IDT Corp (IDT) 2004 Q2 法說會逐字稿

Good morning and welcome to the IDT Corporation's earning release conference call. [Operator Instructions]

I would now like to turn the floor over to your host, Jim Courter, CEO. Sir, the floor is yours.

Good morning. I'd like welcome you to our earning call for the second quarter of FY 2004, that ended January 31, 2004. And remind you that our prepared remarks will be made by just myself and Steve Brown, rather than by Steve and me and the three division CEOs. This is all in an effort to streamline the prepared remarks and leave more time for questions and answers.

Before we begin I must caution all those listening today about any forward-looking statements that you may here during the course of the conference call. During both the prepared remarks and the question and answer period that follows, we may make forward-looking statements either general or specific in nature. These statements are subject to risks and uncertainties that may cause actual results to differ materially from results that we anticipate. These risks and uncertainties include, but are not limited to, the sensitivity of our telecommunications businesses to declining prices, our alliance on success in the prepaid calling card market, our ability to obtain cost-effective termination capacity, the impact of changes to the U.N.I.P. [ph] regulations, our success in restructuring the operations of Winstar, external factors in the motion picture and television industries, general economic conditions in the global telecommunications market, the general condition of the economy in the United States and internationally, the disruption of our facilities and operation due to a variety of causes including terrorism, war, acts of God and any of the other specific risks and uncertainties discussed in our reports filed with the SEC. We assume no obligation to update any forward-looking statements that we have made or may make or to update you about the factors that may cause actual results to differ from those that are forecasted.

We have received quite a few questions from investors regarding any potential impact of the recent DC Court of Appeals decision would have on our businesses. Frankly and simply put, we do not believe the decision will have a negative impact on IDTs bundled service plan nor on IDT as a whole. We do not believe the decision negatively impacts IDT as a whole because the revenue from IDT's bundled services represents about 3% of IDT's revenue. With so high a percentage of IDT's revenue coming from other sources the DC Circuit Court of Appeal decision will have no material impact to our bottom line. And more importantly we do not believe the decision will immediately impact IDT's ability to offer its competitively priced bundled services plan because local residential connectivity will be offered to CLEX [ph] at wholesale prices for the foreseeable future. Even if the Supreme Court does not hear the appeal, which we think it will, we believe the SEC retains the right, and more importantly, the motivation to revise its rules in a manner that preserves U.N.I.P. [ph] throughout much of the country. Until the various issues are resolved IDT's rights under it's existing interconnection agreements provide sufficient protection to permit IDT to continue expanding its local services. Once the dust has settled from the various legal challenges and rule making, even if access to the underlying network is diminished, IDT will be uniquely positioned to benefit through its own ship of Winstar. Winstar's facilities may be used to provide IDT and other CLEX [ph] with access to underlying facilities outside the control of the Auerbach's grasp, thereby maximizing the value of Winstar's facilities and expanding Winstar's business model and revenue base beyond the business market to include a carrier's carrier revenue.

For the tenth consecutive quarter our consolidated revenues set records, increasing 2.7% sequentially and 16.9% year over year to a total of $527 million. Overall the most remarkable aspect of this quarter's results, at least from a financial perspective, was the strong advance in gross profits to $131 million. We set our fourth consecutive all time gross profit record this past quarter.These financial results show the continued strength of the business of IDT, long-term shareholders have been rewarded by these businesses. In fact, as recently at last week, the Wall Street journals shareholder score card reported that IDT ranked number one in shareholder returns among its peers in the fixed line communications industry for one year returns, three-year average returns, and five-year average returns. Number one, in all three categories. Our three-year average return of 25.2% compares to the industry average of a loss of 7.9%. IDT is the only fixed-line communications company to show a positive three-year average return. Our five-year average return was 21.1%, compared with the industry average of a loss of 7.2%. In a further enhancement of shareholder value, we simplified our capital structure by acquiring Liberty Media Corporations preferred interest in IDT Telecom and common and preferred interests in IDT investments for 3.2 million shares of our class B common stock, a move that saves us, by the way, tens of millions of dollars in redemption payments, simplifies our capital structure, and increases Liberty Media's stake in the parent corporation, IDT, to approximately 15%. For IDT Telecom, this quarter was the tenth consecutive quarter of sequential revenue growth and positive operating income.

Income from operations increased better than 50% compared to the second quarter of fiscal 2003. IDT Telecom's adjusted EBITDA hit a record $39 million for the quarter and free cash-flow for the first half of the year, of the FY that is, was $37.8 million, double last years pace. During the second quarter IDT Telecom focused on improving its gross margin, particularly in the U.S. based calling card business, where we were able to raise prices on several calling cards. This resulted in calling card gross margins of 24.3% for the quarter, representing the best quarterly gross margin performance for calling cards since the first half of fiscal 2000. Driven by these gains overall IDT Telecom gross margins improved to 23.1%, up 130 basis points from the first quarter. IDT Telecom's wholesale division enjoyed it's highest quarterly revenue since the fourth quarter of fiscal 2000. This strong growth in revenue is primarily attributed to increased services provided to tier one carriers. Our consumer service division is moving along at a brisk pace with the continued roll-out of America Unlimited, our bundled local and long distance service. We currently offer this service in 11 states. And we are adding approximately 2,500 America Unlimited customers per day, most of them new IDT customers rather than people who are using our old 5 cents long distance service plan. Their average monthly bill is a good bit higher than the typical bill for metered long distance service. Consumer phone service revenues increased a considerable 17.7% over the last quarter. And we expect to further acceleration as America Unlimited is rolled out into more parts of the United States.

IDT entertainment had a big impact on the growth this quarter. It accounted for the lion's share of the revenue growth and almost half of the gains in gross profit dollars. Entertainment is now IDT's second largest operating division in terms of revenues. We expect another big increase in IDT Entertainment's revenues when we report third quarter because that quarter will reflect a full three months of revenues from Anchor Bay and Mainframe Entertainment. Our entertainment division is making exciting progress on several fronts. Our highest profiles projects are animated feature films and development. The feature film for which Christopher Reed is the director and executive producer for us is in final scripting now, with casting to begin shortly. Meanwhile StarPoint Academy, the Gene Roddenberry project underdevelopment is under script and modeling development as well. Just so you know, we've had preliminary discussions with several Hollywood companies regarding the distribution of these films. In addition we are on schedule for the John Williams produced feature, Happily Never After. We anticipate releasing our feature film in the year 2005.

Although, and quite obviously, feature films will undoubtably create the most buzz with the acquisition of Mainframe and Anchor Bay, the distribution of made for DV properties is an equally dynamic business for IDT. We continue to seek to acquire intellectual property for future development projects. During the quarter we took an equity position in Archie entertainment with the rights to develop well known Archie comic characters in animated format. We have also established a joint venture with the Christian Broadcasting Network to develop and distribute family friendly programs. We have an equity stake in the Cabbage Patch Kids and Pez Candy productions, to name two. Our non-equity production work includes the Simpson's, for which IDT just recently received our first Emmy; King of the Hill, and Popeye, to name a few. IDT believes we are producing more CG animation than any other company in the United States. Performance at our IDT Solutions, which you know, of course, has old Winstar, continues to improve. We remain committed to cutting the loss at Winstar. Given the recent court decision and other changes in the regulatory environment we intend to exploit the unfolding opportunities that present themselves for the unique aspects of the Winstar assets. These potential opportunities include managing roof rights for property owners, acquiring cell tower operation, and using the Winstar network to deploy WiFi and WiMax services. One of the most interesting services offerings in development is back call, for cellular phone services and wireless Internet service providers. Back call services can become a significant business. Insat NVR estimates that worldwide revenues from back call services for wireless Internet services alone will reach from $70.5 million in 2002 to $681 million by the year 2007. That points out real opportunity. With our roof rights and CLEX operations we believe that IDT Solutions is well-positioned to deliver these essential communications services. IDT Media, now consists primarily of two businesses, CTM Brochure Distribution and radio properties. Most of IDT Media's revenue still comes from brochure distribution. Our radio station, WMET in Washington, D. C., is are very close to upgrading its signal and Liberty Broadcasting continues to upgrade its program. We recently signed Jose DeSalarks [ph], the only journalist who is anchored both English and Spanish language TV new casts for a daily two-hour show.

The results of our voice over IP component were reported, of course, at length in Net2Phone's quarterly conference call on March 9th. In short Net2Phone is continuing to exploit it's VOIP technology by offering, among other things, a turn key telephony solution to cable operators .Additionally, Net2Phone increased its cash position to $135 million as of January 31, 2004, by raising net proceeds of almost $60 million in November 2003, with a follow on offering of its common stock. We remain confident in Net2Phone's technology and it's future.

To summarize, we had a solid quarter. IDT Telecom is spinning out substantively more free cash-flow than ever before. IDT Entertainment revenue increased 92% compared with last quarter and is poised to be operationally profitable the second half of fiscal '04. IDT Solutions burn was again reduced. IDT Media's build out of WMET is nearing completion. Our gross profits advanced strongly and we maintained a strong balance sheet with $1 billion in cash and marketable securities and no long-term debt. IDT has consistently provided high levels of returns to our stockholders and we are constantly undertaking new initiatives to do so. We are an entrepreneurial company, always discovering and pursuing new opportunities in changing environments. Whether it's the development of an end to end entertainment business from a communications technology to link animation studios, the delivery of new services to a wireless world or crafting new applications for our bread and butter product, the prepaid calling card. As Abraham Lincoln said, things may come to those who wait, but only the things left by those who hustle. I am now pleased to turn the call over to our Chief Financial Officer, Steve Brown, who will discuss the quarterly results and IDT's financial conditions in greater detail. Steve?

Thank you, Jim.

Once again I will direct investors that for a complete picture please review our press release and Form 10(Q) that we will be filing later today. One more important item, in this presentation I will present certain non-GAAP financial measures, a reconciliation of these non-GAAP financial measures, to the more directly comparable GAAP measures, can be found on the Investor Relations page of our Web site at www.IDT.net/IR, by clicking on the word financial. In our few minutes on this call I will review the highlights of our results for the second quarter ended January 31, 2004, and for comparative purposes, as always, I will compare Q2's results against the results of our prior quarter, Q1.

Q2 '04 produced record revenues of $527 million, an increase of 2.7% from last quarter. Drivers of this revenue growth were our entertainment division, and our consumer local and long distance telecom business, which I will refer to as consumer phone services. Overall gross margins increased 160 basis points to 24.8%, driven by increased gross margins in our prepaid phone card business and the growth of the consumer phone services business as a larger percentage of overall telecom revenues, as well as the increased higher margin IDT Entertainment revenue. Net loss from operations were 16.2 million. Included in the consolidated net loss is Net2Phones loss from operations of 8.6 million. Excluding Net2Phone's loss our loss from operations would have been 7.5 million. Please note that Winstar's loss from operations was 15.4 million for the quarter. So IDT operations without Net2Phone and Winstar was profitable to the tune of 7.9 million. Overall IDT Consolidated had positive EBITDA of 14.9 million, a robust 21.8% increase from last quarter. Whereas Net2Phone incurred a EBITDA loss of 3 million and Winstar incurred an EBITDA loss of 11.4 million, IDT Net2Phone and Winstar had positive EBITDA of 29.3 million.

Before I discuss the segments in more detail I would like to discuss two line items on our P&L. Firstly, non-cash compensation charges are included as operational expense; and consist mostly of two components, $2.2 million is Net2Phone's expenses mostly as a result of its earlier repricing options. IDT also incurred a non-cash charge of approximately 1.5 million, related to the issuance of restricted stock grants. As we had previously discussed on the last call IDT had moved away from incentivizing key employees with only stock options, to a format that includes restrictive stock grants along with options. These restricted stock grants are expensed over their vested life and accordingly, there will be a recurring expense for non-cash compensation on a quarter by quarter basis based on our grant of 1.1 million shares which left us with a comp charge of $21.2 million to be amortized over the next three years.

The next item consists of two non-recurring gains, recorded in the other income line item. We recorded a $21.6 million gain as a result of the telephonic arbitration victory. And we also recognized a $9.4 million gain under SAB, or SAB 51, on the sale of the subsidiary stock as a result of Net2Phone's four to one offering in November of 2003. As a result IDT consolidated recognized net income of $18.4 million this quarter, or 20 cents per diluted share.

Now let me go segment by segment.

Telecom revenues increased 1.2% to $460.5 million this quarter, driven by a 17.7% increase in our consumer phone services revenue; which totaled 43.8 million, or 9.5% of overall telecom revenue. Wholesale revenues grew 4.7% to 131.5 million, and prepaid phone card revenues were 285.3 million, a 2.3 decrease from last quarter. This decrease was a result of concentrating on gross margin improvement over the growth of minutes used. As a result, prepaid phone card gross margins improved 170 basis points, to 24.3% this quarter, which means that we realized more dollar profit on less revenues. Consumer phone service gross margin decreased 170 basis points to 50.5%, as we increased the mix of revenues to skew higher toward the fast growing America Unlimited bundled services product which carries lower gross profit margins than the pure long distance product. Wholesale gross margins increased 30 basis points to 11.3%. SG&A costs grew 9.1% this quarter to 67.2 million, or as a percentage of revenues, it grew 110 basis points to 14.6% of overall telecom revenues. This spike is solely due to the growth of the consumer phone services, part of which will be recurring and part which will be non-recurring. The recurring portion relates to the increased advertising and marketing campaigns.This becomes absorbed as our customer base continues to snowball. The non-recurring portion is related to higher than usual bad debt expenses that we have experienced as we enter this new high growth business venture; allowing time to perfect systems needed to weed out bad customers.

We also incurred a non-cash compensation charge to our telecom unit of $1.3 million. Depreciation and amortization were at $16.3 million this quarter, and accordingly whereas net income from operations decreased 4.1% to 21.4 million, EBITDA for telecom increased 3.5%, to $39 million this quarter.

Now Winstar/IDT Solutions, this quarter Winstar had a reduction of revenues of 8.8% to 19.4 million, but because of a 510 basis point improvement in gross margin, Winstar actually had a 24.5% dollar increase in dollar gross profits to $3.7 million. SG&A remained constant at 15.1 million. Depreciation and amortization remained at 3.9 million and IDT Solutions recognized a net loss from operations of 15.4 million and an EBITDA loss of 11.4 million. We are continuing our aggressive cost cutting efforts at Winstar and we continue to explore various new opportunities for IDT Solutions businesses.

IDT Entertainment continues to be the shining new star of the IDT Empire.We plan to achieve our business objective buy combining organic growth with acquisitions of strategic and accretive small and midsize entertainment businesses. These businesses that we are looking to acquire are ones that will fit our mission to own intellectual property, to produce computer generated imaging or 3D animation, as well as 2D animation, as well as the ability to distribute our products to the consumer. To that extent, we completed the acquisition of Mainframe, owning 62% of the Vancouver based CTI shop, as well as 100% oF Anchor Bay, one of the largest independent distributors of DVDs to the retail market. We continue to be actively pursuing other properties that fall within this business model. As a result of these acquisitions, IDT Entertainment revenues grew into 92.3% to 23.2 million, gross profit grew 390% to $7.2 million, SG&A grew 220% to $6.7 million, and depreciation and amortization grew to $1.4 million, and loss from operation were $1.1 million, and we had positive EBITDA of $482,000 for the quarter.

These results include Anchor Bay and Mainframe only since December or for approximately two-thirds of the quarter.

Going forward consolidating Anchor Bay and Mainframe for a full quarter should have an immediate positive impact on all P&L line items of our entertainment divisions. IDT Entertainment's original subsidiary EPS continues to be in production of two fully owned feature films to be completed in late summer or fall, 2005, as well as a few direct direct to DVD animation projects, that will be ready in six to nine months. The timing of revenues and their impact cannot be estimated at the present time, but especially the feature films, the impact may be substantive. IDT Media had revenues of $5.3 million, funds from operation of $1.6 million, and EBITDA loss of $900,000. IDT Corporate had a loss from operation of $10.8 million and an EBITDA loss of $9.3 million. Our cash and marketable securities position continues to be in excess of $1 billion; leaving IDT in great position to execute its strategies and to grow both its telecom business and its entertainment business. At this point I would like to turn the call over to the Q&A session.

Thank you.The floor is now open for questions. [Operator Instructions]. Please hold while we poll for questions.Thank you.

Our first question is coming from Tom Friedberg of Janco. Please go ahead with your questions.

Hi, guys, you did very well with this quarter. I am very happy, it looks like cash is about $40 million ahead of where I thought it would be. I've only really got two things I want to ask. Steve, I saw that the minority interest line on the balance sheet went up something in the order of 45 to $50 million sequentially. Could you tell us what that was about?

Most of that was related to the Net2Phone secondary and -- IDT's participation into that.

Okay.So you recorded that in the minority interest rather than in the shareholders equity.

Yes.

Okay. That's fine. Also, can you give us any more color, -- Winstar -- at least from the expense side I think you hit it right, was fine and anybody -- you guys have been the only people who've ever generated a positive gross margin in the wireless CLEX business. Was there some additional grooming of the network in the second quarter that produced the sequential revenue decline, can you give us some more color on that, please?

Sure.There was some additional grooming, most notably with the rent. We had an ongoing process of negotiating and renegotiating what we are paying for rent, as well as connectivity and a lot of that was based on the increased leverage, based on the increased synergy with IDT Telecom.

Okay.

Those were the two components that really helped add to the improvement on the expense side.

So some of the -- I think I hear Brian back there. Is that, is it fair to say is that some of that revenue -- revenue went away because of quote, unquote, you were able to internalize more of the expenses that would have quote, unquote been passed through?

I'm sorry, this is Brian speaking.

Yeah, no, that's what I thought. It sounded like Brian.

That just adds an added dimension of pressure, now that you know who is talking. The difference in revenue was a combination of what you just mentioned. Actually there were a number of factors in addition to that, number one, understand that what the advantage on the consumer side, most notably the holiday season is actually a disadvantage on our side. Is so Q2 on the enterprise side should be a challenging month in terms of usage and in fact it was. There were a couple of other issues. We had a couple of Legacy whole sale deals that we just basically terminated. And there were a few other issues we got hit with some disconnects based on people moving out of buildings, there were even a few bankruptcies so we lost some customers that way, so there a number of factors that went to the change in revenue including what you had mentioned.

Okay, last question Brian, how are we going to see any progress, for those of us on the outside, how are we going to be able to determine a pick-up and back-haul? And I do think you guys are positioned correctly on that score.

Okay.There's no, everyone is kind of grappling with what the latest Federal Court ruling, the DC Court of Appeals, what it means, but at minimum it has created a tremendous amount of concern and a lot of uncertainty for the UNIP players and especially for the mobile carriers because one of the parts of that ruling, which has really not been focused on, is the impact that it's going to have on the ability of mobile carriers to use the unbundled network, the unbundled element. And we feel that we are superbly positioned to be able to address that, and in fact, many of the discussions we've had -- we have been having with various CLEX, as well as other mobile carriers, have really escalated over the last couple of weeks.

Okay, great guys. Again a fine quarter.

Thank you.Our next question is coming from Andrew Sidoti of William Smith and Company. Please go ahead with your question.

Thank you. Good morning, gentlemen. A couple of questions here on the telecom side. There was, I see that there was a sequential decline in the calling card revenue. I got a nice pick up in margins, but there was a decline in calling card revenue. And I was wondering what that was attributable to?

Good morning, Andrew, this is Moshe. We strategically balance our business on the calling card business to generate profits and low revenues. Looking at the fourth quarter the holiday season we had a large [inaudible] out there. We decided to do grow our profits and have a reduction in the usage. So it's just a seasonal decline, but long-term it's [inaudible] our business.

And in the press release you mentioned that you expected lower gross margins going forward in the calling card business, but you also expect, you expect higher gross margin dollars.

Yeah Andrew, hey this is Norm Rosenberg. And as Moshe alluded to we kind of look at -- we kind of look at revenue versus margin as something of a lever and you can sort of manage one to grow the other. During the second quarter we decided on the U.S. side to, I hate to use the word harvest, but I will use it any way for lack of a better terms, we have a lot of cards out there, we have very large scale and we have the opportunity to raise rates from time to time and to try to bring some more gross profit dollars in, that was the story in the second quarter. As we alluded to in Q3 we've already begun to now turnaround to grow revenue and what we've done is as we always do, as we are won't to do, we introduced several new cards with aggressive rates. You know, the typical kind of things that we do. The margins that we saw in Q2 will be somewhat sticky, though although I do expect a sequential decline from Q2 to Q3. We had a significant pick up in calling card margins from Q1 and to Q2 and we will retain some of that in Q3 to Q4, so we will be somewhere -- we'll be somewhere in that range -- somewhere between where we were in Q1 and what we showed up with in Q2.

Good, and then I saw on the calling card business, one last question is that, I think you mentioned with respect to international calling card sales the increases are the higher proportion of total sales. Do they tend to carry higher margins, same margins, or lower margins than your domestic business?

All of the above.

Typically, -- typically they tend to carry higher margins, I mean that are couple of things that work in our favor. When I do look at the breakdown of our debited business for Q2, for example, calling cards on the revenue side actually did increase in Europe, there happens to be a lot of growth there as far as what we see. Within Europe it's really not a matter of U.S. versus international so much as it is, within Europe for example, a mix between the more mature U.K. and, let's say, Spanish markets versus places like Italy and France wherein Scandinavia there's a lot of growth on the horizon. So they do carry somewhat higher margins, and that should help us in that business. I think that's where the growth is going to come from.

That's very helpful. In the consumer phone business, I see you've had, you have approximately 133,000 taking that service. What is the total customer tally in that business? How many traditional long distance do you still have?

We have approximately traditional long distance, approximately 450,000 consumers and on America Unlimited plan, 130 plus, and we are seriously growing the American Limited plant and see large growth in that space.

I think, Jim had mentioned [inaudible], you adding, was that 2,500 customers, was that per day or per week? That was per day?

That's per day.

Per day.

And the key milestone there is that we are at a point where I think we are again at an all time high, if you look at our total number of customers. I think we had peaked in, I think it was May of '03, and we had some declines, and now we've built that business back to where, not only is that number on a total level higher than where it was in the past, it's also a higher value customer, so we are kind of happy with it and that's why we seen the revenue growth and we expect to fully see some strong revenue growth in that business sequentially as we go into Q3 and Q4.

Great, great, and then if I can jump over to Winstar very quickly, I know you continued to make good progress on the growth line, gross profit line and cost cutting and you are doing a lot of pruning. Let me ask you this question, not to be facetious or anything like that but can you get to profitability just through cost cutting?

The answer is no. But we can get profitability by a combination of the aggressive cost cutting that we've been involved in, increased focus on certain markets and, to a certain extent, changing in a positive way the way that we are conducting business currently.

Okay. And a lot of that would be -- one of the sources of that revenue would be the back-haul that you are talking about earlier.

The use of our spectrum as well as the use of our switches is certainly going to be playing a much more important role, as well as really an increased focus on certain locations [inaudible] beyond that business and looking selectively using our switches and using our capacity, but at times [inaudible] using -- utilizing a -- deploying an alternate strategy in some of the cities that are more challenging to really succeed with an on net strategy.

Okay. Very good. My last question, and I promise i will jump back into queue, is on the, is -- John Malone exchanging his stake that he had in telecom and investments for shares of class b? Is that, -- now that you've done that, does that decrease the possibility or chances that you, may not IPO or spin-off, some of telecom -- I thought one of those -- one of those reasons why you took a position in telecom was because to kind of be one of the early investors in a possible spin-off of that position?

Andrew, it's Jim Porter, it's not going to affect that decision whatsoever. It's totally independent. We did the transactions, it was a very small transaction, you know, about 5%, we did it to simplify, to rationalize, and to eliminate the redemption of cash payments that IDT would have to make without the transaction. So one is totally unrelated to the other.

Also he still has a position in IDT Telecom. It -- he had a preferred position in that and some other subsidiaries and that's what's converted. But he still does have Liberty Media's subsidiary still does have an ownership in IDT Telecom.

Okay. Thank you very much. Very helpful.

At this time there appear to be no further questions in the queue. I would like to turn the floor back over to the presenters for any closing remarks.

Thank you very much. We look forward to the next quarter [inaudible]. Have a good day.

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.