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CallWave Inc (NASDAQ:CALL)

F1Q09 Earnings Call

November 12, 2008 4:30 pm ET

Executives

Moira Conlon - Investor Relations

Jeffrey Cavins - President and Chief Executive Officer

Mark Stubbs - Chief Financial Officer

Analysts

Aram Fuchs - Fertilemind Capital

Michael Coady - B. Riley & Company

Operator

Good afternoon ladies and gentlemen. Welcome to the CallWave Fiscal 2009 first quarter conference call. At this time, all participants are in a listen only mode. Following the presentation the conference will be open for questions. (Operator Instructions). This conference is being recorded today Wednesday, November 12, 2008. At this time I would like to turn the conference over to Moira Conlon, Investor Relations for CallWave. Please go ahead ma’am.

Moira Conlon

Thank you. Good afternoon everyone and thank you for joining us today. With me on the call is Jeff Cavins, President and Chief Executive Officer of CallWave and Mark Stubbs, Chief Financial Officer.

Before we begin let me remind you that during this conference call management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subjects to known and unknown risks, uncertainties or other factors that may cause the Company’s actual results to be materially different from historical results or any results expressed or implied during this call.

The potential risks and uncertainties that could cause the actual growth and results to differ materially include but are not limited to the Company’s limited operating history, especially with respect to new products and services and in certain new markets into which those products and services maybe sold, potential competition from network service providers and other companies already offering compatible products and services. The Company’s ability to attract and retain subscribers, limited barriers to entry, the Company’s ability to commercialize certain of its technology, the Company’s reliance upon third parties, potential systems failures, potential litigation including but not limited to litigation or alleging that the Company’s products and services may infringe on third parties pattern rates, changes in the legal and regulatory environment and its ability to enforce intellectual property rights.

Information in this conference call related to the projections or other forward-looking statements is based on solely current expectations and CallWave expressly disclaims any responsibility to update forward-looking statements should circumstances change.

With that I would now like to turn the call over to Jeff Cavins. Jeff, please go ahead.

Jeffrey Cavins

Thank you, Moira. Good afternoon everyone and thank you all for joining us today for our fiscal 2009 first quarter earnings conference call. Mark Stubbs, our Chief Financial Officer is going to begin with an overview of our first quarter financials. After that I will provided an update on our recent launch of FUZE and WebMessenger, as well as an overview of our business initiatives.

With that Mark, would you like to go ahead?

Mark Stubbs

Thanks, Jeff. For today’s financial discussion, I will be providing the most recent course performance compared to the prior quarter. I will also introducing certain non-GAAP financial metrics that provide a better quarter-over-quarter comparison on the call today. We believe excluding the amortization of intangible assets, stock based compensation and restructuring charges for net income on a non-GAAP basis makes from more meaningful comparison of CallWave’s operating results. We are provided a reconciliation of GAAP and non-GAAP financial performance in our press release above earlier today.

Total revenue for the first quarter was $4.3 million compared with $4.6 million in the prior quarter. The sequential revenue decrease reflects the expected migration of our legacy product’s subscriber base.

Our new FUZE and WebMessenger product lines launch on September 16, 2008 did not contribute meaningful revenue in the current quarter. The number of total paid subscribers across the direct consumer and indirect channels at the end of the first quarter was 457,000 compared with 485,000 reported in the prior quarter.

Churn on our historical base remained consistent over the last quarter. However, we planned to cancel a little margin wholesale Internet Answering Machine contract with a mid-size ISP when it comes up for renewal in the second quarter. Looking ahead, we will continue to maximize the cash flow from our legacy customer base and products to fund our new collaboration in conferencing product lines, FUZE and WebMessenger.

ARPU in the first quarter in the legacy base remained within our historical $3 to $4 range. We expect ARPU to increase over the next two quarters as we discontinued previously mentioned legacy Internet Answering Machine contract. Cost of sales of $1.8 million for both fiscal 2009 first quarter and prior quarter.

Gross margin for the first quarter was 59% compared to 62% in the prior quarter. The sequential decrease in gross margin was caused by the amortization of the WebMessenger and Syncview software purchases during the first quarter. The incremental expense to cost of goods sold associated with these acquisitions was $309,000, and our fiscal second quarter, we expect to incur $527,000 in amortization cost of which $440,000 is related to the WebMessenger and Syncview acquisitions and $87,000 is associated with the previous settlement of various patent place in the same agreements.

On a non-GAAP basis gross margin for the first quarter was 68% compared to 64% in the prior quarter. The incremental non-GAAP margin improvement in the first quarter was primarily due to the migration of our legacy network and dealing systems in the prior quarter.

Operating expenses totaled $5.3 million for the first quarter compared with $3.9 million in the prior quarter. Operating expenses for the first quarter included $787,000 and restructuring charges associated with WebMessenger acquisition in August. We recognized the entire restructuring charge in the first quarter and do not expect further restructuring charges in the current fiscal year. Excluding this charge, operating expenses increased approximately 15% quarter-over-quarter to $4.5 million. The increase is primarily related to additional research and development cost associated with completing FUZE, our unified communications, messaging and collaboration products.

We expect research and development expense remain flat over the next two quarters and sales and marketing to increase at any price with comes up of data and we begin to ramp up our marketing and advertising campaigns.

Our non-GAAP operating expenses, which exclude stock based compensation of $200,000 and restructuring charges of $778,000 totaled $4.3 million in the first quarter. This compares with non-GAAP operating expense of $3.7 million in the prior quarter, which exclude $760,000 stock based compensation expense.

The net loss for the first quarter of fiscal 2009 was $2.5 million or $0.12 per share. This compares with a net loss of $711,000 or $0.03 per share for the prior period. The non-GAAP net loss, which excludes intangible asset amortization, restructuring charges and stock based compensation expense of $1.1 million or $0.05 per share in the first quarter compared with a non-GAAP net loss of $456,000 or $0.02 per share in the prior quarter.

Turning to the balance sheet as of September 30, 2008, we have $31.4 million in cash, cash equivalents, marketable securities and auction rate securities compared with $46.1 million at June 30, 2008. This decrease was primarily related to the purchase of WebMessenger and Syncview for $10 million, cash used in operations of $1.2 million and additional write down of auction rate securities of $3.1 million. Reserve against the $10 million in auction rate securities is $5.8 million. We increase the reserve in the first quarter because of continued uncertainty and illiquidity in the auction rate securities market. We continue to believe, we have sufficiently capital upon our current business plan.

Accounts receivable in the first quarter totaled $1.6 million compared with $1.8 million in the prior quarter. Total assets were $49.8 million, working capital was $27.5 million and total shareholders equity was $46.3 million at September 30, 2008.

Looking ahead to our fiscal second quarter, we expect gross margin be approximately 52% to 54% on a GAAP basis and 65% to 67% on a non-GAAP basis. We expect operating expenses to be between $4.5 million and $4.8 million on a GAAP basis and $4.3 million to $4.6 million on a non-GAAP basis.

Finally, we do not expect to recognize any material revenue contribution from our new products in the second quarter. Going forward, we know that investors will be most interested in tracking progress on our new products. We believe that the most important performance metrics are the number of licensing contracts close, the number of free and paying subscribers associated with our online WebMessenger and FUZE product sales, incremental revenue associated with our new products. We expect to begin reporting on this metric on upcoming conference calls.

With that, I will turn the call over to Jeff.

Jeffrey Cavins

Thank you, Mark. As you know, over the last year we recoup CallWave’s business to address a market opportunity that we believe we will give the Company a new foundation for growth. I have talked about that opportunity over the last few calls and as result I will skip over that and get right into the business update.

I am pleased to announce that since our last call we have successfully launched FUZE, our unique online median application service and WebMessenger for iPhone and BlackBerry. We have also integrated two acquisitions during the quarter.

FUZE empowers global professionals with collaboration and conferencing tools without the cost and hassle of purchasing or downloading software, with FUZE, professionals can collaborate instantly from anywhere in the world at any time. Our goal is that this capability will be available at virtually any mobile device. FUZE is the only collaboration service available today that offers high definition video and audio which is perfectly in sync and can be accessed to any web browser, 3G smartphone or Wi-Fi enabled device. Simultaneous to our launched of FUZE, we have released WebMessenger for iPhone and BlackBerry. WebMessenger offers real time messaging of the mobile device with federation to public and private IM networks as well as federation across the leading present engines. WebMessenger extends Microsoft OCS environment to mobile devices get in professionals, the ability to unfetter from their officers and maintain real time communication capabilities from their mobile devices.

With the released of FUZE and WebMessenger, we now have two high value products in the market, which need a clear need for enterprise class, mobile OCS and collaboration. We believe that FUZE and WebMessenger will prove to be winning products that will generate above growth and financial returns for CallWave.

This will take sometime, however, as we just started delivering these services at the end of our quarter. With the product launch now completed, we continue to refine the products with key and important functionality. We are actively working on developing distribution relationships and ramping our new inside telesales operation. In tandem, we are developing new marketing initiatives to drive our online activities.

We are on track with our, to build our position in the large and growing global collaboration and messaging market. Our sales force has been hard at work meeting with potential clients since we have launched FUZE and WebMessenger at the Web 2.0 Interop conference is September. We have installed an inside sales team, a telesales function, and we have new additions to our online marketing organization.

We have a number of initiatives underway to drive customer acquisition via Web marketing and we have deployed with our first key distribution partner, Apple via their ApStore distribution platform. We are working to bring on additional distribution partners and resellers in order to gain greater leverage on our sales efforts.

As you recall, we have launched FUZE near the end of the quarter, and the early response from our beta users is highly encouraging. Our target customers for FUZE are small and medium businesses, enterprises, and mobile professionals. We are working to increase our traction in each of these customer segments.

To date, a number of customers have signed up for our free trial subscriptions for both FUZE and WebMessengers application via ApStore. We are beginning to see early evidence of these trial beta users translating in the early subscribers.

We are also making inroads within the enterprise and SME markets where we see significant opportunity. We have found that FUZE’s high-def image sharing and video capabilities are particularly attractive to professionals and industries where the requirement to view highly detailed and high resolution content is critical. For example, we have received positive feedback from a number of professionals in the medical and scientific community, who place a high value on being able to share images such as CT scans, x-rays, radiographs, in high resolution and in real time and on their mobile devices. We have seen similar response from creative professionals in the advertising, content production, and entertainment industries. As another example, film editor Billy Fox recently used FUZE extensively during the post production phase of this summer’s major motion picture, Traitor. FUZE enabled Fox to share real time high-def video footage for editing sessions, while he was in Los Angeles and the director was in places as far away as North Africa and France.

We are also pursuing opportunities where adherence to security is a top priority. We believe that FUZE is secure real time mobile presence capabilities can offer advantages and ultimately security policy will become the standard for sharing information and collaboration in most businesses.

During our FUZE beta launch period, which we will conclude at the end of our second fiscal quarter. We are focus on securing customer feedback that will help us optimize the offering. We are listening intently to what our customers want and fine tuning our product features where appropriate.

Our WebMessenger offering is also being very well received; in fact it is currently among the top download applications in the business section in Apple’s ApStore. Currently, the WebMessenger messaging application is a no-charge download for the iPhone, yet its most powerful feature is its ability to make the iPhone an extension of Microsoft OCS environment. To unlock that capability, the user is contacted by our telesales organization and encouraged to purchase additional services that make the WebMessenger application extendable and powerful giving the iPhone enterprise capabilities.

Post beta of FUZE, we will begin an aggressive marketing and telesales campaign to generate subscribers. As we get closer to the end of our beta period, we will be able to provide you more detail about our future business model and our product mix.

We are selling FUZE and WebMessenger via a combination of subscription based pricing and traditional software licensing that also feature annual maintenance charges. As Mark mentioned, our pricing on FUZE currently set at an introductory rate of $29 per month for monthly subscribers. We also charge $228 for annual subscribers. Our pricing on WebMessenger has been costumed to this point as a majority of our early sales activity has been with larger enterprise customers. However, we will announce new pricing packages for WebMessenger and mobile OCS during the current quarter.

With our new products, we believe CallWave is in the right place at the right time to maximize and capture opportunity. Given the current state of global economy, businesses have stronger need than ever before for tools that facilitate collaboration, improve productivity and reduce corporate travel expenses and support corporate re-initiatives. In fact, there was a recent article in ARM magazine that we have just received a few hours ago, the federal government recognized that virtualized work forces will reduce a Company’s carbon footprint and can save upwards of $20,000 per employee, which is more than many corporate IT budgets.

As we read in the newspaper everyday, companies around the world are announcing travel bans, moratoriums. They are looking for ways to cut costs, increase productivity and leverage past investments in their current desktop applications in order to extend their communication applications to mobile and virtualizes organizations.

As with our legacy business, the number of subscribers will be a heap performance measure for further offering. We expect to begin providing investors with this another performance metrics in future conference calls. It is still early on, on our product launch timeline, but I am optimistic about our strategy and our outlook. We have highly differentiated new products that offer business customers a compelling value proposition, particularly now on corporate cutbacks makeup majority of news headlines. We have committed plan for generating customer awareness, interest and subscribers for both FUZE and WebMessenger.

Our early customer feedback from the products is very encouraging. We will of course be completing beta test and converting these users into customers and keeping you addressed of our progress in the coming quarters.

Thank you for your attention and with that I would like open up the call for questions.

Operator, please go ahead.

Question and answer session

Operator

(Operator Instruction) Your first question comes from Aram Fuchs - Fertilemind Capital.

Aram Fuchs - Fertilemind Capital

I was wondering if you can tell me specifically how your marketing is different online. There seems to be quite a few collaboration software, pieces and basic Google keywords are quite expensive, if maybe you can talk about that and I have a couple of unrelated follow-ups.

Jeffrey Cavins

In the form of our marketing and sales activities around both FUZE and WebMessenger, we have a three pronged sales market strategy and that is to sell to via online marketing. We believe that we have differentiated in unique features that enable us to sell in a market that is somewhat active. We also combine telesales and direct sales activities. We were going out for large companies and/or partnerships directly. Then, we sell for distribution partners as I mentioned at stores are first incarnation of the distribution partner. So, three free front strategy is Web marketing, telesales direct sales, and the distribution partnerships.

We have by our sales versus relatively new telesales and direct sales and as I mentioned, we have been adding two on our online marketing team and this is very active since launch in executing on that three pronged strategy.

Aram Fuchs - Fertilemind Capital

Mark, if you can a little bit about the write down on the auction rate securities. Was there any specific metrics that caused you to increase the write down? We have actually seen some companies start getting liquidity on their assets. So, maybe you could talk about that?

Mark Stubbs

Yes, a couple of things. So, the first thing to remember is our auction rate securities are taxable, and so, the liquidity is been coming in the student loans. And in the [28.33], cause we have large and [28.35] we do not have mini. The second thing is, this all start hitting us really at the beginning of the year. And so, on the head for auction rate securities we have that are taxable, we have not seen any liquidity end of the market is the first thing until we figure, we get further away from with more uncertainty. The second item is our investment factor was Lehman Brothers. And so, when they went bankrupt, it put more uncertainty into our model and so, we are still working with Barclay’s and Lehman’s, to figure out, what are you going to do and get those back in the auction process. So, that was added one uncertainty into the valuation model.

Aram Fuchs - Fertilemind Capital

But, how did you come to that number? It is not just concerning educated guess? There is no sort of objective third party metrics for write down right now?

Mark Stubbs

I think, as most public companies now, especially the new FAB 157 and the fair value accounting standards, we use an outside third party evaluation firm and they are looking at liquidity for the specific type of auction rate securities, the underlying variables, put a hold in them and it is bad between a livewire race and so forth and there has been, as far as sales, in the open market on the secondary market to these securities.

Aram Fuchs - Fertilemind Capital

And then, regarding the legacy assets, what is your long-term plan there? Can you just talk about that?

Mark Stubbs

Yes, absolutely. So, most of the restructuring we have done has been to refuse, it must direct cost associated with the legacy business as possible. So, the strategy is to maximize the cash flow out of that business to fund the new FUZE and WebMessenger product lines. So that is what we have really taken a lot of the operating overhead associating with that business line out of the business.

Aram Fuchs - Fertilemind Capital

Jeff, regarding the iPhone app. Maybe you can just talk a little bit more of the up sell approach. So, when I download your app, if I want OCS, the expansibility that that is one I have to touch and sort of legion form, is that –

Jeffrey Cavins

What happens is, when you download WebMessenger for the iPhone, you are a registered customer, we see you and then we send an email campaign, asking you if you have interest in using your iPhone at work. Essentially connecting your iPhone, assuming that you either have OCS deployed in your company or probably deploying OCS and Microsoft just announced that they have now landed over 51% of the Fortune 500 and growing. If you answer to the positive that you want to extend OCS to your iPhone, you are directed to talk with telesales person or in fact the telesales person calls you and we walk you through how you do that, and that includes downloading a piece of software in your company that essentially if they, with the WebMessenger server license that you download into your company that connects to OCS and this is the way that we begin to monetize customers. Monetize you via the server license as we as monetize you for adding the OCS features with your hand set.

So there are powerful features to get unlocked. The [32.0] requires a telesales effort, it is not, but that is how telesales effort] is generated via Legion through campaigns and web marketing.

Operator

Your next question comes from Michael Coady - B. Riley & Company.

Michael Coady - B. Riley & Company

The $4.3 million as auction rate, is that all your remaining exposure?

Mark Stubbs

So, out of $10 million, we have a reserve, we have a $5.8 million reserve against the $10 million in auction rate securities.

Michael Coady - B. Riley & Company

So, $10 million is your total off rate?

Mark Stubbs

Correct.

Michael Coady - B. Riley & Company

So, you could eventually recoup the $5.8 million you have reserved so far?

Mark Stubbs

All the securities are still paying interest Michael. So another one has stopped paying, we shift the overall uncertainty of via liquidity in the market. And right now, the added uncertainty with Lehman’s going bankrupt.

Michael Coady - B. Riley & Company

And the balance of the cash, sorry, I am not at my desk. I don't have everything in front of me. I apologize.

Mark Stubbs

It is in the commercial paper, basically, and money market funds. So, the balance is $27.1 million with excluding auction rate securities.

Michael Coady - B. Riley & Company

Did you mention how many subscribers you will loose when you cancel the legacy Internet voicemail contract?

Mark Stubbs

We did, and those -- it's a wholesale agreement and so it is more we have from the net income perspective. It is more effective for us as -- if we leave the contract when it comes up. We are working with that provider to see how many of that we would want to support, because there is a possibility to up-sell any of those.

So, we will know, at the end of this quarter, how many exact subscriber we are going to loose.

Michael Coady - B. Riley & Company

I'm just wondering for modeling purposes how you expect that to impact the top line in the second and third quarter --

Mark Stubbs

In fact, the top line, Michael, will be immaterial.

Michael Coady - B. Riley & Company

Okay. Jeff, could you talk a little bit more about some of the WebMessenger and your FUZE sales within the pipeline from the early sales activity?

Jeffrey Cavins

Yes, to give a bit of a recap, we spent the last four quarters funding the product bill. We made the acquisition of WebMessenger and Intelligent Gadgets in the summer. We wanted to get these products to market and then build ourselves a marketing organization that could execute on our three pronged strategies.

Because these products launch so late in the quarter, we were on time as we said we are going to launch them in the quarter, they did launch, in just a matter of days before we close the quarter and we are very encouraged by what we see both in WebMessenger and FUZE activity. The FUZE customers, we have decided to launch the product as a beta. We do have paid customers in the beta. We have a pretty active base of non-paid right that are using the product and some of them are names that are pretty notable and noteworthy, I mentioned one on our call. I think over the course of the next call, I will have enough information that I could start to share in metrics, customer names activity, because these products did not produce enough revenue for us to talk about and either the last quarter and we do not expect a lot, of course, to be in material revenue contribution as quarter, we will probably hold off until our next conference call will talk about, customer momentum.

Michael Coady - B. Riley & Company

Okay, fair enough. In terms of ramping up sales and marketing effort, your stock is trading well below where your cash is now, on a market capital per share basis. But, nonetheless, so you are cognizant of the cash balance and how much would you be willing to spend? How much cash burn would you be willing to tolerate, obviously assuming that these new products aren't going to be generating much in way of revenue this quarter?

Jeffrey Cavins

We, the plan that we actually delivered for our board of directors is a plan where we had estimated and expected what we are seeing right now, and I think Mark, you gave a number for our operating expenses for next quarter, still pretty good with the number?

Mark Stubbs

Yes, $4.5 million to $4.8 million. So the cash model -- the cash flow statement stays relatively consistent. And so it's pretty easy to do that you know the map on the cash burn.

Operator

There are no further questions in queue at this time. I will now turn the call back to the speaker for closing remarks.

Jeffrey Cavins

Alright, thank you very much. Well, thank you everyone for participating on our call. I want to reiterate that the management team is very excited about our products and the opportunity that we see in the collaboration, conferencing and messaging markets. We look forward to updating you on our progress, perhaps during the quarter and certainly on our next earnings call.

With that I will wrap our call. Thank you.

Operator

This concludes the conference call for today, you may now disconnect.

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