition, Net2Phone had guaranteed the
repayment of a bank loan to Mr. Balter in the principal sum of $5.0 million.
Net2Phone repaid the bank loan and forgave $2.0 million of the other
indebtedness after the completion of the first three months of Mr. Balter's
consulting arrangement and agreed to forgive the balance after the completion of
the entire consulting period. As a result of this agreement, there were charges
of $2.6 million and $8.4 million for the three and six months ended January 31,
2002, respectively and $0.8 million and $1.8 million for the three and six
months ended January 31, 2003, respectively. There will be future charges of
approximately $0.3 million relating to this separation agreement.
In January 2002, Ilan Slasky tendered his resignation as our Chief
Financial Officer. Mr. Slasky's resignation became effective upon his
successor's assumption of the responsibility in March 2002. Pursuant to an
agreement between Mr. Slasky and the Company, Mr. Slasky waived all of his
rights under his employment agreement, entered into a 2 year restrictive
non-compete covenant and agreed to provide consulting services for a 4 year
period, all in exchange for settlement of various loans with the Company and the
guarantee of continued benefits for a similar period. In addition, Mr. Slasky's
options were repriced on January 31, 2002. Of the 300,000 options granted at
this time 232,000 options were exercised immediately. The remaining 68,000
options were exercised during the second quarter 2003. The aggregate principal
sum of Mr. Slasky's borrowings from Net2Phone was $1.5 million. Net2Phone agreed
to forgive the loans in four equal installments upon the completion of each of
the four years of his consulting arrangement. As a result of this agreement,
there was a charge of $2.4 million for the three and six months ended January
31, 2002. As a result of this agreement, there was a charge of $0.1 million and
$0.3 million for the three and six months ended January 31, 2003, respectively.
There will be future charges of approximately $1.5 million relating to this
separation agreement. In connection with the termination of his employment, Mr.
Slasky sold 500 shares of ADIR stock to IDT Corporation. IDT then transferred
the ADIR shares to us for 273,798 shares of Net2Phone common stock valued at
$1,423,750 or $5.20 per share, the closing price of the stock on January 24,
2002. Under certain circumstances, Net2Phone is required to guarantee to IDT
that the shares still owned by it on January 31, 2007 will have a market value
of at least $5.20 per share on that date. During the three and six months ended
January 31, 2003, we recorded a mark-to-market adjustments of $0.3 million and
$0.1 million, respectively, relating to this guarantee that reduced previously
recorded compensation expense.
o November 2001 Restructuring
In November 2001, the Company announced plans to restructure its
operations, which include the elimination of various lines of development
business related to Voice Hosting products and current Enterprise products,
relocation of certain facilities, and a reduction in workforce by approximately
270 employees. As a result of this restructuring, during the three and six
months ended January 31, 2002, there were charges of $0.9 million related to the
write-down of certain Aplio assets and a litigation-related reserve, $6.2
million related to terminated employees, $1.9 million related to the reduction
of operations at various locations, and $1.3 million related to elimination of
various equipment and network build-outs.
o Reserve Summary
The following table summarizes the remaining reserve balances related to
restructuring, severance, impairment and other charges:
January 31, 2003 July 31, 2002
---------------- -------------
(in thousands)
Workforce reductions $ 1,719 $ 2,086
Exit costs 6,522 6,723
Separation agreements of former CEO and CFO 2,131 4,254
--------- ---------
Total $10,372 $13,063
========= =========
11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion of our financial condition and results of
operations should be read in conjunction with the Management's Discussion and
Analysis of Financial Condition and Results of Operations and the Consolidated
Financial Statements and the Notes thereto included in our Annual Report on Form
10-K for the year ended July 31, 2002. This quarterly report on Form 10-Q
contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. These forward-looking statements involve risks and
uncertainties and actual results could differ materially from those discussed in
the forward-looking statements. For this purpose, any statements contained in
this Form 10-Q that are not statements of historical fact may be deemed to be
forward-looking statements. Factors which may affect our results include, but
are not limited to, our ability to expand our customer base and to develop
additional and leverage our existing distribution channels for our products and
solutions, dependence on strategic and channel partners including their ability
to distribute our products and meet or renew their financial commitments, our
ability to address international markets, the effectiveness of our sales and
marketing activities, the acceptance of our products in the marketplace, the
timing and scope of deployments of our products by customers, fluctuations in
customer sales cycles, our customers' ability to obtain additional funding,
technical difficulties with respect to our products or products in development,
the need for ongoing product development in an environment of rapid
technological change, the emergence of new competitors in the marketplace, our
ability to compete successfully against established competitors with greater
resources, the uncertainty of future governmental regulation, our ability to
manage growth and obtain patent protection and additional funds, general
economic conditions and other risks discussed in this report and in our other
filings with the Securities and Exchange Commission. All forward-looking
statements and risk factors included in this report are made as of the date
hereof, based on information available to us as of the date thereof, and we
assume no obligation to update any forward-looking statement or risk factors.
Company Overview
We are a provider of voice over Internet protocol, or VoIP, telephony
products and services. We began operations in 1995 as a division of IDT
Corporation, and were incorporated in Delaware as a separate subsidiary of IDT
in October 1997. We utilize our VoIP technology to transmit digital voice
communications over the Internet and other data networks. We introduced our
flagship product, the personal computer to telephone, or PC-to-phone, service,
in 1996, which allows our end users to transmit voice communications over data
networks, such as the Internet, to standard phones on public switched telephone
networks. Since we introduced our PC-to-phone service, we have used our VoIP
technology and our ability to bridge VoIP networks with switched networks to
allow end users to send voice communications over the Internet via telephone,
computer or other calling devices virtually anywhere in the world. Since 1996,
we have grown our VoIP services to the extent that, based on our market share,
we believe we are the largest retailer of VoIP services worldwide.
The majority of our revenue comes from the sale of voice minutes over
our data networks. Currently, we market our products and services through three
units, each focused on a different market for those minutes: (1) International
Communications Services; (2) Domestic Retail Services; and (3) Cable Telephony
Solutions. The International Communications Services group, or ICS, is
responsible for the sale of international long distance solutions utilizing VoIP
technology. ICS, in turn, is comprised of three divisions: (a) Channel Sales and
Distribution; (b) Carrier Services; and (c) Direct to Consumer Services. Our
Domestic Retail Services group sells VoIP minutes via both disposable and
rechargeable calling cards primarily to U.S. consumers. Finally, our Cable
Telephony Solutions group is able to provide cable operators with a fully
outsourced end-to-end telecommunications solution utilizing existing high-speed
cable data networks and the "last mile" access into consumers' homes provided by
the cable operator via cable modems.
In January 2003, we completed the first phase of our cable telephony
offering with Liberty Cablevision (LCV) of Puerto Rico, a wholly owned
subsidiary of Liberty Media, and initiated local and long distance residential
VoIP phone service to Liberty Cablevision subscribers. We have begun offering
traditional phone service features and applications such as call waiting, caller
ID, and directory assistance among others. Additionally, we signed and
implemented the second phase of our cable telephony offering with LCV, whereby
LCV is now billing their customers who receive our cable telephony services.
During the quarter, Liberty Media and IDT increased their positions in Net2Phone
through the acquisition of AT&T's shares in NTOP Holdings, our majority
shareholder.
Critical Accounting Policies
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States. These
generally accepted accounting principles require 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 net sales and expenses during the
reporting period. We continually evaluate our estimates, including those related
to revenue recognition, bad debts, intangible assets, income taxes, fixed
assets, access line costs, restructuring, contingencies and litigation. We base
our estimates on historical experience and on various other assumptions that are
believed to be reasonable under the facts and circumstances. Actual results may
differ from these estimates under different assumptions or conditions.
12
We believe the following critical accounting policies impact our most
difficult, subjective and complex judgments used in the preparation of our
consolidated financial statements, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain. For more
information about these and other accounting policies, please see Note 2 of the
Notes to consolidated financial statements included in our Annual Report on Form
10-K for the year ended July 31, 2002.
Revenue Recognition. Our primary source of revenue is communication
services revenue from the sale of minutes over our VoIP network. We sell these
minutes, or access to these minutes, through our various businesses, including
our International Communications Services group and our Domestic Retail Services
group. Our international communications service revenue is recognized as service
is provided, that is, as minutes are used. Our retail sales revenue, which
consists primarily of pre-paid calling card revenue, is also recognized as our
service is provided, that is, as minutes are used, or when service fees are
charged. We also recognize revenue from pre-payments for our services after we
conduct evaluations of outstanding remaining pre-payment balances and determine,
based on historical data, that such balances are not likely to be utilized. The
sale of equipment with software necessary to provide our services is recognized
when such products are delivered, collection of payments is assured and there
are no significant future obligations. To date, we have recognized no revenue
from our broadband business.
Impairment of Long-Lived Assets. The recoverability of long-lived
assets and certain identifiable intangible assets are evaluated when events or
changes in circumstances indicate that the carrying amount of the assets may not
be recoverable. An impairment loss will be recognized when estimated future
undiscounted cash flows expected to result from the use of the asset and its
eventual disposition are less than its carrying amount, with the loss measured
based on discounted expected cash flows. Goodwill and indefinite-lived
intangible assets are tested for impairment annually, or upon an indication that
their value may be impaired.
Expense Recognition versus Capitalized Costs. Purchases that provide
benefit to future periods and have useful lives greater than one year are
capitalized. All other purchases are expensed in the period the underlying goods
and/or services are received.
Specifically:
Equipment and furniture and fixtures are recorded at cost and
depreciated using the straight-line method over the estimated useful
lives of the assets, which range from five to fifteen years.
Computer software is amortized using the straight-line method over the
shorter of five years or the term of the related agreement. Software
development costs for the internal development of new software products
and substantial enhancements to existing software products are expensed
as incurred until technological feasibility has been established, at
which time any additional costs would be capitalized. As we have
completed our software development concurrently with the establishment
of technological feasibility, we have not capitalized these costs. We
capitalize certain costs incurred in connection with developing or
obtaining internal use software. These costs consist of payments made
to third parties and the salaries of employees working on such software
development.
Six Months Ended January 31, 2003 Compared to Six Months Ended January 31, 2002
Results of Operations
Revenue. Our revenues are primarily derived from per-minute charges we bill
to our customers on a pre-paid basis and from the sale of Internet telephony
equipment and services to resellers, IDT and other carriers. Revenue decreased
41.8% from $80.7 million for the six months ended January 31, 2002 to $47.0
million for the six months ended January 31, 2003. The decrease in revenue was
primarily driven by the restructurings of operations announced during fiscal
2002 and in October 2002. We purposefully de-emphasized seeking revenue from
relatively low-margin services such as disposable calling cards in favor of
building up activities to generate revenue in relatively high-margin services
such as International Communications Services during the upcoming periods.
Direct Cost of Revenue. Net2Phone's direct cost of revenue consists
primarily of network costs associated with carrying our customers' traffic on
our network and leased networks, routing their calls through a local telephone
company to reach their final destination and wholesale costs of internet
telephony devices. Direct cost of revenue decreased 43.7% from $46.6 million for
the six months ended January 31, 2002 to $26.2 million for the six months ended
January 31, 2003. As a percentage of total revenue, these costs decreased from
57.7% for the six months ended January 31, 2002 to 55.8% for the six months
ended January 31, 2003. The decrease was a result of continuing initiatives to
reduce fixed costs in our network infrastructure.
13
Selling, General and Administrative. Selling, general and administrative
expense consists of salaries of our employees and associated benefits, and the
cost of insurance, legal, rent, utilities and other services, expenses
associated with acquiring customers, including commissions paid to our sales
personnel, advertising costs, travel, entertainment and referral fees. Selling,
general and administrative expense decreased 62.2% from $74.6 million for the
six months ended January 31, 2002 to $28.2 million for the six months ended
January 31, 2003 due to continuing cost management initiatives and elimination
of certain expenses directly related to the restructurings of our operations
that were announced during fiscal 2002 and October 2002. We anticipate selling,
general and administrative expense will continue to decrease in the remainder of
fiscal 2003 due to the aforementioned restructurings.
Depreciation and Amortization. Depreciation and amortization decreased
65.3% from $14.1 million for the six months ended January 31, 2002 to $4.9
million for the six months ended January 31, 2003. As a percentage of total
revenues, these costs decreased from 17.4% for the six months ended January 31,
2002 to 10.3% for the six months ended January 31, 2003. Depreciation and
amortization declined as a result of the impairment charge for long-lived assets
recognized during the quarter ended April 30, 2002, which reduced the carrying
value of such assets.
Restructuring, severance, impairment and other items.
The following table summarizes the charges included in Restructuring,
severance, impairment and other items in the statements of operations:
Six Months Ended January 31,
2003 2002
--------------------------------------------
(in thousands)
Workforce reductions $ 3,649 $ 6,164
Reserve adjustments (3,406) -
Exit costs 1,787 1,879
Impairment of long-lived assets 1,851 2,324
Separation agreements of former
CEO & CFO 1,995 10,830
-------- --------
Total $ 5,876 $ 21,197
======== ========
o First Quarter 2003 Restructuring
On October 24, 2002, we announced that we were consolidating the
development and support of our products for both our core business and our
broadband effort within one unit working on standards-based solutions that will
service the entire organization. This consolidation reduced our staff by
approximately 20%, or about 55 employees. As a result of this restructuring,
there was a charge of $3.6 million related to terminated employees, $0.9 million
related to the reduction of operations at various locations, and $1.4 million
related to elimination of various equipment and network build-outs.
As of January 31, 2003 approximately $1.7 million of involuntary
termination benefits have been paid and charged against the reserve.
o Reserve Adjustments
During the three months ended April 30, 2002, we recognized a charge of
$4.7 million related to the elimination of specific connectivity and network
related costs. We reversed $2.9 million of those previously recognized charges
as a result of successful settlement negotiations with vendors regarding
cancellation charges and $0.3 million of previously recognized severance expense
as a result of the subsequent retention of several individuals whose employment
had been terminated.
14
For the three months ended January 31, 2003 there was a $0.2 million
reduction in the charge related to terminated employees. This reduction reflects
our decision to retain certain employees whose employment had been scheduled for
termination.
o Other Exit Costs & Impairment Charges
We recognized, during the first quarter of fiscal 2003, an additional $0.5
million charge relating to the sale of our web-based banner advertising business
in fiscal 2002.
For the three months ended January 31, 2003, we incurred exit charges of
$0.7 million. These include the following: $0.4 million relating to a lease
termination of one our New Jersey locations; $0.4 million for the write-off of
capitalized software relating to the de-emphasis of our carrier services
business; and $0.1 million in severance for a former employee of Net2Phone
following a short term of employment at IDT. Also, during the second quarter of
fiscal 2003, we recorded a favorable mark-to-market adjustment of $0.6 million
relating to the proceeds owed to former shareholders of an operation we
purchased in fiscal 2000 and discontinued during fiscal 2001. For the six months
ended January 31, 2003, there was a favorable mark-to-market adjustment of $0.1
million.
o Separation Agreements of Former CEO and CFO
In October 2001, Howard Balter resigned as our Chief Executive Officer.
Pursuant to an agreement between Mr. Balter and the Company, Mr. Balter waived
various rights under his employment agreement, entered into a 30 month
restrictive non-compete covenant and agreed to provide consulting services for a
15 month period, all in exchange for settlement of various loans from the
Company and the guarantee of continued benefits for a similar period. In
addition, Mr. Balter's options were repriced at the conclusion of the first
three months of the consultancy period. Mr. Balter waived all rights to assert
any claims against Net2Phone and ADIR relating to his employment agreement with
Net2Phone. The aggregate principal amount of Mr. Balter's borrowing from
Net2Phone and ADIR was $4.4 million. In addition, Net2Phone had guaranteed the
repayment of a bank loan to Mr. Balter in the principal sum of $5.0 million.
Net2Phone repaid the bank loan and forgave $2.0 million of the other
indebtedness after the completion of the first three months of Mr. Balter's
consulting arrangement and agreed to forgive the balance after the completion of
the entire consulting period. As a result of this agreement, there were charges
of $1.8 million and $8.4 million for the six months ended January 31, 2003 and
2002, respectively. There will be future charges of approximately $0.3 million
relating to this separation agreement.
In January 2002, Ilan Slasky tendered his resignation as our Chief
Financial Officer. Mr. Slasky's resignation became effective upon his
successor's assumption of the responsibility in March 2002. Pursuant to an
agreement between Mr. Slasky and the Company, Mr. Slasky waived all of his
rights under his employment agreement, entered into a 2 year restrictive
non-compete covenant and agreed to provide consulting services for a 4 year
period, all in exchange for settlement of various loans with the Company and the
guarantee of continued benefits for a similar period. In addition, Mr. Slasky's
options were repriced on January 31, 2002. Of the 300,000 options granted at
this time 200,000 options were exercised immediately. The remaining 100,000
options were exercised during the second quarter 2003. The aggregate principal
sum of Mr. Slasky's borrowings from Net2Phone was $1.5 million. Net2Phone agreed
to forgive the loans in four equal installments upon the completion of each of
the four years of his consulting arrangement. As a result of this agreement,
there was a charge of $0.3 million and $2.4 million for the six months ended
January 31, 2003 and 2002, respectively. There will be future charges of
approximately $1.5 million relating to this separation agreement. In connection
with the termination of his employment, Mr. Slasky sold 500 shares of ADIR stock
to IDT Corporation. IDT then transferred the ADIR shares to us for 273,798
shares of Net2Phone common stock valued at $1,423,750 or $5.20 per share, the
closing price of the stock on January 24, 2002. Under certain circumstances,
Net2Phone is required to guarantee to IDT that the shares still owned by it on
January 31, 2007 will have a market value of at least $5.20 per share on that
date. During the six months ended January 31, 2003, we recorded a mark-to-market
adjustment of $0.1 million relating to this guarantee that reduced previously
recorded compensation expense.
o November 2001 Restructuring
In November 2001, the Company announced plans to restructure its
operations, which include the elimination of various lines of development
business related to Voice Hosting products and current Enterprise products,
relocation of certain facilities, and a reduction in workforce by approximately
270 employees. As a result of this restructuring, during the six months ended
January 31, 2002, there were charges of $0.9 million related to the write-down
of certain Aplio assets and a litigation-related reserve, $6.2 million related
to terminated employees, $1.9 million related to the reduction of operations at
various locations, and $1.3 million related to elimination of various equipment
and network build-outs.
15
Settlement of CISCO Litigation. On March 19, 2002 we filed suit in the
United States District Court for the District of New Jersey against Cisco
Systems, Inc. and a Cisco executive who had been a member of the board of
directors of ADIR Technologies, Inc., a majority-owned subsidiary of the
Company. The suit arose out of the relationships that had been created in
connection with Cisco's and Net2Phone's original investments in ADIR and out of
ADIR's subsequent purchase of NetSpeak, Inc. in August 2001. The parties settled
the suit and all related claims against Cisco and the Cisco executive in
exchange for: (i) the transfer, during the first quarter of fiscal 2003, to
Net2Phone of Cisco's and Softbank Asia Infrastructure Fund's respective 11.5%
and 7.0% interests in ADIR, and (ii) the payment by Cisco, during such quarter,
of $19.5 million to Net2Phone and ADIR. As a result of this settlement, we
recognized during the quarter ended October 31, 2002, a gain of $58.4 million
consisting of a $38.9 million reduction in minority interests as a result of the
transfer of the ADIR shares and receipt of settlement proceeds of $19.5 million
less $1.6 million of legal and other expenses related to the settlement that
were recorded in fiscal 2002. No income taxes have been reported on the gain as
the Company has sufficient net operating loss carryforwards to offset the gain.
During the second quarter 2003, we approved and therefore recorded an
additional $0.4 million in compensation expense directly related to the Cisco
litigation settlement.
Acquired in-process research and development. For the six months ended
January 31, 2002, purchased in-process research and development ("IPR&D")
represents the value assigned in a purchase business combination to research and
development projects of the acquired business that had commenced but had not yet
been completed at the date of acquisition and which have no alternative future
use. In accordance with SFAS No. 2, Accounting for Research and Development
Costs, as clarified by FASB Interpretation No. 4, amounts assigned to IPR&D
meeting the above stated criteria must be charged to expense as part of the
allocation of the purchase price of the business combination. Accordingly,
charges totaling $13.9 million were recorded during fiscal 2002 as part of the
allocation of the purchase price related to the acquisition of NetSpeak by ADIR,
our majority-owned subsidiary.
The IPR&D relates primarily to advanced telephony software products for
Internet protocol ("IP") networks. The Route Server Infrastructure product
provides real-time IP address resolution ensuring high performance, scalability
and reliability. The Route Server Virtual Private Network ("VPN") product
integrated with the infrastructure product creates a solution that enables
service providers to address the long distance service market. The Residential
Cable Solution products provide routing and call management for end-user cable
subscribers.
The valuation of the IPR&D included both cost and income valuation
approaches, and utilized replacement cost and discounted cash flow methodologies
for various aspects of the analysis. The calculations were based on estimates of
operating earnings, capital charges, and working capital requirements to support
the cash flows attributed to the technologies. Discount rates reflecting the
stage of development, complexity and the risk associated with each technology
were used to value IPR&D. The fair value total of $13.9 million has been
assigned as follows: Route Server Infrastructure product -- $10.3 million; Route
Server VPN product -- $2.9 million, Residential Cable Solution products -- $0.7
million. Development of the Route Server Infrastructure and Route Server VPN
products were completed during the second quarter of fiscal 2002. Effective
February 14, 2002, further research and development of the Residential Cable
Solution products were suspended while ADIR reevaluated the products'
anticipated attractiveness relative to current market conditions. It is
currently unlikely that such research and development efforts will be resumed.
Non-cash Compensation. Non-cash compensation charges decreased 61.6% from
$11.2 million for the six months ended January 31, 2002 to $4.3 million for the
six months ended January 31, 2003. As a percentage of total revenue, these costs
decreased from 13.9% for the six months ended January 31, 2002 to 9.3% for the
six months ended January 31, 2002. This decrease was primarily caused by lower
compensation expense related to stock options granted at below fair market value
prices as a large number of stock options became fully vested in fiscal 2002. In
addition, due to our various restructurings, a number of previously granted
options have been forfeited. On December 18, 2001, the Board of Directors
approved the repricing of options outstanding under Net2Phone's 1999 Amended and
Restated Stock Option and Incentive Plan. The repriced options are subject to
variable accounting treatment and therefore must be marked-to-market each
quarter. For the six months ended January 31, 2003 and 2002, we recorded charges
of $0.4 million and $1.7 million, respectively, related to these repriced
options. If our stock price increases, we will continue to incur charges until
the options are exercised. Lastly, the Company has recorded $2.6 million and
$3.3 million for the six months ended January 31, 2003 and 2002, respectively,
for the amortization of the discount of ADIR shares sold to Net2Phone and ADIR
employees in fiscal 2001. The total discount of approximately $17.9 million is
being amortized over the vesting period of such shares.
Income (Loss) from Operations. Loss from operations was $100.7 million for
the six months ended January 31, 2002 ascompared to income from operations of
$35.5 million for the six months ended January 31, 2003. The decrease in loss
from operations is primarily due to the gain from the settlement of the Cisco
litigation, as well as operating expenses that decreased at a faster rate than
revenues decreased.
16
Interest Income, net. Interest income consists primarily of interest earned
on cash and cash equivalents. Interest income decreased 48.2% from $2.7 million
for the six months ended January 31, 2002 to $1.4 million for the six months
ended January 31, 2003. The reduction primarily results from lower cash balances
and interest rate reductions. We anticipate reduced interest income from
interest bearing accounts due to lower interest rates and cash balances.
Three Months Ended January 31, 2003 Compared to Three Months Ended
January 31, 2002
Results of Operations
Revenue. Our revenues are primarily derived from per-minute charges we bill
to our customers on a pre-paid basis and from the sale of Internet telephony
equipment and services to resellers, IDT and other carriers. Revenue decreased
38.9% from $37.8 million for the three months ended January 31, 2002 to $23.1
million for the three months ended January 31, 2003. The decrease in revenue was
primarily driven by the restructurings of operations announced during fiscal
2002 and in October 2002. We purposefully de-emphasized seeking revenue from
relatively low-margin services such as disposable calling cards in favor of
building up activities to generate revenue in relatively high-margin services
such as International Communications Services during the upcoming periods.
Direct Cost of Revenue. Net2Phone's direct cost of revenue consists
primarily of network costs associated with carrying our customers' traffic on
our network and leased networks, routing their calls through a local telephone
company to reach their final destination and wholesale costs of internet
telephony devices. Direct cost of revenue decreased 45.3% from $22.5 million for
the three months ended January 31, 2002 to $12.3 million for the three months
ended January 31, 2003. As a percentage of total revenue, these costs decreased
from 59.5% for the three months ended January 31, 2002 to 53.3% for the three
months ended January 31, 2003. The decrease was a result of continuing
initiatives to reduce fixed costs in our network infrastructure.
Selling, General and Administrative. Selling, general and administrative
expense consists of salaries of our employees and associated benefits, and the
cost of insurance, legal, rent, utilities and other services, expenses
associated with acquiring customers, including commissions paid to our sales
personnel, advertising costs, travel, entertainment and referral fees. Selling,
general and administrative expense decreased 60.0% from $36.5 million for the
three months ended January 31, 2002 to $14.6 million for the three months ended
January 31, 2003 due to continuing cost management initiatives and elimination
of certain expenses directly related to the restructurings of our operations
that were announced during fiscal 2002 and October 2002. We anticipate selling,
general and administrative expense will continue to decrease in the remainder of
fiscal 2003 due to the aforementioned restructurings.
Depreciation and Amortization. Depreciation and amortization decreased
67.1% from $7.3 million for the three months ended January 31, 2002 to $2.4
million for the three months ended January 31, 2003. As a percentage of total
revenues, these costs decreased from 19.4% for the three months ended January
31, 2002 to 10.3% for the three months ended January 31, 2003. Depreciation and
amortization declined as a result of the impairment charge for long-lived assets
recognized during the quarter ended April 30, 2002 which reduced the carrying
value of such assets.
Restructuring, severance, impairment and other items.
The following table summarizes the charges included in Restructuring,
severance, impairment and other items in the statements of operations:
Three Months Ended January 31,
2003 2002
------------------------------
(in thousands)
Workforce reductions $ _ $ 6,164
Reserve adjustments (250) -
Exit costs (113) 1,879
Impairment of long-lived assets 408 2,284
Separation agreements of former 658 4,960
CEO & CFO
--------- --------
Total $ 703 $ 15,287
========= ========
17
o Reserve Adjustments
For the three months ended January 31, 2003 there was a $0.2 million
reduction in the charge related to terminated employees. This reduction was
reflects our decision to retain certain employees whose employment had been
scheduled for termination.
o Other Exit Costs & Impairment Charges
For the three months ended January 31, 2003, we incurred exit charges of
$0.7 million. These include the following: $0.4 million relating to a lease
termination of one our New Jersey locations; $0.4 million for the write-off of
capitalized software relating to the de-emphasis of our carrier services
business; and $0.1 million in severance for a former employee of Net2Phone
following a short term of employment at IDT. As an offset to these items we
recorded a favorable mark-to-market adjustment of $0.6 million relating to the
proceeds owed to former shareholders of an operation we purchased in fiscal 2000
and discontinued during fiscal 2001.
o Separation Agreements of Former CEO and CFO
In October 2001, Howard Balter resigned as our Chief Executive Officer.
Pursuant to an agreement between Mr. Balter and the Company, Mr. Balter waived
various rights under his employment agreement, entered into a 30 month
restrictive non-compete covenant and agreed to provide consulting services for a
15 month period, all in exchange for settlement of various loans from the
Company and the guarantee of continued benefits for a similar period. In
addition, Mr. Balter's options were repriced at the conclusion of the first
three months of the consultancy period. Mr. Balter waived all rights to assert
any claims against Net2Phone and ADIR relating to his employment agreement with
Net2Phone. The aggregate principal amount of Mr. Balter's borrowing from
Net2Phone and ADIR was $4.4 million. In addition, Net2Phone had guaranteed the
repayment of a bank loan to Mr. Balter in the principal sum of $5.0 million.
Net2Phone repaid the bank loan and forgave $2.0 million of the other
indebtedness after the completion of the first three months of Mr. Balter's
consulting arrangement and agreed to forgive the balance after the completion of
the entire consulting period. As a result of this agreement, there were charges
of $0.8 million and $2.6 million for the three months ended January 31, 2003 and
2002, respectively. There will be future charges of approximately $0.3 million
relating to this separation agreement.
In January 2002, Ilan Slasky tendered his resignation as our Chief
Financial Officer. Mr. Slasky's resignation became effective upon his
successor's assumption of the responsibility in March 2002. Pursuant to an
agreement between Mr. Slasky and the Company, Mr. Slasky waived all of his
rights under his employment agreement, entered into a 2 year restrictive
non-compete covenant and agreed to provide consulting services for a 4 year
period, all in exchange for settlement of various loans with the Company and the
guarantee of continued benefits for a similar period. In addition, Mr. Slasky's
options were repriced on January 31, 2002. Of the 300,000 options granted at
this time 232,000 options were exercised immediately. The remaining 68,000
options were exercised during the second quarter 2003. We recorded a mark-to-
market adjustment of $0.1 million during the second quarter 2003 relating to
these options. The aggregate principal sum of Mr. Slasky's borrowings from
Net2Phone was $1.5 million. Net2Phone agreed to forgive the loans in four equal
installments upon the completion of each of the four years of his consulting
arrangement. As a result of this agreement, there was a charge of $0.1 million
and $2.4 million for the three months ended January 31, 2003 and 2002,
respectively. There will be future charges of approximately $1.5 million
relating to this separation agreement. In connection with the termination of his
employment, Mr. Slasky sold 500 shares of ADIR stock to IDT Corporation. IDT
then transferred the ADIR shares to us for 273,798 shares of Net2Phone common
stock valued at $1,423,750 or $5.20 per share, the closing price of the stock on
January 24, 2002. Under certain circumstances, Net2Phone is required to
guarantee to IDT that the shares still owned by it on January 31, 2007 will have
a market value of at least $5.20 per share on that date. During the three months
ended January 31, 2003, we recorded a mark-to-market adjustment of $0.3 million
relating to this guarantee that reduced previously recorded compensation
expense.
o November 2001 Restructuring
In November 2001, the Company announced plans to restructure its
operations, which include the elimination of various lines of development
business related to Voice Hosting products and current Enterprise products,
relocation of certain facilities, and a reduction in workforce by approximately
270 employees. As a result of this restructuring, during the three months ended
January 31, 2002, there were charges of $0.9 million related to the write-down
of certain Aplio assets and a litigation-related reserve, $6.2 million related
to terminated employees, $1.9 million related to the reduction of operations at
various locations, and $1.3 million related to elimination of various equipment
and network build-outs.
18
Settlement of CISCO Litigation. During the second quarter 2003 we recorded
an additional $0.4 million in compensation expense related directly to the Cisco
litigation settlement.
Non-cash Compensation. Non-cash compensation charges decreased 57.1% from
$6.3 million for the three months ended January 31, 2002 to $2.7 million for the
three months ended January 31, 2003. As a percentage of total revenue, these
costs decreased from 16.6% for the three months ended January 31, 2002 to 11.7%
for the three months ended January 31, 2003. This decrease was primarily caused
by lower compensation expense related to stock options granted at below fair
market value prices as a large number of stock options became fully vested in
fiscal 2002. In addition, due to our various restructurings, a number of
previously granted options have been forfeited. On December 18, 2001, the Board
of Directors approved the repricing of options outstanding under Net2Phone's
1999 Amended and Restated Stock Option and Incentive Plan. The repriced options
are subject to variable accounting treatment and therefore must be
marked-to-market each quarter. For the three months ended January 31, 2003 and
2002, we recorded a charge of $1.0 million and $1.7 million, respectively, of
compensation expense related to these repriced options. If our stock price
increases, we will continue to incur charges until the options are exercised.
Lastly, the Company has recorded $1.3 million and $1.6 million for the three
months ended January 31, 2003 and 2002, respectively, for the amortization of
the discount of ADIR shares sold to Net2Phone and ADIR employees in fiscal 2001.
The total discount of approximately $17.9 million is being amortized over the
vesting period of such shares.
Income (Loss) from Operations. Loss from operations was $50.0 million for
the three months ended January 31, 2002 as compared $10.0 million for the three
months ended January 31, 2003. The decrease in loss from operations is primarily
due to operating expenses that decreased at a faster rate than revenues
decreased.
Interest Income, net. Interest income consists primarily of interest earned
on cash and cash equivalents. Interest income decreased 25% from $0.8 million
for the three months ended January 31, 2002 to $0.6 million for the three months
ended January 31, 2003. The reduction primarily results from lower cash balances
and interest rate reductions. We anticipate reduced interest income from
interest bearing accounts due to lower interest rates and cash balances.
Liquidity and Capital Resources
Historically, we have satisfied our cash requirements through a
combination of cash flow from operating activities, sales of equity securities
and borrowings from third parties. For the most part our cash requirements have
been satisfied through our existing cash, cash equivalents and marketable
securities balances.
The following table provides our cash flow data for the six months ended
January 31, 2003 and 2002.
Six Months Ended January 31,
----------------------------
2003 2002
-------- --------
(in thousands)
Net cash provided by (used in)
operating activities................. $ 6,400 $(58,138)
Net cash used in investing
activities........................... (4,771) (35,583)
Net cash (used in) provided by
financing activities................. (465) 9,731
Effect of exchange rate on cash....... - (219)
-------- --------
Net increase (decrease) in cash
and cash equivalents................. $ 1,164 $(84,209)
======== ========
Operating activities
As of January 31, 2003, we had cash, cash equivalents and marketable
securities of approximately $111.6 million and working capital of $79.6 million.
We generated positive cash flow from operating activities of $6.4 million during
the six months ended January 31, 2003, compared with negative cash flow from
operating activities of $58.1 million during the six months ended January 31,
2002. The increase in cash flow from operating activities is primarily due to
receipt of $19.5 million from the settlement of litigation with Cisco Systems,
significantly reduced operating costs, and favorable changes in working capital
as a result of the timing of receipts and disbursements.
19
Investing activities
Net cash used in investing activities decreased from $35.6 million
during the six months ended January 31, 2003, to $4.8 million for the six months
ended January 31, 2003. Our capital expenditures decreased from $13.4 million
during the six months ended January 31, 2002 to $3.4 million for the six months
ended January 31, 2003, as we completed the majority of the expansion of our
domestic and international network infrastucture during fiscal 2002. Capital
expenditures during the second quarter declined to $1.4 million, primarily due
to the company's distributed softswitch architecture enabling Net2Phone to
continue to expand its product offerings to new markets without requiring
significant incremental infrastructure expenditures. The net cash from the
proceeds from the sale of marketable securities decreased from $80.0 million
during the six months ended January 31, 2002 to $28.6 million for the six months
ended January 31, 2003.
Financing activities
Net cash used in financing activities was $0.5 million during the six
months ended January 31, 2003 compared to net cash provided of $9.7 million
during the six months ended January 31, 2002. During the six months ended
January 31, 2002, we received $14.0 million in a private placement of shares of
preferrred stock for ADIR.
We believe that, based upon our present business plan, our existing
cash resources will be sufficient to meet our currently anticipated working
capital and capital expenditure requirements, and to fund any potential
operating cash flow deficits for at least the next twelve months. If our growth
exceeds current expectations or if we acquire the business or assets of another
company, or if our operating cash flow deficit exceeds our expectations to the
point that we cannot meet our working capital and capital expenditure
requirements, we will need to raise additional capital from equity or debt
sources. There can be no assurance that we will be able to raise such capital on
favorable terms or at all. If we are unable to obtain such additional capital,
we may be required to reduce the scope of our anticipated expansion, which could
have a material effect on our business, financial condition, or results of
operations.
Contractual Obligations and Commercial Commitments
The following table provides a summary of our contractual obligations and
commercial commitments.
Payments Due by Period
-----------------------------------------------------------------
Less than After
Contractual Obligations Total 1 year 1-3 years 4-5 years 5 years
-------- --------- ---------- --------- -------
(in thousands)
Capital lease obligations $ 5,072 $ 3,452 $ 1,620 $ -- $ --
Operating leases 26,605 4,182 12,055 6,722 3,646
Other long term obligations 17,320 17,320 -- -- --
-------- -------- -------- ------- --------
Total contractual obligations $ 48,997 $ 24,954 $ 13,675 $ 6,722 $ 3,646
======== ======== ======== ======= ========
Payments Due by Period
-----------------------------------------------------------------
Less than After
Other Commercial Total 1 year 1-3 years 4-5 years 5 years
Commitments -------- --------- ---------- --------- -------
(in thousands)
Standby letters of credit $ 22,952 $ 20,812 $ 1,605 $ 162 $ 373
Guarantee 531 175 356
-------- -------- ------- ------- --------
Total other commercial
commitments $ 23,483 $ 20,987 $ 1,605 $ 518 $ 373
======== ======== ======= ======= ========
Effects of Inflation
Due to relatively low levels of inflation over the last several years,
inflation has not had a material effect on our results of operations.
Recently Issued Accounting Standards
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities ("SFAS 146"). SFAS 146 requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. Previous accounting guidance was provided by Emerging Issues Task Force
("EITF") Issue No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring) ("EITF 94-3"). SFAS 146 replaces EITF 94-3 and is to be
applied prospectively to exit or disposal activities initiated after December
31, 2002. We do not expect that the adoption of SFAS 146 will have a material
impact on our consolidated financial statements.
20
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure, An Amendment of FASB Statement No. 123.
This statement provides alternative methods of transition for a voluntary change
to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
Statement No. 123 to require more prominent and more frequent disclosures in
financial statements about the effects of stock-based compensation. The
provisions of SFAS No. 148 are effective for fiscal years ending after December
15, 2002, and the interim disclosure provisions are effective for financial
reports containing financial statements for interim periods beginning after
December 15, 2002. We adopt the disclosure provisions of SFAS No. 148 beginning
with the three and nine months ending April 30, 2003. The adoption of SFAS No.
148 will not have an impact on our of operations or financial position as we
currently do not plan to change its method of accounting for stock-based
compensation.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Securities and Exchange Commission's rule related to market risk
disclosure requires that we describe and quantify our potential losses from
market risk sensitive instruments attributable to reasonably possible market
changes. Market risk sensitive instruments include all financial or commodity
instruments and other financial instruments (such as investments and debt) that
are sensitive to future changes in interest rates, currency exchange rates,
commodity prices or other market factors. We are not materially exposed to
market risks from changes in foreign currency exchange rates or commodity
prices. We do not hold derivative financial instruments nor do we hold
securities for trading or speculative purposes. We are exposed to changes in
interest rates primarily from our investments in cash equivalents. Under our
current policies, we do not use interest rate derivative instruments to manage
our exposure to interest rate changes.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. Our Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules 13a-14(c)
and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act")) as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"). Based on such evaluation, such
officers have concluded that, as of the Evaluation Date, our disclosure controls
and procedures are effective in alerting them on a timely basis to material
information relating to Net2Phone (including its consolidated subsidiaries)
required to be included in our reports filed or submitted under the Exchange
Act.
Changes in Internal Controls. Since the Evaluation Date, there have not
been any significant changes in our internal controls or in other factors that
could significantly affect such controls.
21
PART II--OTHER INFORMATION
Item 1. Legal Proceedings
Multi-Tech
On February 15, 2000, Multi-Tech Systems, Inc. filed suit against
Net2Phone and other companies in the United States Federal District Court in
Minneapolis, Minnesota. Multi-Tech alleged that "the defendant companies are
infringing because they are providing the end users with the software necessary
to simultaneously transmit voice and data on their computers in the form of
making a phone call over the Internet." On August 16, 2002, following an initial
hearing, the Court issued an order construing the claims of all the patents in
suit that we consider favorable to our non-infringement defenses. On October 31,
2002, the Court entered a consent judgment dismissing the patent infringement
claims asserted by Multi-Tech Systems, Inc. On November 19, 2002, Multi-Tech
filed an appeal with the United States Court of Appeals for the Federal Circuit.
We continue to defend this lawsuit vigorously.
Class-Actions
Four substantially similar class-action lawsuits were filed in the
United States District Court for the Southern District of New York on behalf of
all persons who acquired our stock between July 29, 1999 and December 6, 2000.
Net2Phone, certain of our executive officers, directors and underwriters
involved in our initial public offering are named as defendants in these
complaints. The complaints allege, in part, that certain underwriters of our
initial public offering violated federal securities laws by failing to disclose
that they had solicited and received undisclosed commissions and allocated
shares in our initial public offering to those investors in exchange for their
agreement to purchase our shares in the after-market at pre-determined prices.
The complaints also allege that, whether or not Net2Phone and the named
executives were aware of the underwriters' arrangements, Net2Phone and the named
executives have statutory liability under the federal securities laws for
issuing a registration statement in connection with our initial public offering
that failed to disclose that these allegedly undisclosed arrangements existed.
The suits against us are substantially the same as suits asserting the same
allegations that have been filed against several hundred other companies that
closed their initial public offerings at or about the same time. The deadline
for all defendants to respond to the complaints has been extended by the court
to which the various cases have been assigned. We recently have been able to
secure the voluntary dismissal of all claims against those executive officers
and directors named in the lawsuits. In addition, our underwriting agreement
with our underwriters provides for indemnification of Net2Phone and its
executives and directors for liabilities arising out of misstatements in our
registration statement attributable to material non-disclosures by the
underwriters. We intend to pursue our indemnification claims against the
underwriters. In addition, we maintain directors and officers liability
insurance coverage which should substantially cover the costs of defending the
various suits. However, an unfavorable decision in these areas could have a
material adverse effect on our business operations, financial condition, results
of operations and cash flows.
Settlement of Cisco Litigation
In August 2002, Net2Phone and its ADIR subsidiary consummated
the settlement of their lawsuit in the United States District Court for the
District of New Jersey against Cisco and a Cisco executive who had been a member
of the board of directors of ADIR Technologies, Inc., our majority-owned
subsidiary. The suit arose out of the relationships that had been created in
connection with Cisco's and Net2Phone's original investments in ADIR and out of
ADIR's subsequent purchase of NetSpeak, Inc. in August 2001. The parties settled
the suit and all related claims against Cisco and the Cisco executive in
exchange for: (i) the transfer, during the first quarter of fiscal 2003, to
Net2Phone of Cisco's and Softbank Asia Infrastructure Fund's respective 11.5%
and 7.0% interests in ADIR, and (ii) the payment by Cisco, during such quarter,
of $19.5 million to Net2Phone and ADIR. As a result of this settlement, the
Company recognized, for the quarter ended October 31, 2002, a gain of $58.4
million consisting of a $38.9 million reduction in minority interests as a
result of the transfer of the ADIR shares and receipt of settlement proceeds of
$19.5 million less $1.6 million of legal and other expenses related to the
settlement that were recorded in fiscal 2002 and $0.4 million in compensation
expense related directly to the settlement that was recorded during the three
months ended January 31, 2003.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
22
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
We held our Annual Meeting of Stockholders on December 19, 2002. At
this meeting, the stockholders voted in favor of the following items listed in
the Proxy Statement dated November 18, 2002:
(1) Election of Directors:
Nominee For Withheld
----------------------------------------------------------------------
James A. Courter 84,223,387 866,875
Daniel H. Schulman 84,769,118 319,144
Jesse P. King 84,555,439 532,823
Michael J. Weiss 84,555,439 532,823
Stephen Goldsmith 84,770,868 317,394
The other continuing directors who were not up for reelection include:
Howard S. Jonas, Stephen M. Greenberg, James R. Mellor, Anthony G. Werner, Joyce
J. Mason, Michael Fischberger, Harry C. McPherson, and Stephen R. Brown.
(2) Ratification of the selection of Ernst & Young, LLP as our
independent auditors for the fiscal year ending July 31, 2003:
For Against Abstain
-----------------------------------------------------------------
84,788,680 267,517 32,065
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits.
Exhibit No. Description
- ----------- -----------
10.1 Employment Agreement by and between the Registrant and Norman Klugman, dated
January 1, 2003.
10.2 Memorandum Amending Employment Agreement by and between the Registrant and Bruce
Shoulson, dated December 10, 2002.
10.3 Memorandum Amending Employment Agreement by and between the Registrant and Glenn
Williams, dated December 20, 2002.
99.1 Certification of the Chief Executive Officer and Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K.
None.
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NET2PHONE, INC.
Date: March 17, 2003 By: /s/ Stephen M. Greenberg
--------------------------------
Stephen M. Greenberg
Chief Executive Officer
Date: March 17, 2003 By: /s/ Arthur Dubroff
--------------------------------
Arthur Dubroff
Chief Financial Officer
24
CERTIFICATIONS
I, Stephen M. Greenberg, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Net2Phone, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 17, 2003
/s/ Stephen M. Greenberg
- ------------------------------
Stephen M. Greenberg
Chief Executive Officer
25
CERTIFICATIONS
I, Arthur Dubroff, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Net2Phone, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 17, 2003
/s/ Arthur Dubroff
- ---------------------------
Arthur Dubroff
Chief Financial Officer
26