<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2000
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 (I.R.S. Employer Identification No.)
Incorporation or Organization)
171 Main Street, Hackensack, New Jersey 07601
(Address of Principal Executive Offices, including Zip Code)
Registrant's Telephone Number, Including Area Code: (201) 530-4000
___________________________
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No
---- ---
As of June 12, 2000, the registrant had outstanding 21,524,793 shares of
common stock, $.01 par value and 33,924,250 shares of Class A stock, $.01 par
value
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NET2PHONE, INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
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PART I. FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements:..................................................................... 3
Condensed Consolidated Balance Sheets as of April 30, 2000 and July 31, 1999...................... 3
Condensed Consolidated Statements of Operations for the nine months and three months ended
April 30, 2000 and 1999......................................................................... 4
Condensed Consolidated Statement of Stockholders' Equity for the nine months ended
April 30, 2000.................................................................................. 5
Condensed Consolidated Statements of Cash Flows for the nine months ended April 30, 2000
and 1999........................................................................................ 6
Notes to Condensed Consolidated Financial Statements.............................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................................ 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 13
Item 2. Changes in Securities and Use of Proceeds.................................................. 13
Item 3. Defaults Upon Senior Securities............................................................ 13
Item 4. Submission of Matters to a Vote of Security Holders........................................ 13
Item 5. Other Information.......................................................................... 13
Item 6. Exhibits and Reports on Form 8-K........................................................... 13
Signatures........................................................................................... 15
</TABLE>
2
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PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
NET2PHONE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
April 30, July 31,
---------------- ------------------
2000 1999
------------ ------------
(unaudited) (note 1)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents.................................................... $ 65,265,829 $ 20,379,048
Marketable securities - current.............................................. 59,097,223 --
Trade accounts receivable.................................................... 5,403,433 531,536
Prepaid contract deposits.................................................... 22,917,030 6,162,084
Other current assets......................................................... 10,910,874 999,918
Investment in Yahoo! Inc. Common stock....................................... 105,040,301 --
------------ ------------
Total current assets...................................................... 268,634,690 28,072,586
Property and equipment, net.................................................. 43,208,027 17,844,901
Trademark, net............................................................... 4,481,884 4,791,667
Investments.................................................................. 20,663,546 --
Marketable securities - long term............................................ 52,960,381 --
Other assets................................................................. 1,097,918 107,737
------------ ------------
Total assets.............................................................. $391,046,446 $ 50,816,891
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable............................................................. $ 6,133,417 $ 2,151,778
Accrued expenses............................................................. 4,187,674 4,692,953
Deferred revenue............................................................. 2,686,353 2,370,632
Due to IDT Corporation....................................................... 4,725,820 12,553,771
------------ ------------
Total current liabilities................................................. 17,733,264 21,769,134
Due to IDT Corporation......................................................... -- 5,181,624
------------ ------------
Total liabilities......................................................... 17,733,264 26,950,758
Commitments and contingencies
Redeemable convertible preferred stock, Series A, $.01 par value; 3,150,000 shares
authorized; no and 3,140,000 shares issued and outstanding..................... -- 27,929,000
Stockholders' equity (deficit):
Common stock, par value $.01; 200,000,000 shares authorized 21,135,606 and 211,356 48,198
4,819,777 shares issued and outstanding...................................
Class A stock, par value $.01, 37,042,089 shares authorized; 33,924,250 and 339,242 276,220
27,622,089 shares issued and outstanding..................................
Additional paid-in capital................................................... 508,172,225 61,126,266
Accumulated deficit.......................................................... (67,729,044) (30,455,286)
Accumulated other comprehensive loss......................................... (44,959,699) --
Deferred compensation - stock options........................................ (20,197,957) (31,908,275)
Loans to stockholders........................................................ (2,522,941) (3,149,990)
------------ ------------
Total stockholders' equity (deficit)...................................... 373,313,182 (4,062,867)
------------ ------------
Total liabilities and stockholders' equity (deficit)...................... $391,046,446 $ 50,816,891
============ ============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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NET2PHONE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Nine months ended Three months ended
----------------------------- --------------------------
April 30, April 30,
----------------------------- --------------------------
2000 1999 2000 1999
------------- ------------ ------------- -----------
<S> <C> <C> <C> <C>
Revenue:
Service revenue....................................................... $ 43,083,128 $ 21,757,721 $ 16,157,012 $8,929,301
Product revenue....................................................... 4,395,402 445,536 2,712,789 108,071
------------- ------------ ------------- ----------
Total revenues...................................................... 47,478,530 22,203,257 18,869,801 9,037,372
Costs and expenses:
Direct cost of revenue:
Service cost of revenue........................................... 26,848,960 11,787,689 9,831,614 4,463,938
Product cost of revenue........................................... 2,320,318 60,400 1,111,498 60,400
------------- ------------ ------------- ----------
Total direct cost of revenue.................................... 26,169,278 11,848,089 10,943,112 4,524,338
------------- ------------ ------------- ----------
Gross profit............................................................ 21,309,252 10,355,168 7,926,689 4,513,034
Operating expenses:
Selling and marketing................................................. 26,628,894 4,746,316 11,133,197 1,754,603
General and administrative............................................ 23,497,976 7,298,106 9,779,478 3,111,102
Depreciation and amortization......................................... 3,536,361 1,216,712 1,559,995 477,659
Compensation charge from the issuance of stock options................ 11,710,318 - 4,368,886 -
------------- ------------ ------------- ----------
Total costs and expenses............................................ 91,542,827 25,109,223 37,784,668 9,867,702
Loss from operations.................................................... (44,064,297) (2,905,966) (18,914,867) (830,330)
------------- ------------ ------------- ----------
Interest income, net.................................................... 6,970,539 - 3,148,803 -
------------- ------------ ------------- ----------
Net loss................................................................ ($37,273,758) ($2,905,966) ($15,766,064) ($830,330)
============= ============ ============= ==========
Basic and diluted net loss per common shares............................ ($ .74) ($ .09) ($ .30) ($ .03)
============= ============ ============= ==========
Weighted average number of common shares used in the calculation of
basic and diluted net loss per common share 50,488,359 30,960,000 53,208,004 30,960,000
============= =========== ============= ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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Net2Phone, Inc.
Condensed Consolidated Statement of Stockholders' Equity (Deficit)
(Unaudited)
<TABLE>
<CAPTION>
Additional
Common Stock Class A Stock Paid-In Accumulated
Shares Amount Shares Amount Capital Deficit
--------- -------- ---------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at July 31, 1999.............. 4,819,777 $ 48,198 27,622,089 $276,220 $ 61,126,266 $(30,455,286)
Issuance of Common Stock
in initial public offering.......... 6,210,000 62,100 83,744,373
Conversion of Preferred Stock
to Class A Stock.................... 9,420,000 94,200 27,834,800
Conversion of Class A Stock
to Common Stock..................... 3,117,839 31,178 (3,117,839) (31,178)
Exercise of stock options............. 810,212 8,102 8,146,200
Amortization of
Deferred Compensation...............
Repayment of Loans
to Stockholders.....................
Secondary Equity Offering............. 3,400,000 34,000 177,348,364
Issuance of Common Stock
to Yahoo! Inc....................... 2,777,778 27,778 149,972,222
Comprehensive income:
Net Loss for Nine Months
Ended April 30, 2000................ (37,273,758)
Unrealized investment loss............
========================================================================
Balance at April 30, 2000............. 21,135,606 $211,356 33,924,250 $339,242 $508,172,225 $(67,729,044)
========================================================================
<CAPTION>
Accumulated
Other Total
Comprehensive Deferred Loans to Stockholders'
Loss Compensation Stockholders Equity (Deficit)
------------- ------------ ------------ ---------------
<S> <C> <C> <C> <C>
Balance at July 31, 1999.............. $ (31,908,275) $ (3,149,990) $ (4,062,867)
Issuance of Common Stock
in initial public offering.......... 83,806,473
Conversion of Preferred Stock
to Class A Stock.................... 27,929,000
Conversion of Class A Stock
to Common Stock..................... -
Exercise of stock options............. 8,154,302
Amortization of
Deferred Compensation............... 11,710,318 11,710,318
Repayment of Loans
to Stockholders..................... 627,049 627,049
Secondary Equity Offering............. 177,382,364
Issuance of Common Stock
to Yahoo! Inc....................... 150,000,000
Comprehensive income:
Net Loss for Nine Months
Ended April 30, 2000................ (37,273,758)
Unrealized investment loss............ (44,959,699) (44,959,699)
========================================================================
Balance at April 30, 2000............. $ (44,959,699) $ (20,197,957) $ (2,522,941) $ 373,313,182
========================================================================
</TABLE>
The accompanying notes are an integral part
of these condensed consolidated financial statements.
5
<PAGE>
NET2PHONE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
April 30,
2000 1999
------------- -----------
<S> <C> <C>
Operating activities:
Net loss......................................................................... ($37,273,758) ($2,905,966)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization.................................................... 3,536,361 1,216,712
Amortization of deferred compensation............................................ 11,710,318 --
Changes in assets and liabilities:
Accounts receivable.............................................................. (4,871,897) 1,135,898
Prepaid contract deposits........................................................ (16,754,946) (4,000,000)
Other current assets............................................................. (9,910,955) (31,051)
Other assets..................................................................... (990,182) (10,614)
Accounts payable................................................................. 3,981,639 (97,501)
Accrued expenses................................................................. (505,279) --
Deferred revenue................................................................. 315,721 685,661
------------- ------------
Net cash used in operating activities.............................................. (50,762,978) (4,006,861)
Investing activities:
Purchases of property and equipment.............................................. (28,589,706) (4,035,869)
Purchases of marketable securities - net......................................... (112,057,602) --
Purchase of trademark............................................................ -- (5,000,000)
Investments...................................................................... (20,663,546) --
------------- ------------
Net cash used in investing activities.............................................. (161,310,854) (9,035,869)
Financing activities:
Proceeds from issuance of common stock in initial public offering, net........... 83,806,473 --
Proceeds from issuance of common stock in secondary offering, net................ 177,382,364 --
Proceeds from exercise of stock options.......................................... 8,154,302 --
Proceeds from repayment of loans to stockholders................................. 627,049 --
Net (repayments to) advances from IDT Corporation................................ (13,009,575) 10,185,012
Capital contributions from IDT Corporation....................................... -- 4,629,838
------------- ------------
Net cash provided by financing activities.......................................... 256,960,613 14,814,850
------------- ------------
Net increase in cash and cash equivalents.......................................... 44,886,781 1,772,120
Cash and cash equivalents at beginning of period................................... 20,379,048 10,074
------------- ------------
Cash and cash equivalents at end of period......................................... $ 65,265,829 $ 1,782,194
============= ============
Supplemental disclosure of cash flow information:
Cash payments made for interest.................................................... $ 558,355 $ --
============= ============
Cash payments made for income taxes................................................ $ -- $ --
============= ============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
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NET2PHONE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Net2Phone, Inc. and Subsidiaries (collectively "the Company") have been prepared
in accordance with generally accepted accounting principles 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 generally accepted accounting principles for annual
financial statements. In the opinion of management, all adjustments (consisting
only of normal recurring accruals) considered necessary for a fair presentation
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, 1999 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. For further information, refer to the financial statements
and notes thereto included in Net2Phone's annual report on Form 10-K for the
year ended July 31, 1999.
Marketable Securities
Marketable securities consist of debt securities, which are considered to
be held to maturity, and are carried at amortized cost which approximates fair
value .
2. Recently Issued Accounting Standards
In June, 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which is
required to be adopted in fiscal years beginning after June 15, 2000. Management
does not anticipate that the adoption of this standard will have a significant
effect on earnings or the financial position of the Company.
3. Earnings Per Share
The shares issuable upon the exercise of stock options and warrants are
excluded from the calculation of net loss per share as their effect would be
antidilutive.
4. Secondary Offering
On November 30, 1999, the Company completed a public offering of 7,245,000
shares of common stock at a price of $55.00 per share. 3,845,000 shares were
sold by selling stockholders and 3,400,000 shares were sold by Net2Phone. Net
proceeds to Net2Phone, after deducting underwriting discounts and commissions
and offering expenses were approximately $177.9 million.
5. Investments
In March 2000, the Company acquired 806,452 shares of Yahoo! Inc. in
exchange for 2,777,778 shares of the Company's common stock at a then equivalent
market value of approximately $150,000,000. As of April 30, 2000 the market
value of the Yahoo! shares was $105,040,000. The Company accounts for its
investment in Yahoo! in accordance with SFAS No. 115 Accounting for Certain
Investments in Debt and Equity Securities. The unrealized depreciation of
approximately $45 million has been recorded as other comprehensive loss in the
accompanying statement of stockholders' equity.
In February 2000, the Company acquired 1,696,667 shares of WebDialogs
Series D Convertible Preferred Stock at $5.893 per share. WebDialogs is an e-
commerce enabler that focuses on collaborative browsing applications. The
Company is accounting for this investment using the cost method.
In March 2000, the Company acquired 181,818 shares of eCal Corporation
Series G Preferred stock at $11.00 per share. eCal is a supplier of internet
calendar communications. This investment is being accounted for using the cost
method.
7
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In January 2000, the Company purchased 240,000 shares of Series A Preferred
Stock at $3.00 per share in WebEx, a provider of online meetings on the Web. In
March 2000, the Company purchased 14,640 shares of Series D Preferred Stock at
$12.50 per share. These investments are being accounted for using the cost
method
In April 2000, the Company acquired 38,352 shares of Webley Systems, Inc.
Series B Preferred stock at $195.56 per share. Webley is a unified
communications and messaging provider. This investment is being accounted for
using the cost method.
6. Warrant Issued to America Online
In connection with the Company's distribution and marketing agreement with
ICQ, the Company issued a warrant to America Online to purchase up to 3% of the
Company's outstanding capital stock on a fully-diluted basis. This warrant will
vest in 1% increments upon the achievement of each of three incremental
thresholds of revenue generated under the agreement during the first four years
the warrant is outstanding. The per share exercise price under the warrant will
be equal to the lesser of $12.00 per share or $450 million divided by the number
of the Company's fully-diluted shares on the initial exercise date.
The warrants are accounted for in accordance with the provisions of EITF 96-
18, "Accounting for Equity Instruments that are Issued to Other than Employees
for Acquiring or in Conjunction with Selling, Goods or Services." Due to the
uncertainty of reaching the performance measures stipulated in the warrant
agreement, the Company has not recorded any expense relating to the issuance of
the warrant. Upon determination that the achievement of the revenue thresholds
is probable ("measurement date"), the Company will value the warrant and expense
it over the remaining period until the performance criteria is met. The three
thresholds of revenues are $10 million, $50 million and $75 million and the term
of the distribution and marketing agreement is four years. If the three
incremental thresholds had been met on April 30, 2000, the Company would have
expensed $77 million.
In November 1999, the warrant was amended to include the right to purchase
an additional .5% of the Company's outstanding capital stock on a fully diluted
basis at a per share exercise price of $60.46 per share upon the achievement of
$100 million of revenue.
7. Related Party Transactions
In February 2000, the remaining principal of the promissory note to IDT of
$5,951,000 was repaid.
8. AT&T Agreement
On March 31, 2000, we entered into an agreement with AT&T Corp. and IDT
Corporation. Pursuant to the terms of the agreement, we agreed, subject to
stockholder approval and the satisfaction of other conditions, to issue to
Newco, a newly formed corporation controlled by AT&T, 4,000,000 newly-authorized
shares of our Class A Common Stock for an aggregate purchase price of
$300,000,000. In addition, the agreement between AT&T and IDT provides that
Newco, upon our stockholders' approval and satisfaction of the other conditions
in the agreement, purchase from IDT 14.9 million of the approximately 24.9
million shares of our Class A Common Stock it owns for an aggregate purchase
price of approximately $1.1 billion. Upon consummation of these transactions:
. Newco will own approximately 32% of our outstanding capital stock, but it
will control 39% of the aggregate voting power of our capital stock because
it will hold Class A Common Stock with two votes per share. Newco also has
a right of first refusal to purchase IDT's remaining shares of our Class A
Common Stock. If IDT sells all its remaining shares and Newco exercises its
right to purchase such shares, Newco will have approximately a 49% economic
interest and approximately a 59% voting interest in Net2Phone. This right
of first refusal expires on August 1, 2003.
. IDT's ownership of our outstanding capital stock will be reduced from
approximately 45% to 17%, and its voting power will be reduced from
approximately 56% to 21%. IDT's voting power can be further reduced by the
conversion of its remaining shares of our Class A Common Stock (2 votes per
share) to our common stock (1 vote per share) upon Newco's cash payment to
IDT of an amount equal to 10% of the average daily closing price per share
of our common stock for the 20-day trading period ending on the day prior
to the date Newco notifies IDT that it wishes to exercise its right of
conversion. This right of conversion expires on August 1, 2003.
. Newco and IDT will enter into a voting agreement with respect to the
election of mutually acceptable nominees to the Board. So long as they
agree on nominees, Newco and IDT will collectively control approximately
60% of our voting power and will therefore likely control the election of
all our directors; however, if they are unable to agree on acceptable
8
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nominees, the votes of our other stockholders will determine the election
of our directors. This agreement terminates by its terms no later than
August 1, 2003.
. Initially, Newco also will have the right to designate three individuals to
be appointed as directors on our Board, one of whom shall be elected to
fill the vacancy created by the resignation of a director designated by
IDT. Newco and IDT has each agreed to use its best efforts, so long as it
beneficially owns between 15% and 85% of our voting power, to assure that
our Board consists of at least 5 directors who are not employees of or
affiliated with Net2Phone, IDT, AT&T or Newco or any of their affiliates.
These "independent" directors will take action on behalf of our Board on
matters involving or relating to our relationship with Newco, IDT, AT&T and
other interested parties.
We have agreed, subject to and in connection with the transactions, to:
. grant to AT&T and IDT, on terms, conditions and pricing to be negotiated
that are no less favorable than those granted to other licensees of
Net2Phone, a license for our present and future technology; and
. enter into a registration rights agreement, which grants Newco certain
demand and piggyback registration rights with respect to the shares of our
capital stock acquired by it from IDT and from us.
Further, pursuant to the letter agreement, AT&T has agreed to support good
faith negotiations to work together with us to enter into certain commercial
arrangements.
A portion of the options outstanding under our stock option plan held by
our officers and employees contain change of control provisions that will give
rise to accelerated vesting as a result of the transactions with AT&T and IDT.
The accelerated vesting of stock options upon consummation of the transactions
will result in a one-time non-cash charge against earnings in the first quarter
of fiscal 2001 (assuming the transactions are consummated in the first quarter)
of approximately $12 million. In addition, we previously granted to IDT
employees options to purchase our common stock pursuant to our stock option
plan. The transactions with AT&T and IDT could cause the options held by IDT
employees to terminate. Therefore, our Board has agreed to take all necessary
action to ensure that the rights of the employees of IDT under the plan are not
terminated or affected in any way as a result of the transactions. The extension
of the stock options will result in a one time non-cash charge against earnings,
prior to the closing of the transactions, which is currently estimated to be
approximately $28 million, and additional significant charges over the remaining
vesting period of such options.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion of the financial condition and results of
operations of Net2Phone should be read in conjunction with the Management's
Discussion and Analysis of Financial Condition and Results of Operations and the
Consolidated Financial Statements and the Notes thereto included in the
Company's Annual Report on Form 10-K for the year ended July 31, 1999. 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. All forward-
looking statements and risk factors included in this document are made as of the
date hereof, based on information available to Net2Phone as of the date thereof,
and Net2Phone assumes no obligation to update any forward-looking statement or
risk factors.
Nine Months Ended April 30, 2000 Compared to Nine Months Ended April 30, 1999
Results of Operations
Revenue. Our revenues are derived from per-minute charges we billed to our
customers on a pre-paid basis and from the sale of internet telephony equipment
and services to resellers, IDT and other carriers. Revenue increased 114% from
approximately $22.2 million for the nine months ended April 30, 1999 to
approximately $47.5 million for the nine months ended April 30, 2000. The
increase in revenue was primarily due to an increase in billed minutes of use
resulting from additional marketing of our products and services and the
introduction of our product line of internet telephony devices.
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 cost of internet
telephony devices. Direct cost of revenue increased by 121%, from approximately
$11.8 million for the nine months ended April 30, 1999 to approximately $26.2
million for the nine months ended April 30, 2000. As a percentage of total
revenue, these costs increased from approximately 53.4% for the nine months
9
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ended April 30, 1999 to approximately 55.1% for the nine months ended April 30,
2000. This increase is primarily attributable to monthly recurring costs from
leased lines and other connectivity in anticipation of increased traffic volumes
from our various distribution relationships.
Selling and Marketing. Selling and marketing expenses consist primarily of
expenses associated with acquiring customers, including commissions paid to our
sales personnel, advertising costs, referral fees and amounts paid to our
strategic partners, some of which contain revenue-sharing arrangements. Selling
and marketing expenses increased approximately 461% from approximately $4.7
million for the nine months ended April 30, 1999 to approximately $26.6 million
for the nine months ended April 30, 2000. This increase primarily reflects the
increased marketing and advertising expenses associated with the agreements
established with Priceline.com, Compuserve, Infospace.com, Yahoo!, Excite, Snap
and other strategic partners.
General and Administrative. General and administrative expenses consist of
the salaries of our employees and associated benefits, and the cost of
insurance, travel, entertainment, rent and utilities. General and administrative
expenses increased approximately 222% from approximately $7.3 million for the
nine months ended April 30, 1999 to approximately $23.5 million for the nine
months ended April 30, 2000. As a percentage of total revenue these costs
increased from approximately 33% for the nine months ended April 30, 1999 to
approximately 49% for the nine months ended April 30, 2000. This increase was
primarily attributable to the additional organizational infrastructure and
increase in personnel as the Company continues to build its operations, customer
service, marketing and business development functions.
Depreciation and Amortization. Depreciation and amortization increased
approximately 191% from approximately $1.2 million for the nine months ended
April 30, 1999 to approximately $3.5 million for the nine months ended April 30,
2000. As a percentage of total revenues, these costs increased from
approximately 5.5% for the nine months ended April 30, 1999 to approximately
7.4% for the nine months ended April 30, 2000. Depreciation will continue to
increase as we increase capital expenditures for the deployment of network
equipment both domestically and internationally to manage increased call
volumes.
Compensation Charge from the Issuance of Stock Options. We recognized $11.7
million of non-cash compensation expense in the nine months ended April 30,
2000. As a percentage of total revenue, the compensation charge from the
issuance of stock options was 24.7%. No compensation charge from the issuance of
stock options was recognized in the nine months ended April 30, 1999.
Loss from Operations. Loss from operations was approximately $2.9 million for
the nine months ended April 30, 1999 as compared to loss from operations of
approximately $44.1 million for the nine months ended April 30, 2000. Excluding
the non-cash compensation charge described above, our loss from operations for
the nine months ended April 30, 2000 would have been $32.4 million.
Interest Income, net. Interest income, consists primarily of interest
earned on cash and cash equivalents. Interest income for the nine months ended
April 30, 2000 was approximately $7.0 million. No interest income was recognized
for the nine months ended April 30, 1999. The interest income resulted from the
investment of the proceeds of our offerings.
Three Months Ended April 30, 2000 Compared to Three Months Ended April 30, 1999
Results of Operations
Revenue. Our revenues are derived from per-minute charges we billed to our
customers on a pre-paid basis and from the sale of internet telephony equipment
and services to resellers, IDT and other carriers. Revenue increased 109% from
approximately $9.0 million for the three months ended April 30, 1999 to
approximately $18.9 million for the three months ended April 30, 2000. The
increase in revenue was primarily due to an increase in billed minutes of use
resulting from additional marketing of our products and services and the
introduction of our product line of internet telephony devices.
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 cost of internet
telephony devices. Direct cost of revenue increased by 142%, from approximately
$4.5 million for the three months ended April 30, 1999 to approximately $10.9
million for the three months ended April 30, 2000. As a percentage of total
revenue, these costs increased from approximately 50.1% for the three months
ended April 30, 1999 to approximately 58% for the three months ended April 30,
2000. This increase is primarily attributable
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to monthly recurring costs from leased lines and other connectivity in
anticipation of increased traffic volumes from our various distribution
relationships.
Selling and Marketing. Selling and marketing expenses consist primarily of
expenses associated with acquiring customers, including commissions paid to our
sales personnel, advertising costs, referral fees and amounts paid to our
strategic partners, some of which contain revenue-sharing arrangements. Selling
and marketing expenses increased approximately 535% from approximately $1.8
million for the three months ended April 30, 1999 to approximately $11.1 million
for the three months ended April 30, 2000. This increase primarily reflects the
increased marketing and advertising expenses associated with the agreements
established with Priceline.com, Compuserve, Infospace.com, Yahoo!, Excite, Snap
and other strategic partners.
General and Administrative. General and administrative expenses consist of
the salaries of our employees and associated benefits, and the cost of
insurance, travel, entertainment, rent and utilities. General and administrative
expenses increased approximately 214% from approximately $3.1 million for the
three months ended April 30, 1999 to approximately $9.8 million for the three
months ended April 30, 2000. As a percentage of total revenue these costs
increased from approximately 34.4% for the three months ended April 30, 1999 to
approximately 51.8% for the three months ended April 30, 2000. This increase was
primarily attributable to the additional organizational infrastructure and
increase in personnel as the Company continues to build its operations, customer
service, marketing and business development functions.
Depreciation and Amortization. Depreciation and amortization increased
approximately 226% from approximately $478,000 for the three months ended April
30, 1999 to approximately $1.6 million for the three months ended April 30,
2000. As a percentage of total revenues, these costs increased from
approximately 5.3% for the three months ended April 30, 1999 to approximately
8.3% for the three months ended April 30, 2000. Depreciation will continue to
increase as we increase capital expenditures for the deployment of network
equipment both domestically and internationally to manage increased call
volumes.
Compensation Charge from the Issuance of Stock Options. We recognized $4.4
million of non-cash compensation expense in the three months ended April 30,
2000. As a percentage of total revenue, the compensation charge from the
issuance of stock options was 23.2%. No compensation charge from the issuance of
stock options was recognized in the three months ended April 30, 1999.
Loss from Operations. Loss from operations was approximately $0.8 million for
the three months ended April 30, 1999 as compared to loss from operations of
approximately $18.9 million for the three months ended April 30, 2000. Excluding
the non-cash compensation charge described above, our loss from operations for
the three months ended April 30, 2000 would have been $14.5 million.
Interest Income, net. Interest income, consists primarily of interest earned
on cash and cash equivalents. Interest income for the three months ended April
30, 2000 was approximately $3.1 million. No interest income was recognized for
the three months ended April 30, 1999. The interest income resulted from the
investment of the proceeds of our offerings.
Liquidity and Capital Resources
In the nine months ended April 30, 2000, the Company has invested over
$20,000,000 in six companies, primarily to enhance strategic relationships and
to provide access to emerging technologies in order to strengthen the Company's
products and services. As of April 30, 2000, the Company had cash, cash
equivalents and marketable securities of approximately $177.3 million and
working capital of approximately $251 million. The Company generated negative
cash flow from operating activities of approximately $50.8 million during the
nine months ended April 30, 2000, compared with negative cash flow from
operating activities of $4.0 million during the nine months ended April 30,
1999. The decrease in cash flow from operating activities was primarily caused
by an increase in the net loss before depreciation and amortization and non-cash
compensation expense and an increase in prepaid and other assets.
The Company's capital expenditures increased from approximately $4.0 million
in the nine months ended April 30, 1999 to approximately $28.6 million in the
nine months ended April 30, 2000, as the Company expanded its domestic and
international network infrastucture.
The Company believes that, based upon its present business plan, the Company's
existing cash resources will be sufficient to meet its currently anticipated
working capital and capital expenditure requirements for at least twelve months.
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On March 31, 2000, we entered into an agreement with AT&T Corp. and IDT
Corporation. Pursuant to the terms of the agreement, we agreed, subject to
stockholder approval and the satisfaction of other conditions, to issue to
Newco, a newly formed corporation controlled by AT&T, 4,000,000 newly-authorized
shares of our Class A Common Stock for an aggregate purchase price of
$300,000,000. In addition, the agreement between AT&T and IDT provides that
Newco, upon our stockholders' approval and satisfaction of the other conditions
in the agreement, purchase from IDT 14.9 million of the approximately 24.9
million shares of our Class A Common Stock it owns for an aggregate purchase
price of approximately $1.1 billion. Upon consummation of these transactions:
. Newco will own approximately 32% of our outstanding capital stock, but it
will control 39% of the aggregate voting power of our capital stock because
it will hold Class A Common Stock with two votes per share. Newco also has
a right of first refusal to purchase IDT's remaining shares of our Class A
Common Stock. If IDT sells all its remaining shares and Newco exercises its
right to purchase such shares, Newco will have approximately a 49% economic
interest and approximately a 59% voting interest in Net2Phone. This right
of first refusal expires on August 1, 2003.
. IDT's ownership of our outstanding capital stock will be reduced from
approximately 45% to 17%, and its voting power will be reduced from
approximately 56% to 21%. IDT's voting power can be further reduced by the
conversion of its remaining shares of our Class A Common Stock (2 votes per
share) to our common stock (1 vote per share) upon Newco's cash payment to
IDT of an amount equal to 10% of the average daily closing price per share
of our common stock for the 20-day trading period ending on the day prior
to the date Newco notifies IDT that it wishes to exercise its right of
conversion. This right of conversion expires on August 1, 2003.
. Newco and IDT will enter into a voting agreement with respect to the
election of mutually acceptable nominees to the Board. So long as they
agree on nominees, Newco and IDT will collectively control approximately
60% of our voting power and will therefore likely control the election of
all our directors; however, if they are unable to agree on acceptable
nominees, the votes of our other stockholders will determine the election
of our directors. This agreement terminates by its terms no later than
August 1, 2003.
. Initially, Newco also will have the right to designate three individuals to
be appointed as directors on our Board, one of whom shall be elected to
fill the vacancy created by the resignation of a director designated by
IDT. Newco and IDT has each agreed to use its best efforts, so long as it
beneficially owns between 15% and 85% of our voting power, to assure that
our Board consists of at least 5 directors who are not employees of or
affiliated with Net2Phone, IDT, AT&T or Newco or any of their affiliates.
These "independent" directors will take action on behalf of our Board on
matters involving or relating to our relationship with Newco, IDT, AT&T and
other interested parties.
We have agreed, subject to and in connection with the transactions, to:
. grant to AT&T and IDT, on terms, conditions and pricing to be negotiated
that are no less favorable than those granted to other licensees of
Net2Phone, a license for our present and future technology; and
. enter into a registration rights agreement, which grants Newco certain
demand and piggyback registration rights with respect to the shares of our
capital stock acquired by it from IDT and from us.
Further, pursuant to the letter agreement, AT&T has agreed to support good
faith negotiations to work together with us to enter into certain commercial
arrangements.
A portion of the options outstanding under our stock option plan held by our
officers and employees contain change of control provisions that will give rise
to accelerated vesting as a result of the transactions with AT&T and IDT. The
accelerated vesting of stock options upon consummation of the transactions will
result in a one-time non-cash charge against earnings in the first quarter of
fiscal 2001 (assuming the transactions are consummated in the first quarter) of
approximately $12 million. In addition, we previously granted to IDT employees
options to purchase our common stock pursuant to our stock option plan. The
transactions with AT&T and IDT could cause the options held by IDT employees to
terminate. Therefore, our Board has agreed to take all necessary action to
ensure that the rights of the employees of IDT under the plan are not terminated
or affected in any way as a result of the transactions. The extension of the
stock options will result in a one time non-cash charge against earnings, prior
to the closing of the transactions, which is currently estimated to be
approximately $28 million, and additional significant charges over the remaining
vesting period of such options.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
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PART II--OTHER INFORMATION
Item 1. Legal Proceedings
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. In its press release, Multi-Tech stated that "the defendant companies
are infringing because they are providing the end users with the software
necessary to simultaneously transmit voice and data on their computers in the
form of making a phone call over the Internet." Net2Phone intends to defend the
lawsuit vigorously. Net2Phone has filed an answer and a scheduling conference is
planned for June 26, 2000. Net2Phone believes that the Multi-Tech claims are
without merit. However, should a judge issue an injunction against Net2Phone
requiring that Net2Phone cease distributing its software or providing its
software-based services, such an injunction could have an adverse effect on
Net2Phone's business operations.
Item 2. Changes in Securities and Use of Proceeds
On November 30, 1999, the Securities and Exchange Commission declared
effective Net2Phone's registration statement on Form S-1 (File No. 333-90317),
pursuant to which Net2Phone completed a public offering of 7,245,000 shares of
common stock at an offering price of $ 55.00 per share (the "Secondary
Offering"). 3,845,000 shares were sold by selling stockholders and 3,400,000
shares were sold by Net2Phone. The Secondary Offering was managed by Hambrecht &
Quist LLC, Donaldson Lufkin & Jenrette Securities Corporation, Deutsche Bank
Securities, BancBoston Robertson Stephens Inc. and Bear, Stearns & Co. Inc.
Proceeds to Net2Phone were approximately $177.9 million after deducting
underwriting commissions and discounts of approximately $8.6 million and
expenses of $620,000. Net2Phone expects to use the net proceeds for developing
and maintaining strategic relationships, advertising and promotion, upgrading
and expanding its network, international expansion, research and development,
potential acquisitions and general corporate purposes. Over the past five months
the Company has entered into and expanded upon its strategic distribution
relationships and invested considerably to build its consumer brand. In
addition, the Company has expanded its network to reach more points of presence,
both domestically and internationally and is in the process of upgrading its
fiber capacity.
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Information
Not Applicable.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits.
Exhibit No. Description
----------- -----------
3.1* Certificate of Incorporation, as amended.
3.2* Bylaws.
3.3* Certificate of Amendment to the Restated Certificate of
Incorporation of the Registrant.
3.4* Certificate of Amendment to the Restated Certificate of
Incorporation of the Registrant.
4.1* Specimen Common Stock Certificate of the Registrant.
10.1* Employment Agreement, dated May 1, 1997, by and between Clifford
M. Sobel and IDT Corporation.
10.2* Amendment to Employment Agreement between IDT Corporation and
Clifford M. Sobel, dated as of May 11, 1999, by and between
Clifford M. Sobel, IDT Corporation and the Registrant.
10.3#* Bundling and Distribution Services Agreement, dated as of April
30, 1999, by and between Netscape Communications Corporation and
the Registrant.
10.4* General License Terms & Conditions, dated as of April 30, 1999, by
and between
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Netscape Communications Corporation and the Registrant.
10.5* Trademark License Agreement, dated as of April 30, 1999, by and
between Netscape Communications Corporation and the Registrant.
10.6* Internet/Telecommunications Agreement, dated as of May 7, 1999, by
and between IDT Corporation and the Registrant.
10.7* Joint Marketing Agreement, dated as of May 7, 1999, by and between
IDT Corporation and the Registrant.
10.8* IDT Services Agreement, dated as of May 7, 1999, by and between
IDT Corporation and the Registrant.
10.9* Net2Phone Services Agreement, dated as of May 7, 1999, by and
between IDT Corporation and the Registrant.
10.10* Assignment Agreement, dated as of May 7, 1999, by and between IDT
Corporation and the Registrant.
10.11* Tax Sharing and Indemnification Agreement, dated as of May 7,
1999, by and between IDT Corporation and the Registrant.
10.12* Separation Agreement, dated as of May 7, 1999, by and between IDT
Corporation and the Registrant.
10.13* Lease Agreement, dated as of March 1, 1999, by and between 171-173
Main Street Corporation and the Registrant.
10.14* Lease Agreement, dated as of March 1, 1999, by and between 294-298
State Street Corporation and the Registrant.
10.15* The Registrant's Amended and Restated 1999 Stock Option and
Incentive Plan.
10.16* Series A Subscription Agreement, dated as of May 13, 1999, by and
between the Investors listed therein and the Registrant.
10.17* Series A Preferred Shareholder Registration Rights Agreement,
dated as of May 13, 1999, by and between the Investors listed
therein and the Registrant.
10.18* Form of Warrant to Purchase Common Stock.
10.19* Promissory Note of Registrant to IDT Corporation, dated as of May
12, 1999.
10.20* Stockholders Agreement, dated as of May 13, 1999, by and among the
Investors listed therein, IDT Corporation, Clifford M. Sobel,
the trustee of the Scott Sobel Annual Gift Trust and the
Registrant.
10.21* Letter agreement, dated as of May 12, 1999, by and among IDT
Corporation, Clifford M. Sobel and the Registrant.
10.22* Letter agreement, dated as of May 17, 1999, by and among IDT
Corporation, Clifford M. Sobel and the Registrant.
10.23* Co-Location and Facilities Management Services Agreement, dated as
of May 20, 1999, by and between IDT Corporation and the
Registrant.
10.24* Form of Loan Agreement between the Registrant and each of its
executive officers.
10.25* Form of Stock Option Agreement for Executive Officers.
10.26#* Letter agreement, dated as of June 25, 1999, by and between
National Broadcasting Company, Inc. and the Registrant.
10.27* Employment Agreement, dated July 2, 1999, by and between Jonathan
Fram and the Registrant.
10.28#* IP Telephony Services Distribution and Interactive Marketing
Agreement, dated as of July 15, 1999, by and between ICQ, Inc.
and the Registrant.
10.29#* Stock Subscription Warrant, dated July 15, 1999, by and between
America Online, Inc. and the Registrant.
10.30* Amendment No. 1 to Employment Agreement, dated July 16, 1999, by
and between Jonathan Fram and the Registrant.
10.31** Amendment to Stock Subscription Warrants, dated November 19, 1999,
by and between America Online, Inc. and the Registrant.
10.32*** Letter Agreement, dated March 30, 2000, among the Registrant, IDT
Corp. and AT&T Corp.
10.33**** Stock Exchange Agreement, dated March 30, 2000, by and between
Yahoo! Inc. and the Registrant.
10.34**** Registration Rights Agreement, dated March 30, 2000, by and
between Yahoo! Inc. and the Registrant.
27.1**** Financial Data Schedule.
--------
* Incorporated by reference from our registration statement on Form S-1
(Registration No. 333-78713).
** Incorporated by reference from our registration statement on Form S-1
(Registration No. 333-90317).
*** Incorporated by reference from our Proxy Statement on Schedule 14A (File
No. 000-26763), filed June 6, 2000.
**** Filed herewith.
# Confidential treatment granted as to parts of this document.
b) Reports on Form 8-K.
No reports on Form 8K were filed during the quarter ended April 30, 2000.
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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.
By:
/s/ Howard S.Balter
----------------------------------------
Howard S.Balter
Chief Executive Officer
By:
/s/ Ilan M. Slasky
-----------------------------------------
Ilan M. Slasky
Chief Financial Officer
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