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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 April 30, 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 of Incorporation or (I.R.S. Employer
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 ___
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act) Yes X No __
As of June 9, 2003, the registrant had outstanding 30,937,792 shares of
common stock, $.01 par value and 28,920,750 shares of Class A stock, $.01 par
value.
NET2PHONE, INC.
TABLE OF CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of April 30, 2003 and July 31, 2002....................... 3
Condensed Consolidated Statements of Operations for the three months and nine months ended
April 30, 2003 and 2002..................................................................... 4
Condensed Consolidated Statement of Stockholders' Equity for the nine months ended
April 30, 2003.............................................................................. 5
Condensed Consolidated Statements of Cash Flows for the nine months ended April 30, 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............................................................................. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................... 22
Item 4. Controls and Procedures....................................................................... 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................. 23
Item 2. Changes in Securities and Use of Proceeds..................................................... 23
Item 3. Defaults Upon Senior Securities............................................................... 23
Item 4. Submission of Matters to a Vote of Security Holders........................................... 24
Item 5. Other Information............................................................................. 24
Item 6. Exhibits and Reports on Form 8-K.............................................................. 24
Signatures.............................................................................................. 25
Certifications.......................................................................................... 26
2
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
NET2PHONE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
April 30, July 31,
(In thousands, except per share data) 2003 2002
(unaudited) (audited)
ASSETS:
Current assets:
Cash and cash equivalents .................................................. $ 36,854 $ 41,226
Restricted cash - short term ............................................ 1,305 19,904
Marketable securities - current ......................................... 42,593 25,771
Notes receivable from employees - current .................................. 778 855
Due from IDT ............................................................ -- 682
Other current assets ....................................................... 13,164 15,690
--------- ---------
Total current assets .................................................. 94,694 104,128
Property and equipment, net ..................................................... 27,839 32,875
Restricted cash -long term ...................................................... 21,290 3,086
Marketable securities - long term ............................................... -- 18,704
Notes receivable from employees - long term ..................................... 5,890 6,924
Other assets .................................................................... 5,491 5,979
--------- ---------
Total assets .......................................................... $ 155,204 $ 171,696
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable ........................................................... $ 2,282 $ 7,727
Accrued expenses ........................................................... 21,699 27,266
Capital lease obligations - short term ..................................... 2,498 3,003
Due to IDT ................................................................. 212 -
Other current liabilities .................................................. 7,304 15,821
--------- ---------
Total current liabilities ............................................. 33,995 53,817
Other liabilities ............................................................... 2,917 1,973
Capital lease obligations - long term ........................................... 1,539 2,670
Long-term obligations ........................................................... 7,541 -
--------- ---------
Total liabilities ..................................................... 45,992 58,460
Minority interests .............................................................. 7,892 46,881
Redeemable common stock, $.01 par value; 294 and 294 shares outstanding ......... 9,659 9,753
Stockholders' equity:
Common stock, $.01 par value; 200,000 shares authorized including redeemable
shares; 34,026 and 33,871 shares issued ........................... 340 339
Class A stock, $.01 par value, 37,924 shares authorized;
28,984 and 28,995 shares issued ........................... 290 290
Additional paid-in capital ................................................. 886,412 885,165
Accumulated deficit ........................................................ (748,822) (773,266)
Accumulated other comprehensive income ..................................... 659 240
Deferred compensation ...................................................... (7,858) (12,919)
Loans to stockholders ...................................................... (1,942) (2,040)
Treasury stock, at cost; 3,540 and 3,751 shares ............................ (37,418) (41,207)
--------- ---------
Total stockholders' equity ........................................... 91,661 56,602
--------- ---------
Total liabilities and stockholders' equity ........................... $ 155,204 $ 171,696
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
NET2PHONE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Nine months ended Three months ended
(In thousands, except per share data) April 30, April 30,
------------------------------------------------------------
2003 2002 2003 2002
------------------------------------------------------------
Revenue .................................................... $ 70,787 $ 111,293 $ 23,788 $ 30,563
Costs and expenses:
Direct cost of revenue (exclusive of items shown below) 40,386 63,412 14,158 16,830
Selling, general and administrative ................... 40,961 99,661 12,739 25,398
Depreciation and amortization ......................... 7,161 21,116 2,305 7,046
Restructuring, severance, impairment and other items .. 7,584 135,633 1,708 114,436
Settlement of Cisco litigation ........................ (58,034) -- -- --
Acquired in-process research and development .......... -- 13,850 -- --
Non-cash compensation ................................. 7,058 17,919 2,709 6,435
--------- --------- --------- ---------
Total costs and expenses ................. 45,116 351,591 33,619 170,145
--------- --------- --------- ---------
Income (loss) from operations .............................. 25,671 (240,298) (9,831) (139,582)
Interest income, net ....................................... 1,930 3,442 531 584
Other loss, net ............................................ (67) (8,288) (73) (8,179)
--------- --------- --------- ---------
Income (loss) before minority interests .................... 27,534 (245,144) (9,373) (147,177)
Minority interests ......................................... (60) (18,983) (84) (8,685)
--------- --------- --------- ---------
Net income (loss) .......................................... 27,594 (226,161) (9,289) (138,492)
Redeemable common stock accretion .......................... - (133) - -
--------- --------- --------- ---------
Net income (loss) available to common stockholders ......... $ 27,594 $(226,294) $ (9,289) $(138,492)
========= ========= ========= =========
Net income (loss) per common share-basic & diluted ......... $ 0.46 $ (3.89) $ (0.16) $ (2.35)
========= ========= ========= =========
Weighted average of number of common shares used in the
calculation of basic net income per common share .... 59,634 58,162 59,758 59,042
========= ========= ========= =========
Weighted average of number of common shares used in the
calculation of diluted net income per common share ... 59,711 58,162 59,758 59,042
========= ========= ========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
NET2PHONE, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine months ended April 30, 2003
(in thousands)
Common Stock Class A Stock Additional
---------------------- ------------------------ Paid-In Accumulated
Shares Amount Shares Amount Capital Deficit
--------- ----------- ---------- ----------- ------------ ----------
Balance at July 31, 2002 33,871 $ 339 28,995 $ 290 $ 885,165 $(773,266)
Net loss for the nine months ended April 30, 2003 - - - - - 27,594
Foreign currency translation - - - - - -
Unrealized equity securities gain, net - - - - - -
Comprehensive income
Treasury share funding of 401K Plan - - - - - (3,150)
Conversion of Class A stock to common stock 11 - (11) - - -
Exercise of stock options 144 1 - - 137 -
Issuance of Restricted Share grant to executive - - - - 394 -
Repayment of loans to stockholders
Forfeiture of stock options - - - - (729) -
Repricing of stock options - - - - 1,445 -
Amortization of deferred compensation - - - - - -
--------- --------- --------- --------- --------- ---------
Balance at April 30, 2003 34,026 $ 340 28,984 $ 290 $ 886,412 $(748,822)
========= ========= ========= ========= ========= =========
Accumulated
Other Treasury Stock Total
Comprehensive Deferred Loans to ---------------------- Stockholders'
Income (Loss) Compensation Stockholders Shares Amount Equity
------------ ------------ ------------ --------- ---------- ------------
Balance at July 31, 2002 $ 240 $ (12,919) $ (2,040) 3,751 $ (41,207) $ 56,602
Net loss for the nine months ended April 30, 2003 - - - - - 27,594
Foreign currency translation (353) - - - - (353)
Unrealized equity securities gain, net 772 - - - - 772
---------
Comprehensive income 28,013
Treasury share funding of 401K Plan - - - (211) 3,789 639
Conversion of Class A stock to common stock - - - - - -
Exercise of stock options - - - - - 138
Issuance of Restricted Share grant to executive - - - - - 394
Repayment of loans to stockholders 98 98
Forfeiture of stock options - 729 - - - -
Repricing of stock options - (1,445) - - - -
Amortization of deferred compensation - 5,777 - - - 5,777
--------- --------- --------- -------- --------- ---------
Balance at April 30, 2003 $ 659 $ (7,858) $ (1,942) 3,540 $ (37,418) $ 91,661
========= ========= ========= ======== ========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
NET2PHONE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended
(In thousands) April 30,
--------------------------------
2003 2002
--------------------------------
Operating activities:
Net income (loss) .................................................................. $ 27,594 $(226,161)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization ...................................................... 7,161 21,056
Non-cash compensation .............................................................. 7,058 17,518
Loss on sale of assets ............................................................. - 1,921
Write-down of equity investment .................................................... - 7,251
Write-off of acquired in-process research and development .......................... - 13,850
Impairment of assets ............................................................... - 99,710
Restructuring, severance, impairment, and other non-cash items ..................... 7,687 21,902
Charitable contribution ............................................................ - 2,952
Non-cash litigation settlement ..................................................... (38,929) -
Changes in assets and liabilities: - -
Other assets .................................................................... 251 (1,657)
Accounts payable and accrued expenses ........................................... (12,513) (26,418)
Deferred revenue ................................................................ (839) (259)
Net advances from (repayments to) IDT Corporation ............................... 804 (11,174)
--------- ---------
Net cash used in operating activities ................................................... (1,726) (79,509)
Investing activities:
Purchases of property and equipment ................................................ (4,592) (15,974)
Purchases of marketable securities ................................................. (41,033) (71,220)
Proceeds from the sale of marketable securities .................................... 43,331 86,166
Payments of acquisition related obligations ........................................ - (13,889)
Acquisitions, net of cash acquired ................................................. - (27,764)
Issuance of notes receivable....................................................... - (3,912)
Other .............................................................................. 354 (276)
--------- ---------
Net cash used in investing activities ................................................... (1,940) (46,869)
Financing activities:
Proceeds from the issuance of subsidiary preferred stock ........................... - 13,999
Payments of capital lease obligations .............................................. (1,509) (1,349)
Purchases of redeemable common stock ............................................... - (3,306)
Repurchase of common stock ......................................................... - (510)
Release of restricted cash ......................................................... 394 -
Other .............................................................................. 409 283
--------- ---------
Net cash (used in) provided by financing activities ..................................... (706) 9,117
--------- ---------
Net decrease in cash and cash equivalents ............................................... (4,372) (117,261)
Cash and cash equivalents at beginning of period ........................................ 41,226 158,445
--------- ---------
Cash and cash equivalents at end of period .............................................. $ 36,854 $ 41,184
========= =========
Supplemental disclosure of cash flow information:
Cash payments made for interest ......................................................... $ 171 $ 106
========= =========
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. 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 year. Each reference
below to a Fiscal Year refers to the Fiscal Year ending in the year indicated
(e.g., fiscal 2002 refers to the Fiscal Year ended July 31, 2002).
Certain reclassifications have been made to the prior year's condensed
consolidated financial statements to conform to the current year's presentation.
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 adopted the disclosure provisions
of SFAS No. 148 beginning with the three and nine months ended April 30, 2003.
The adoption of SFAS No. 148 did not have an impact on our results of operations
or financial position as we have not changed our method of accounting for
stock-based compensation. The following table illustrates the effect on net
income (loss) and earnings (loss) per share if we had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee compensation.
Nine Months Ended April 30, Three Months Ended April 30,
2003 2002 2003 2002
--------------------------------------------------------------
(in thousands, except per share
amounts)
Net Income (Loss), as reported $ 27,594 $(226,294) $ (9,289) $(138,492)
Add: Stock option-related employee
compensation expense included in
reported net income (loss) 2,434 14,075 1,324 5,221
Deduct: Total stock option-related
employee compensation expense
determined under fair value
based method for all awards 8,067 21,770 2,730 11,222
-------- --------- -------- ---------
Pro forma net income (loss) $ 21,961 $(233,989) $(10,695) $(144,493)
-------- --------- -------- ---------
Basic and diluted earnings per share,
as reported $ 0.46 $ (3.89) $ (0.16) $ (2.35)
-------- --------- -------- ---------
Basic and diluted earnings per share,
Pro forma $ 0.37 $ (4.02) $ (0.18) $ (2.45)
======== ========= ======== =========
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
Statement establishes standards for classifying and measuring as liabilities
certain financial instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. The provisions of SFAS No. 150
are effective for all financial instruments created or modified after May 31,
2003, and otherwise effective at the beginning of the first interim period
beginning after June 15, 2003. We will adopt SFAS No. 150 as of August 1, 2003.
The adoption of SFAS No. 150 will not have a material impact on our consolidated
financial statements.
3. Earnings Per Share
The weighted average number of common shares outstanding for computing
dilutive earnings per share for the nine months ended April 30, 2003, includes
77,000 shares for the assumed conversion of dilutive stock options.The shares
issuable upon the exercise of stock options and warrants are excluded from the
calculation of earnings per share if their effect would be antidilutive. Stock
options of 10.8 million shares for the three months ended April 30, 2003 and 8.9
million shares for the nine months ended April 30, 2003 were not included in the
computation of diluted earnings per share. Stock options of 11.0 million shares
for the three and nine months ended April 30, 2002 were not included in the
computation of diluted earnings per share.
7
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 nine months ended April 30, 2003, we
provided carrier services to IDT of $2.8 million and $5.7 million, respectively
and sold disposable calling cards to IDT affiliates totaling $1.6 million and
$5.1 million, respectively. In the three and nine months ended April 30, 2003,
we purchased wholesale carrier services from IDT of $2.0 million and $8.0
million, respectively.
In the three and nine months ended April 30, 2002, we provided carrier
services to IDT of $2.9 million and $11.1 million, respectively, and sold
disposable calling cards to IDT affiliates totaling $3.1 million and $15.0
million, respectively. In the three and nine months ended April 30, 2002, we
purchased wholesale carrier services from IDT of $6.0 million and $21.2 million,
respectively.
Our corporate headquarters and several other facilities are leased from
IDT. In the three and nine months ended April 30, 2003, we paid IDT $0.3 million
and $1.1 million, respectively, in facilities lease payments. In the three and
nine months ended April 30, 2002, we paid IDT $0.8 million and $3.5 million,
respectively, in facilities lease payments. During the same period, we arranged
for IDT's treasury function to provide investment management services relating
to our portfolio of marketable securities. During this period, IDT's treasury
department purchased $10.1 million in securities and other short term
investments from us based upon our cost plus accrued interest in order to
facilitate transactions for short term liquidity needs more efficiently and cost
effectively.
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 balances we owed to IDT during the three and nine months
ended April 30, 2003 were $2.1 million and $1.3 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 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. 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:
Nine Months Ended April 30, Three Months Ended April 30,
2003 2002 2003 2002
---------- ---------- --------- ---------
(in thousands)
Net income (loss) $ 27,594 $(226,161) $ (9,289) $ (138,492)
--------- --------- --------- ----------
Other Comprehensive Income (Loss):
Foreign currency translation adjustments (353) (219) 2 -
Unrealized gains on available-for-sale
securities 772 359 49 -
--------- --------- --------- -----------
419 140 51 -
--------- --------- --------- -----------
Total comprehensive income (loss) $ 28,013 $(226,021) $ (9,238) $ (138,492)
========= ========= ========= ===========
8
7. Stock Options
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. Options to purchase 6,373,863 shares of common stock
outstanding were 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 April 30, 2003, the Company recorded
compensation expense of $1.0 million and $2.0 million for the three and nine
months ended April 30, 2003, respectively. For the three and nine months ended
April 30, 2002, the Company recorded compensation expense of $2.0 million and
$3.7 million, respectively, 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.
9
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 "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 in a way 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 appeal 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 were 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 have been able to secure the
voluntary dismissal of all claims against our 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 matters 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.
No income taxes have been reported on the gain as we have sufficient
unrecognized net operating loss carry forwards to offset the gain.
During the second quarter of fiscal 2003, we approved and recorded an
additional $0.4 million in compensation expense directly related to the Cisco
litigation settlement.
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:
Nine Months Ended April 30, Three Months Ended April 30,
2003 2002 2003 2002
-------------------------------------------------------------------
(in thousands)
Workforce reductions $ 3,736 $ 11,884 $ 86 $ 5,720
Separation agreements of former CEO,
CFO and COO 2,967 11,653 972 798
Reserve adjustments (2,799) - 607 -
Exit costs 1,828 11,482 43 8,208
Impairment of long-lived assets 1,852 100,614 - 99,710
-------- --------- --------- --------
Total $ 7,584 $ 135,633 $ 1,708 $114,436
======== ========= ========= ========
10
o Restructurings
Fiscal 2003
On October 24, 2002, we announced that we were reducing our staff by
approximately 20%, or 55 employees. This staff reduction was primarily focused
on consolidating our development and support organizations and scaling back
development activities that were not critical to revenue generating business
lines. As a result of this restructuring, for the nine months ended April 30,
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 April 30, 2003 approximately $2.8 million of involuntary
termination benefits have been paid and charged against the liability.
Fiscal 2002
In November 2001, we announced plans to restructure our operations,
which included the elimination of various lines of development business related
to Voice Hosting products and specific Enterprise products, relocation of
certain facilities, and a reduction in workforce by approximately 270 employees.
As a result of this restructuring, there was a charge of $6.2 million related to
terminated employees. All 270 employees to be terminated under the plan were
terminated in November 2001 when the plan was announced.
In February 2002, ADIR announced a reduction of workforce by 60
employees. ADIR reduced its workforce since much of its business plans and
activities focused on developing software for Cisco equipment and an impasse was
reached with Cisco refusing to honor commitments provided to Net2Phone during
ADIR's formation. ADIR recorded a charge of approximately $1.4 million related
to the terminated employees.
Also in February 2002, we announced plans to reduce our workforce by 85
employees or approximately 28%. We underwent a significant restructuring
process, identifying business lines that required lower capital expenditures and
provided a greater return on investment with higher margins. As such, we
significantly reduced our workforce and scaled back certain unprofitable
businesses, including our disposable calling card business and wholesale
termination business. By reducing our workforce and eliminating some associated
allocated costs, we were able to retain the profitable calling cards and
terminating routes. We recorded a severance charge of approximately $3.5 million
relating to the workforce reduction.
Also in April 2002, we communicated plans to further reduce our
workforce by 20 employees. We scaled back our technical development team, which
had been working on projects related to the restructured businesses. We recorded
severance of approximately $0.9 million related to this additional workforce
reduction.
o Separation Agreements of Former CEO, CFO & COO
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 $0.6 million and $9.1 million for the three and nine months ended April 30,
2002, respectively. A nominal charge relating to the amortization of Mr.
Balter's non-compete agreement was recorded for the three months ended April 30,
2003 and a total of $ 1.8 million was recorded for the nine months ended April
30, 2003. There will be future charges of approximately $0.2 million relating to
this separation agreement.
11
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 of fiscal 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 were charges of $0.2 million and $2.6 million for the
three and nine months ended April 30, 2002, respectively, and $0.1 million and
$0.4 million for the three and nine months ended April 30, 2003, respectively.
There will be future charges of approximately $1.4 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
$1.4 million 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 nine months ended
April 30, 2003, we recorded mark-to-market adjustments of $0.1 million and $0.2
million, respectively, relating to this guarantee that reduced previously
recorded compensation expense.
In April 2003, Norman Klugman, our Chief Operating Officer, announced
his intention to resign and will terminate his employment with us. The three
months ended April 30, 2003 reflect a $0.8 million charge related to a severance
agreement reached with Mr. Klugman. Mr. Klugman waived all of his rights under
his employment agreement.
o Reserve Adjustments
For the nine months ended April 30, 2003, we recorded reserve
adjustments of $2.8 million. In the first quarter of fiscal 2003, we reversed
$2.9 million of previously recognized charges as a result of a preliminary
settlement agreement with vendors regarding cancellation charges. In the first
and second quarter of fiscal 2003, we reversed a total of $0.5 million of
previously recognized severance expense as a result of the subsequent retention
of several individuals whose employment had been terminated. These reversals
were partially offset by an additional $0.5 million charge taken during the
third quarter of fiscal 2003 for continued costs associated with unutilized
circuits. Additionally, in accordance with SFAS 146, in the third quarter of
fiscal 2003, we increased our reserve related to exited lease space by $0.1
million based on a review of all related costs.
o Exit Costs & Impairment Charges
Fiscal 2003
For the nine months ended April 30, 2003 we incurred exit charges of
$1.4 million. These include the following: $0.6 million relating to lease
termination costs on various leases, including ADIR's Boca Raton lease, which
was ultimately terminated on May 8, 2003; $0.5 million relating to the sale of
our web-based banner advertising business in fiscal 2002; $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. Additionally, during the
nine months ended April 30, 2003, we recorded favorable mark-to-market
adjustments totaling $0.2 million that relate to the proceeds owed to former
shareholders of an operation we purchased in fiscal 2000 and discontinued during
fiscal 2001.
Fiscal 2002
As part of the November 2001 restructuring plan we reduced operations
at various locations by $1.9 million, eliminated various equipment and network
build-outs by $1.3 million and recorded a charge of $0.9 million related to the
write-down of certain Aplio assets and a litigation-related reserve. During the
third quarter of fiscal 2002, we recorded a charge of $4.7 million related to
the elimination of specific connectivity and related costs; a $0.6 million
charge related to the abandonment of certain leases; and ADIR recorded a charge
of $4.2 million related to the loss on a lease to a facility that was exited.
12
An impairment charge of $83.9 million was recognized during the third
quarter of fiscal 2002 when it was determined that the future undiscounted cash
flows of our long-lived assets were estimated to be insufficient to recover
their related carrying values. As such, the carrying values of these assets were
written down to their estimated fair value, estimated using the present value of
expected future cash flows.
Additionally, during the third quarter of fiscal 2002, as a result of
the significant reduction in ADIR's workforce, the goodwill for ADIR's software
sales reporting unit was tested for impairment and, as a result, a goodwill
impairment loss of $11.5 million was recognized. The fair value used to measure
the impairment was estimated using the present value of expected future cash
flows.
Also during the third quarter of fiscal 2002, as a result of the plan
to restructure its operations and eliminate various lines of development, an
impairment review of our long-lived assets and identifiable intangible assets
was conducted as of April 30, 2002, in accordance with SFAS No. 121. As a result
of this analysis, we recorded impairment charges of approximately $2.0 million
related to customer lists, $0.5 million related to technology and $1.7 million
related to developed product technology assets. The impairment charge was
calculated as the amount by which the carrying amount of the assets exceeded
their fair values, estimated using the present value of expected future cash
flows.
o Reserve Summary
The following table summarizes the remaining reserve balances related
to restructuring, severance, and exit costs:
April 30, 2003 July 31, 2002
-----------------------------------
(in thousands)
Workforce reductions $ 705 $ 2,086
Separation agreements of
former CEO, CFO and COO 1,107 389
Exit costs 6,475 9,624
-----------------------------------
Total $ 8,287 $ 12,099
===================================
11. Subsequent Event
On July 7, 2000, we acquired all of the outstanding capital stock of
Aplio, S.A. As previously reported, we had payment obligations to certain former
shareholders of Aplio with respect to 585,325 shares of the Company's common
stock transferred to those shareholders as partial consideration for the
acquisition of their shares of Aplio. As part of this transaction, and under the
terms of settlement agreements with these shareholders entered into in June and
July, 2001, we were required to pay the shareholders $19.2 million, less the
then current value of the 585,325 shares, on April 30, 2003. The fair market
value of these obligations are recorded in long term obligations and redeemable
stock as of April 30, 2003. On May 7, 2003, as the result of several
simultaneous transactions, our payment obligations with respect to the shares
were extended to May 1, 2006. The former Aplio shareholders transferred their
585,325 Company shares and assigned their rights under the 2001 settlement
agreements to Deutsche Bank AG London in exchange for a payment of $19.2
million. Simultaneously, we and Deutsche Bank amended and restated the
settlement agreements to provide for the extension of the payment obligation to
May 1, 2006 and payment by us of annual interest of 3.5% on the unpaid balance
during the period.
Under the amended and restated settlement agreements, on May 1, 2006,
we are required to purchase from Deutsche Bank the 585,325 shares for a total
price of $19.2 million. However, we also have, at our sole and exclusive option,
the right to cause Deutsche Bank, on or before December 31, 2005, to commence
selling the shares in regular market transactions during the period between
January 2, 2006 and April 25, 2006. In the event we exercise this right, we will
pay Deutsche Bank on May 1, 2006, only the excess of $19.2 million over the
amount, net of commissions, received by Deutsche Bank from the sales of the
shares during this period. As a result we recorded a long term obligation of
$19.2 million less the value of the 585,325 shares of Net2phone common stock on
May 7, 2003. We will continue to mark-to-market this obligation at each
reporting period based on the value of Net2Phone's common stock. The redeemable
common stock balance was eliminated as of the date of this transaction.
13
Our payment obligations are secured by standby letters of credit from a
US commercial bank, which are, in turn, collateralized by a $21.8 million money
market account held by the bank. The letters of credit expire on August 4, 2006.
The restricted money market account funds will be classified as restricted
cash-long term on our balance sheet.
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 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 then
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.
We announced on June 9, 2003, a planned change in our corporate
structure. This plan, which is subject to approval by the Board of Directors,
calls for the creation of two wholly-owned operating subsidiaries and is
intended to provide the investment community with a clearer picture of
Net2Phone's operations, and the ability to understand the value elements of its
two business lines. Net2Phone, Inc., which will act as a holding company, will
own both subsidiaries. We plan to provide segment reporting of the results of
these subsidiaries as their structures are completed in the fourth quarter of
fiscal 2003. The new structure will also allow each of the newly created units
to facilitate its growth opportunities through investments by strategic partners
in each subsidiary, if appropriate.
14
One of the new subsidiaries, Net2Phone Global Services (NGS), is to be
comprised of our ICS and Domestic Retail Services units, while the second,
Net2Phone Cable Telephony (NCT), will be comprised of our Cable Telephony
Solutions unit.
NGS, through its ICS unit, will primarily align itself with
international regional partners that purchase calling time or hardware products
combined with calling time. This unit is expanding its market opportunities by
entering newly liberalized markets, diversifying products to cater to
businesses, as well as penetrating established markets with competitive
offerings. NGS will also be comprised of our Domestic Retail Services unit. This
unit's products include rechargeable calling cards which provide attractive
margins with low churn.
NCT will be responsible for empowering cable operators with all the
tools they need to bring residential cable telephony to their customers in the
US, Western Europe and Latin America. Net2Phone believes that its value
proposition to a cable operator is attractive because it minimizes financial,
operational and technical risks for the cable operator while giving them a
flexible scalable proven product to take to market.
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.
We believe the critical accounting policies noted in our Annual Report
on Form 10-K for the year ended July 31, 2002 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 our Annual Report.
Nine Months Ended April 30, 2003 Compared to Nine Months Ended April 30, 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 VoIP equipment
and services to resellers, IDT and other carriers. Revenue decreased 36.4% from
$111.3 million for the nine months ended April 30, 2002 to $70.8 million for the
nine months ended April 30, 2003. The decrease in revenue was primarily the
result of the restructurings of operations announced during fiscal 2002 and in
October 2002. Our revenues also decreased because we 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 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 VoIP devices.
Direct cost of revenue decreased 36.3% from $63.4 million for the nine months
ended April 30, 2002 to $40.4 million for the nine months ended April 30, 2003.
These costs were 57% of total revenue during each of the aforementioned periods.
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 58.9% from $99.7 million
for the nine months ended April 30, 2002 to $41.0 million for the nine months
ended April 30, 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 these restructurings.
15
Depreciation and amortization. Depreciation and amortization decreased
66.1% from $21.1 million for the nine months ended April 30, 2002 to $7.2
million for the nine months ended April 30, 2003. As a percentage of total
revenues, these costs decreased from 19% for the nine months ended April 30,
2002 to 10.1% for the nine months ended April 30, 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:
Nine Months Ended April 30,
2003 2002
-----------------------------
(in thousands)
Workforce reductions $ 3,736 $ 11,884
Separation agreements of former CEO,
CFO and COO 2,967 11,653
Reserve adjustments (2,799) -
Exit costs 1,828 11,482
Impairment of long-lived assets 1,852 100,614
--------- ---------
--------- ---------
Total $ 7,584 $ 135,633
========= =========
Restructuring, severance, impairment and other items decreased from
$135.6 million for the nine months ended April 30, 2002 to $7.6 million for the
nine months ended April 30, 2003. This decrease is due mainly to various
impairment charges taken in fiscal 2002, including a $83.9 million impairment of
fixed assets, a $11.5 million impairment of goodwill and a $4.2 million
impairment of intangible assets. Also, we went through several restructurings
during fiscal 2002, which resulted in a higher charge related to workforce
reductions. Another factor in the decrease for the nine months ended April 30,
2003 as compared to the nine months ended April 30, 2002 is lower charges in
fiscal 2003 related to the separation agreements of the former CEO and CFO as
components of the agreements become fully amortized. Additionally, exit costs
were higher for the nine months ended April 30, 2002 due mainly to charges
incurred for exiting various locations and eliminating various equipment and
network build-outs. See Note 10 of our Condensed Consolidated Financial
Statements for additional information.
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.
No income taxes have been reported on the gain as we have sufficient net
operating loss carryforwards to offset the gain.
During the second quarter of fiscal 2003, we approved and recorded an
additional $0.4 million in compensation expense directly related to the Cisco
litigation settlement.
16
Acquired in-process research and development. For the nine months ended
April 30, 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 was 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 60.6%
from $17.9 million for the nine months ended April 30, 2002 to $7.1 million for
the nine months ended April 30, 2003. As a percentage of total revenue, these
costs decreased from 16.1% for the nine months ended April 30, 2002 to 10% for
the nine months ended April 30, 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 nine months ended April 30, 2003 and 2002, we recorded
charges of $2.0 million and $3.7 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 $3.3
million for the nine months ended April 30, 2003 and 2002, 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 $240.3 million
for the nine months ended April 30, 2002 as compared to income from operations
of $25.7 million for the nine months ended April 30, 2003. The decrease in loss
from operations is primarily due to operating expenses decreasing at a faster
rate than revenues, lower restructuring, severance, impairment and other related
expenses, and a net gain of $58.0 million from the settlement of the Cisco
litigation during the nine months ended April 30, 2003.
Interest income, net. Interest income consists primarily of interest
earned on cash and cash equivalents. Interest income decreased 43.9% from $3.4
million for the nine months ended April 30, 2002 to $1.9 million for the nine
months ended April 30, 2003. The reduction primarily resulted 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.
Other loss, net. Other losses include the losses or gains resulting
from non-operating transactions. Other losses decreased from $8.3 million during
the nine months ended April 30, 2002 to $0.1 million during the nine months
ended April 30, 2003. During the third quarter of fiscal 2002 we recorded a loss
relating to an other-than-temporary decline in value of several of our cost
method investments resulting in a charge to other loss of approximately $6.9
million and to a loss relating to the sale of equipment of approximately $1.4
million. The other loss incurred during the third quarter of fiscal 2003
reflects a loss on the sale of equipment.
17
Three Months Ended April 30, 2003 Compared to Three Months Ended April 30, 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 VoIP equipment
and services to resellers, IDT and other carriers. Revenue decreased 22.1% from
$30.6 million for the three months ended April 30, 2002 to $23.8 million for the
three months ended April 30, 2003. The decrease in revenue was primarily the
result of the restructurings of operations announced during fiscal 2002 and in
October 2002. Our revenue also decreased because we 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 VoIP devices.
Direct cost of revenue decreased 15.8% from $16.8 million for the three months
ended April 30, 2002 to $14.2 million for the three months ended April 30, 2003.
As a percentage of total revenue, these costs increased from 55.1% for the three
months ended April 30, 2002 to 59.5% for the three months ended April 30, 2003
primarily due to changes in traffic calling patterns.
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 49.8% from $25.4 million
for the three months ended April 30, 2002 to $12.7 million for the three months
ended April 30, 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 these restructurings.
Depreciation and amortization. Depreciation and amortization decreased
67.3% from $7.0 million for the three months ended April 30, 2002 to $2.3
million for the three months ended April 30, 2003. As a percentage of total
revenues, these costs decreased from 23.1% for the three months ended April 30,
2002 to 9.7% for the three months ended April 30, 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 April 30,
2003 2002
-----------------------------
(in thousands)
Workforce reductions $ 86 $ 5,720
Separation agreements of former CEO, 972 798
CFO & COO
Reserve adjustments 607 -
Exit costs 43 8,208
Impairment of long-lived assets - 99,710
--------- --------
--------- --------
Total $ 1,708 $114,436
========= ========
Restructuring, severance, impairment and other items decreased from
$114.4 million for the three months ended April 30, 2002 to $1.7 million for the
three months ended April 30, 2003. This decrease is due mainly to various
impairment charges taken during the third quarter of fiscal 2002, including a
$83.9 million impairment of fixed assets, a $11.5 million impairment of goodwill
and a $4.2 million impairment of intangible assets. Also, we went through
several restructurings during the third quarter of fiscal 2002, which resulted
in a higher charge related to workforce reductions. Additionally, exit costs
were higher for the three months ended April 30, 2002 due mainly to charges
incurred for exiting various locations and the elimination of specific
connectivity and related costs. See Note 10 of our Condensed Consolidated
Financial Statements for additional information.
18
Non-cash compensation. Non-cash compensation charges decreased 57.9%
from $6.4 million for the three months ended April 30, 2002 to $2.7 million for
the three months ended April 30, 2003. As a percentage of total revenue, these
costs decreased from 21.1% for the three months ended April 30, 2002 to 11.4%
for the three months ended April 30, 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 April 30, 2003 and 2002, we recorded a
charge of $1.0 million and $2.0 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. In addition, the
Company has recorded $1.1 million for the three months ended April 30, 2003 and
2002, 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 $139.6 million
for the three months ended April 30, 2002 as compared $9.8 million for the three
months ended April 30, 2003. The decrease in loss from operations is primarily
due to operating expenses decreasing at a faster rate than revenues and lower
restructuring, severance, impairment and other related expenses during the nine
months ended April 30, 2003.
Interest income, net. Interest income consists primarily of interest
earned on cash and cash equivalents. Interest income decreased 9.1% from $0.6
million for the three months ended April 30, 2002 to $0.5 million for the three
months ended April 30, 2003. The reduction primarily results from lower cash
balances and interest rate reductions. We continue to anticipate reduced
interest income for the remainder of fiscal 2003 due to lower interest rates and
cash balances.
Other loss, net. Other losses include the losses or gains resulting
from non-operating transactions. Other losses decreased from $8.2 million for
the three months ended April 30, 2002 to $0.1 million for the three months ended
April 30, 2003. During the third quarter of fiscal 2002 we recorded a loss
relating to an other-than-temporary decline in value of several of our cost
method investments resulting in a charge to other loss of approximately $6.9
million and to a loss relating to the sale of equipment of approximately $1.4
million. The other loss incurred during the third quarter of fiscal 2003
reflects a loss on the sale of equipment.
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 nine months
ended April 30, 2003 and 2002.
Nine Months Ended April 30,
2003 2002
---------- ---------
(in thousands)
Net cash used in operating activities.... $ (1,726) $ (79,509)
Net cash used in investing activities.... (1,940) (46,869)
Net cash (used in) provided by
financing activities..................... (706) 9,117
--------- ---------
Net decrease in cash and cash
equivalents............................. $ (4,372) $(117,261)
========= =========
Operating activities
As of April 30, 2003, we maintained cash, restricted cash, cash
equivalents and marketable securities of $102 million and working capital of
$60.7 million. As of April 30, 2003, we had $1.3 million in short term
restricted cash and $21.3 million in long term restricted cash, as collateral
for various letter of credit obligations. As of April 30, 2003, the majority of
these collateral obligations related to our purchase of Aplio, S.A. from the
stockholders of Aplio. On May 7, 2003, these obligations were assigned to
Deutsche Bank AG London. Our payment obligations to Deutsche Bank are secured by
standby letters of credit from a US commercial bank, which are, in turn,
collateralized by a $21.8 million money market account held by the bank. The
letters of credit expire on August 4, 2006. The restricted money market account
funds will be classified as restricted cash-long term on our balance sheet. For
more information on this assignment, please see Note 11 to our consolidated
financial statements included elsewhere in this Report.
19
We generated negative cash flow from operating activities of $1.7
million during the nine months ended April 30, 2003, compared with negative cash
flow from operating activities of $79.5 million during the nine months ended
April 30, 2002. The decrease in negative 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.
Investing activities
Net cash used in investing activities decreased from $46.9 million
during the nine months ended April 30, 2002, to $1.9 million for the nine months
ended April 30, 2003. Our capital expenditures decreased from $16.0 million
during the nine months ended April 30, 2002 to $4.6 million for the nine months
ended April 30, 2003, as we completed the majority of the expansion of our
domestic and international network infrastructure during fiscal 2002. During the
nine months ended April 30, 2002 we invested $27.8 million in the acquisition of
NetSpeak. No acquisitions were completed during the nine months ended April 30,
2003.
Financing activities
Net cash used in financing activities was $0.7 million during the nine
months ended April 30, 2003 compared to net cash provided of $9.1 million during
the nine months ended April 30, 2002. During the nine months ended April 30,
2002, we received $14.0 million in a private placement of ADIR preferrred stock.
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 as of April 30, 2003.
Payments Due by Period
---------------------------------------------------------------------------------
Contractual Obligations Total Less than 1 year 1-3 years 4-5 years After 5 years
(in thousands)
Capital lease obligations $ 4,037 $ 2,498 $ 1,539 $ -- $ --
Operating leases 26,353 4,619 12,282 6,447 3,005
Other long term obligations 17,200 - - 17,200 -
----------- ----------------- ------------ ------------- -----------
Total contractual obligations $ 47,590 $ 7,117 $ 13,821 $ 23,647 $ 3,005
----------- ----------------- ------------ ------------- -----------
Payments Due by Period
--------------------------------------------------------------------------------
Other Commercial Commitments Total Less than 1 year 1-3 years 4-5 years After 5 years
(in thousands)
Standby letters of credit $ 22,338 $ 1,048 $ 1,605 $ 19,375 $ 310
Guarantees 473 175 298
Purchase Commitments 845 845
----------- -------------- ------------ ------------ --------------
Total other commercial
commitments $ 23,656 $ 2,068 $ 1,605 $ 19,673 $ 310
----------- -------------- ------------ ------------ --------------
20
Related Party Transactions
For a discussion of our related party transactions with IDT Corp., see
Note 4 of our Condensed Consolidated Financial Statements.
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. The adoption of SFAS 146 did not 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 adopted the disclosure provisions
of SFAS No. 148 beginning with the three and nine months ended April 30, 2003.
The adoption of SFAS No. 148 did not have an impact on our of operations or
financial position as we have not changed our method of accounting for
stock-based compensation.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
Statement establishes standards for classifying and measuring as liabilities
certain financial instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. The provisions of SFAS No. 150
are effective for all financial instruments created or modified after May 31,
2003, and otherwise effective at the beginning of the first interim period
beginning after June 15, 2003. We will adopt SFAS No. 150 as of August 1, 2003.
The adoption of SFAS No. 150 will not have a material impact on our consolidated
financial statements.
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.
21
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.
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 "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 in a way 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 appeal 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 were 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 have been able to secure the
voluntary dismissal of the 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 matters 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.
22
During the second quarter of fiscal 2003, we approved and recorded an
additional $0.4 million in compensation expense directly related to the Cisco
litigation settlement.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits.
Exhibit No. Description
- ----------- -----------
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.
The Company filed a report on Form 8-K dated May 14, 2003 reporting
under Item 5 that the Company entered into amended settlement agreements with
shareholders of Aplio, Inc. and assigned the rights under such settlement
agreements to Deutsche Bank AG London.
The Company furnished a report on Form 8-K dated June 9, 2003 reporting
under Item 9 and Item 12 its press release regarding its earnings for the
quarter ended April 30, 2003.
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: June 16, 2003 By: /s/ Stephen M. Greenberg
-------------------------------
Stephen M. Greenberg
Chief Executive Officer
Date: June 16, 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: June 16, 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: June 16, 2003
/s/ Arthur Dubroff
- ------------------
Arthur Dubroff
Chief Financial Officer
26