NTOP – Conference Call/Earnings – 12/10/03
Sarah Hofstetter: Welcome to our first quarter, 2004 conference call. Forward Looking Statements ….
Steve Greenberg, CEO, Net2Phone:
Thank you Sarah. And thank each of you for joining us as Net2Phone reports our first quarter results. Now, I hope you have at least had a few minutes to review our release but let me now provide you with the highlights of the subjects that we will talk about during this evening’s call. First of all, we have achieved positive cash flow. I want to say that again – positive cash flow from our core Global Services operation. Specifically, this past quarter Net2Phone Global Services segment income exceeded its segment capital expenditures for the first time in our history. Our gross margins have exceeded 40% for the 10th consecutive quarter. During this time period, we signed an agreement, as most of you know, in principle with Cebridge Connections, the 12th largest cable operator in the country. And we just completed a follow-on equity offering bringing net proceeds of close to $60 million into our treasury.
Now, before I drill down on the specifics of our quarter, I thought it would be important to talk briefly about Time Warner Cable’s recent announcement to deploy voIP cable telephony and a just published voIP sector analysis, and what the implications of those two events are as we see it for Net2Phone in our near term prospects. The report makes clear that this company, Net2Phone, is well positioned to win over even the most skeptical cable operators, while providing a product where, now I’m quoting, “quality concerns should be low.” Now having that type of solution in a world where a major cable operator publicly announces plans to deploy voIP cable telephony through their entire footprint only emphasizes the brightness of our future. This is a pure validation of Net2Phone’s strategy of delivering a PSPN quality line phone service on a fully outsourced basis. Now, cable operators are feeling competition from satellite providers on the video side, pressure from the RBOCS on the high-speed data side, and there is even some rumblings on the voIP side from certain best efforts second line telephony services.
The best way for a cable operator to aggressively beat this competition and still keeping an eye on quality top line revenue is by delivering voIP today. And we here at Net2Phone are the best game in town. A recent Wall Street report says that there will be a $10 billion shift in revenue from RBOCs to domestic cable operators, and we again are the best-positioned company to deliver the necessary capabilities to those MSOs to capture that revenue. Now that $10 billion number excludes all of our international opportunities. So, our cable pipeline is full of seriously interested customers, and these very recent events are another harbinger of good news for the near term.
I now want to tell you how proud I am of our entire team at Net2Phone for implementing our dual strategy. First, for making our core business profitable. And of course laying the groundwork to exploit the tremendous opportunity I just spoke about in cable telephony. As you can clearly see from our earnings release, we have reported positive cash flow from our core business this quarter and at the same time signed a Memorandum of Understanding with a yet second cable operator to deploy residential quality phone service to its subscribers. The new corporate structure that we put in place at the start of this fiscal year – by separating our core business from our cable business – was the right move because now each of you can quickly and quantitatively gauge our success. And personally after meeting with more than 100 institutional investors and analysts during our follow-on road show just a few weeks ago, I am more convinced than ever that the time for Net2Phone is now.
Our CFO, Arthur Dubroff, will go into the details of the financials, but you will see that our fundamental metrics are moving in a direction that bodes well for the continued success of our company. Now, I will briefly discuss trends that we see in both segments. Within Net2Phone Global Services, our core international voIP long distance business, we have, and I want to say it again, achieved positive net cash flow. That is, our segment income exceeds our segment cap ex for the first time in our history. This fixed cost platform provides us with operating leverage so we can benefit incrementally as our revenue begins to grow in the second half of this year in newer markets through a variety of products and services. Some new services that we have discussed recently include enterprise solutions, as well as some consumer alternative long distance services, and of course rechargeable calling cards, both in the U.S. and abroad.
As part of our restructuring initiatives a couple of years ago, we specifically chose to exit certain businesses and to scale back some of our more unprofitable ones, including our U.S. disposal calling card business. This business had been largely responsible for our revenue growth three or four years ago, but it produced low profit margin. In fiscal 2001 for example, that business represented 27% of our revenue and we only reported and we only reported 28% gross margins as a result that year. We expect to fully exit that business by the end of the current fiscal year. This accelerated exit from our U.S. disposal calling card business has continued to exert some minor downward pressure on our revenue. But on the other side, it has also provided an immediate uptick in our gross margin percentage, as clearly reflected in the 46.4% gross margin we just reported for this quarter. We expect our gross margins in the quarters ahead to be similar to what we have accomplished over the past 10 quarters, that being in the range of approximately 40%.
The implementation of our cable telephony strategy is also starting to take hold, as we have now agreed in principle to deploy telephony for yet a second important cable operator. Cebridge Connections, the 12th largest cable operator in this country, has turned to Net2Phone to provide a strong telephony offering to its current and potential subscribers. Cebridge’s adoption of our services will serve as a catalyst among like-minded MSOs. Cebridge is the ideal customer for us as it represents the right size MSO, having a large enough footprint to leverage our distributed architecture and to support voIP.
As I told you last quarter, we signed a six-year production agreement with Liberty Cablevision of Puerto Rico, the first customer to implement our telephony service. All of our previous activities with Liberty Cablevision have been a great success for them and for us. They have become our show place. And we use them to market our services to cable operators worldwide. They have also acted as our testing ground for the past 12 months as we have tested and implemented our very scaleable and robust solution. We enable Liberty to offer its residential customers today a phone service that is as good or better than the local incumbent at very attractive rates.
From these two deals, as well as our ongoing intense negotiations with other MSOs, we have learned that telephony is a must have service for the cable world. To best serve the needs of these MSOs today, we have two business offerings to them whereby they can offer their customers our voIP telephony services immediately. In both instances, the cable operator retains the brand of the service and the customer receives one or a unified bill from the MSO for the bundle of voIP, video, and high speed Internet access. This allows the MSO to truly benefit from the incremental voIP revenue, along with churn reduction associated with the triple play.
Now, we have spoken to you about our hosted business in the past, where we share the investment required for cap ex with the cable operator. We deliver a complete end-to-end telephony solution, with the MSO paying us a monthly fee for all of those elements, which include licensing our platform, as well as the full telcom administration on the local, long distance, and international levels. Although we expect the details of each of our MSO relationships to be unique, our agreement with Liberty Cablevision is essentially a contract for the hosted service. The deal with Cebridge, however, is closer to our franchise offering. That model, as we have described in the past, provides the cable operator with the ability to avoid negative cash flow while deploying telephony.
With the completion of our follow on offering, we are now certainly more than well funded to roll out a number of markets through either model. Now, since our last earnings conference call we have received additional endorsements from IDT and Liberty Media, our two partners, who continually help us to complete our cable telephony package. Liberty acts as our guide to the cable industry, while IDT helps us every day with the nitty gritty telecommunications administration. With its POPs and switches in over a dozen countries, not to mention its robust footprint on the local side in the U.S., IDT provides us with an unmatchable telecommunications infrastructure that causes cable executives’ eyes to literally light up in recognition of the obvious rapid deployment advantages we bring. Once they hear and learn of the intense amount of expertise and infrastructure that is entailed in delivering the kind of phone service we have, they are happy that there is an overabundance of intellectual capital within Net2Phone’s family of companies to support that deployment.
Now also, both IDT and Liberty Media have put their money where their mouths’ are, by each buying 10% of the recent follow on offering that I described a few moments ago.
Now, on a going forward basis you can look for certain key metrics by which to gauge each of our business units. Within our Global Services business, look toward continued segment profitability and continued cash flow in excess of its capital expenditures. On the cable telephony side, we know we will deliver more cable deals this fiscal year, and we are now at this moment starting to provide telephony service to more and more subscribers.
This quarter’s results effectively show you what we are about: A global voIP company, focused on profitable growth, laying the groundwork for an explosive opportunity in cable telephony, both in the U.S. and certain markets in Europe and Latin America. Net2Phone provides the investor with the value of an established division, with eight years of valuable experience, earning its spurs in voIP deployment, combined with an exciting cable market opportunity.
Now to go through our financial results in greater detail, I will turn the microphone over to our CFO, Arthur Dubroff.
[BUSINESS AND FINANCIALS – NOT TRANSCRIBED]
Questions and Answers:
Ari Moses, Blaylock & Partners – Hi guys, how are you?
Steve: Good, Ari. How are you?
Ari: Good. Two questions. One, a discussion of the revenue decline, which I know was expected. I just wanted to talk about I guess the three contributors to that. One, we talked about the decline as you exit disposal calling cards. Two, was some pricing pressure. With regards to the third piece, which I know was highlighted last quarter, kind of like the delay in penetrating certain emerging markets, I know you were saying revenues should start growing again second half, but if there is any incremental information on those markets – what is deregulating; what might not be that may have been expected? I know you have laid out a number of markets previously that you were expecting to get into. I was just wondering if there was any update there? And …. Actually, I will lead with that one and I have one follow up after that.
Greenberg: Okay, why don’t we ask Brian to address that one quickly, and then we will give you your follow up.
Ari: Okay, great.
Brian: Hey, Ari.
Ari: Hey.
Brian: I thinking terms of some of the larger markets that were on schedule to deregulate in 2003, just did not occur. I think that Turkey and Pakistan weren’t approved’. In terms of the markets we have launched, in the last quarter we have launched rechargeable calling cards in Greece, Cyprus, Czech Republic, and Sri Lanka. So, those are contributing some incremental growth. But as you can imagine, when you launch services it takes a while to ramp the revenue. So, we are seeing some progress in some of these smaller markets. And I think as we have highlighted previously, over the next 12-18 months we see markets like markets like Brazil, Mexico, and Turkey actually opening up and providing significant opportunities. And that’s why Arthur has guided that we see more meaningful revenue growth happening in fiscal ‘05, but the beginning of revenue growth returning in the second half of this fiscal year.
Steve: Okay. You want to give us your follow up, Ari?
Ari: It was actually just a question on that. Of those four markets you talked about, I think I heard correctly you said kind of penetrated those with the calling card?
Brian: We’ve launched. We’ve launched services in the quarter. And now we’re going through the process of penetrating the market – which is a ramp up time.
Ari: Got it. Okay. So from that regulatory perspective, you are seeing I guess, increased activity. Things are starting to occur, and the market – you know, deregulation is really on track. It’s just a question of timing of revenues.
Brian: Yeah, absolutely. There is a tremendous movement towards that. You know, pressure from the WTO (World Trade Organization). There are over 60 countries that have announced deregulation scheduled. So we are extremely bullish on this. It’s just a matter of predicting the actual month or quarter it is going to happen is a little difficult. But certainly over a three year time horizon, we feel very good at where we are and where our initial strategy has presented it.
Steve: And, Ari, you know that we have been saying that over the past weeks that over a five year horizon, we’re very comfortable in saying that we expect the top line revenue just from that segment alone to double.
Ari: Right. Yeah, absolutely. Okay, great. The follow on actually is a different topic. But, Steve you were talking about the announcement recently from Time Warner – their relationship with Sprint, MCI. Which as I read, that I agree definitely is a great incremental sign of demand in the industry, etc. I was wondering how you could comment on that in regard to your view of what Sprint and MCI are now – obviously they just got in this market are starting to offer as compared to what you will bring to the table regarding your relationship with IDT. If it’s even comparable? It that apples to apples?
Steve: I think you are right on the money. It is apples to apples. And what it really does is validates our market opportunity, because as you know we have an inter-company agreement with IDT and WinStar, which gives us all their POPs, all their NOCs, all the switches, and all their NFL cities. And it’s at cost plus 5%. So actually, you know, the relationship, and I don’t the details of it, but from everything that I’ve seen, is a similar relationship between Time Warner and Sprint. Whether or not they can achieve, you know, the same kind of cogs that we can is unknown to me. But, you know, we have to remember and we have to be very careful that we know that all MSOs require connectivity to the PSPN. So, you know this is really nothing that we didn’t expect to happen.
I am very bullish about the announcement. And I purposely thought it was important to note at the outset, because obviously when something clearly in our sector is on the front page of the New York Times in the lead left column, I meant what I said when I say that for Time Warner to be deploying voIP through its network, really only validates what we’ve been saying that the time for Net2Phone and IP telephony over a cable pipe is now.
Ari: Okay. Alright. Great.
Steve: Okay. Thanks, Ari.
Eric Vutz (?), Janco Partners: Thank you. Good afternoon, guys. A couple of questions. First, Art, can you kind of give us the data points between the $2.6 million cash loss and the actual $6.2 million cash utilization in the quarter?
Arthur: That’s a great question. The main thing would always usually be a reflection of working capital – and we haven’t broken down the working capital in detail – when we come out with our 10Q – in the cash flow statement in the 10Q, I think you will be able to see that. But I think you are looking at apples to apples, and it’s pretty common that when you look at the cash flows – if you remember that $2.6 million is without cap ex.
Eric: Right.
Arthur: Cap ex immediately adds $800,000 to it.
Eric: So it was $500 in NGS and $300 in NCT?
Arthur: Correct.
Eric: Okay.
Arthur: Correct.
Eric: And the rest is working capital?
Arthur: Yeah. And the rest is probably working capital. Actually, why don’t you ask your second question. I am going to double-check. I believe it was $800,000 in NGS alone, and actually the cap ex in NCT was another $500,000. So that’s actually $1.3 million above the $2.6 million.
Eric: Okay. Because the press release talks about half a million for cap ex in NGS.
Arthur: That’s right. And it’s $800,000 – the press release should be saying that it exceeded it by $500,000.
Eric: Oh, I’m sorry. You’re right, you’re right.
Arthur: It’s $1.3 million in segment income and $800,000 in cap ex. So it exceeded it by $500,000.
Eric: Okay, okay. I got it.
Arthur: $800 for NGS and it’s $500 for NCT for a total of $1.3 in cap ex.
Eric: And then second question. In terms of the ramp up of the SG&A expenses on NCT, are those comments predicated on additional deals being signed or would you expect a substantial ramp from current levels with just the deals that you have.
Arthur: Absolutely, it’s variable. If we don’t sign more subscribers, we will not have more SG&A expenses. The economic model is a very attractive one in that as we bring on subscribers, we bring on expenses. And we believe that over the fairly intermediate term, that we’re going to see some excellent financial results from that.
Eric: Okay. Thank you.
Steve: Thank you.
Russ Valinde, Rocker Partners: Good afternoon, thanks for taking my call, and congratulations on the quarter.
Steve: Thank you.
Russ: I know you guys can’t talk specifically about other cable operators that you might be in negotiations with, but can you just give us a sense of how many you may be negotiating with now and kind of what’s the time table of them making decisions or, you know, are we going to hear more announcements this year possibly?
Steve: Let me answer you as specifically as I can.
Russ: Okay.
Steve: I just completed a road show. And actually I just presented at Lehman. And at that conference, and if you go to the web site if it is still up; if not, we will get it to you. We actually put a list up of those cable companies that we are in negotiations with. And there are to my recollection, about a dozen. And, you know, that’s information that we have put out. So, you know, there are a dozen that we have listed that we are in active negotiations with, but that is not to say that we are not talking to all cable operators – both domestically and internationally, tier 1 and tier 2. And our pipeline as I have said is full. And I think that there will be other announcements coming in the not too distant future.
[INSERT: Cable companies Net2Phone is in active negotiations with, from the Lehman website:
Charter
Adelphia
Brighthouse
Mediaroom
Insight
RCN Corp
WideOpenWest
CableOne
Cequel
BresnanComm]
Russell: Okay. At what point do you expect to see a significant revenue build on the Cebridge deal.
Steve: We purposely have not given any guidance on the NCT side. And with Cebridge specifically, I think you are going to see –you use the word “significant” – I think fiscal 05 is the time that you will see significant numbers coming out of that deal.
Russ: Okay, great. Thank you very much.
Steve: Thank you.
Richard Klugman, Jeffreys and Company: Hi. Thanks a lot. Good evening.
Arthur: Hi.
Richard: Could you explain a little bit more about the gross margin – 46% -- a pretty substantial uptick there, and I’m not exactly sure why that should quickly drop back to 40%, unless you’re talking about some kind of ramp up in pricing pressure. That was the one major issue that you cited. Is that something that you could probably sustain more perhaps that you indicated?
Arthur: Well, I think it is a factor in terms of our product mix as well. I didn’t allude to it, but I think you are aware that we still have a fairly small wholesale carrier business which has low margins. We are in that business because it is strategic in terms of adding incremental revenue when we develop a presence in a particular country and deploy bandwidth into that country. If we have excess capacity we will utilize it. But we will utilize it at low margins. That also certainly has an impact on why the margins were at 40% in the previous quarter. But it also may reoccur. As you know, the wholesale carrier business can be quite volatile. It’s a spot market. And those services are sold you know from week to week and almost from day to day. That’s one factor that would affect the margins. Other factors are, you know we continue to clean up small amounts of bandwidth that we’ve had from prior periods, and that adds a positive impact on gross margins. But as we deploy to a particular country, as we put in fixed capacity as I described in that kind of relationship, that fixed capacity until it’s full would show up as reduced margins as well.
Russ: Okay. So effectively, if I heard the first part of that correctly Arthur, there was a lot of low margin wholesale in the last quarter and not a lot this quarter, and so the mix really helped you.
Arthur: Certainly more last quarter than this quarter, that’s for sure.
Russ: How much this quarter was from – you said there was tail off in the disposal card – if I recall it’s going to zero by the end of this fiscal year. How much was it in the quarter?
Arthur: I think you might have to wait for the 10Q to come out. You might be able to see that in the latest transactions. But you will see it was precipitous. I can say this – it was over a 100% decline. Excuse me well, 50%. It depends on what you use as a denominator. It was more than 50%.
Russ: It got more than cut in half sequentially?
Arthur: Yes, that’s correct.’
Russ: Okay, that’s helpful. And just one final thing. Steve, if I heard you correctly when you were describing the Cebridge deal as it currently exists, you said it was closer to your franchise offering. I know you are still in negotiations there. But I was wondering if you could kind of elaborate what that phrase means?
Steve: I think that would basically not be appropriate for me to do because as I sit here today, I have folks in St. Louis who are going through that. But you know, these are really going to be as I have talked to you about these are really going to be on a market by market basis. And, you know, when I say closer to the franchise model, I mean that. But because it is pending a definitive agreement which is being done as we speak, I would behoove me not to go any further than that.
Arthur: I would give you some guidance without talking about Cebridge. Let’s take Cebridge out of the equation – to say, as we said there is a spectrum of agreements. On the far end of the franchise agreement we are going to pick up all of the cap ex, as an example. There may be an arrangement that is made where some of the cap ex is picked up by the MSO because they have the breadth for it and the capacity for that and want to pick some of that up. So that’s when we talk about a spectrum, that’s the kind of element in that spectrum that we are talking about.
Russell: Okay, that’s helpful. Thank you.
Steve: Thank you. |
