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As I have written previously, I have been long VOCL for a while. Their merger, or reverse merger with Ymax, makers of magicJack, caught me by surprise. So much so that a friend of mine who bought the stock after reading my post here called me Sunday to ask me what happened with Vocaltec, and I had not heard the news of the Ymax merger.

It has taken me a few days to digest the 6K and the press releases, but I wanted to provide some high-level analysis. I was in the middle of my analysis when the company announced yesterday that it would buy back $12M of shares over the next year and report $3M in net income for Q2, which caused the stock to jump almost $2 or $23M in market cap.

1. If you have been a VOCL shareholder, VOCL CEO Ido Gur has significantly upgraded your holding. Per my thesis in the previous post on management, Mr. Gur pulled off a stunning turnaround at VOCL, leveraging the value of patents and the public stock to create a $100M+ revenue company that is profitable.

I want to try to unpack both the press release and the 6K a bit.

2. These paragraphs about revenues and cash flows from the 6K caught my attention:

"We generate revenues primarily from the sale and shipping of the magicJack, which includes a one-year license to access our network for a year of free broadband telephone service to anywhere in the U.S. or Canada, subsequent license renewal fees for an additional one to five-year period, and sales of additional magicJack-related services and fees. We sell magicJack units on a direct sales basis through our website and through national retailers on a resale basis. Shipping and handling fees are charged to customers purchasing magicJack units through our website. License renewals are presently offered on a direct sales basis through our website or our softphone. Combined revenues from the sale of the magicJack, shipping and handling, license renewals and related services and fees, such as fees charged for custom phone numbers and changing a phone number assigned to an existing magicJack, represented approximately 82%, 90% and 83% of our revenues in fiscal years 2009, 2008 and 2007, respectively."

Last year saw a significant increase in the number of magicJacks sold (more on that in the financials below), but those licenses have not yet come up for renewal. There is essentially no cost to those renewal revenues, so if CALL can keep churn down, the next year should bring significant high margin revenue to the company. What makes this particularly attractive is that they are front and center in their customers' desktop through the softphone client, much in the same way that Skype gets you to top off your Skype Minutes account through their desktop software. This is a low friction sale. I would guess that this is contributing to Q2 profits.

Here are the key paragraphs on Cash Flow. Note the bolded section for further indication the leverage in the renewal model.

During the fiscal year ended December 31, 2009, we generated positive operating cash flows of $23.9 million, as compared to $1.1 million for the fiscal year ended December 31, 2008. The increase was primarily attributable to: (i) a $29.3 million decrease in net loss, based on significant growth, offset in part by smaller percentage increase in costs of sales and operating expenses, and (ii) a $25.6 million non-cash bonus in fiscal year 2009. These items were partially offset by changes in operating assets and liabilities attributable primarily to increases in deferred revenues and deferred costs.

"Net cash provided by operating activities was $23.9 million and $1.1 million for the fiscal year ended December 31, 2009 and 2008, respectively. During the fiscal year ended December 31, 2009, the increase in net cash provided by operating activities was primarily attributable to: (i) a $20.3 million increase in deferred revenues attributable primarily by the increase in sale of renewals, (ii) a $5.4 million increase in accrued expenses and other current liabilities, (iii) a $2.3 million decrease in inventories, and (iv) a $27.5 million in non-cash expenses primarily due to an increase in accrued bonuses due to the $25.6 million bonus subsequently paid in shares of the Company’s common stock discussed in Note 17, “Accrued Bonuses,” in the Notes to YMax’s Consolidated Financial Statements included elsewhere herein, $2.9 million in depreciation and amortization expense, a $1.6 million provision for doubtful accounts related to our receivables from access charges and a $0.6 million loss on extinguishment of the SJ Labs note, offset in part by a $4.3 million realized gain on sale of available-for-sale securities. These items were partially offset by: (i) a $22.5 million net loss, (ii) a $5.9 million increase in accounts receivable driven by higher access charges revenues and an increase in sales of magicJack to retailers, as well as accounts receivables related to our wholly-owned subsidiary, Stratus, which was acquired in January 2009, (iii) a $2.0 million decrease in accounts payable due to timing of payments, and (iv) a $0.9 million increase in deferred costs."

3. The OpEx line in the 6K also merits further analysis.

"Total operating expenses was $79.4 million and $55.1 million for the fiscal year ended December 31, 2009 and 2008, respectively, representing an increase of $24.3 million, or 44.0%. This increase in operating expenses was primarily due to a combined $25.3 million increase in general and administrative expenses and research and development expenses primarily attributable to higher personnel-related costs, including $23.0 million of the 2009 bonus for 2009 services. These increases were partially offset by a $1.0 million decrease in advertising expenses as a result of reduced advertising volume in fiscal year 2009 as compared to fiscal year 2008, when the magicJack was still being initially introduced to the market."

The significantly good news in here is the increase in sales volume while reducing ad spend. That is an encouraging sign that the brand is gaining momentum, that the channels are working and the flywheel is turning. I would like to understand from management the increase in G&A and R&D personnel costs better. I plan to watch the ad spend and R&D numbers here going forward.

4. I do not know the CEO Mr. Borislow, but as a VC investor, I found this mess-up in investing corporate cash interesting. What is most interesting is Mr. Borislow clearly spotted a problem and moved on his own to fix it. That is encouraging as it shows that the CEO takes charge when he identifies an issue. Although I am not sure why he was paid an advisory fee?

"Realized gain on marketable securities in the fiscal year ended December 31, 2009 was $4.3 million, as compared to a realized loss on marketable securities of $1.4 million in twelve months ended December 31, 2008. We were adversely affected by the deteriorating capital markets in fiscal year 2008, and as a result, realized significant losses in our investments. During the twelve months ended December 31, 2009, our investments were closely monitored and managed by our Chief Executive Officer, Mr. Borislow, which contributed to significant realized gains. We incurred a one-time investment advisory fee of $1.1 million during fiscal year 2009, which was paid to Mr. Borislow for his investment advisory services."

Mr. Borislow's bio reads like an aggressive entrepreneur who is right out central casting for this role.

Daniel Borislow, Chief Executive Officer and Director. Mr. Borislow was appointed our President and Chief Executive Officer upon the consummation of the Merger. Mr. Borislow is the founder of YMax and served as an executive officer and a director since its inception in 2005. Mr. Borislow is the inventor of the magicJack. In 1989, Mr. Borislow founded Tel Save (later known as Talk.com), a telecommunications company and served as the Chairman and Chief Executive Officer of Talk.com until 1999. Mr. Borislow has a Bachelor of Arts and honorary Doctorate degrees from Widener University, where he also serves on the Board of Directors.

5. I read the section on patents with some amusement and I imagine someone at Skype read them with less amusement. For anyone in Israel, you know that Vocaltec has been around for an eternity. They were the pioneer in VOIP, although clearly not the winner. That gives them a significant patent base. When I read the line about protect in this press release, I could not help but think that someone at CALL thinks that they can extract royalties on these patents and help the business. This might be especially true as Skype contemplates an IPO and might be most vulnerable to a patent lawsuit. With this as background, read this paragraph from the press release again.

"The combined companies have the use of over 30 patents, some dating to when VocalTec invented VOIP. In the current legal world we live in, this protection is crucial. The company believes that its patents, technology, and inventions are prior art to other existing patents and may also expose patent invalidity. The combination of patents and softphone/softswitch technology were the primary drivers of the merger. The combined company is much stronger now."

6. I pasted the company's financials (pro-forma combined and others) below for reference. My quick analysis says the following: the company has $40M in cash and is generating cash of at least $5M per quarter right now. That means the company should have at least $50M by the end of the year. That equates to roughly $4.50 per new share of cash, given that there are 11.7M shares outstanding. CALL announced they will do $3M of GAAP net income in Q2. If I assume no growth, which I am certain is conservative, and assume the company lost $1M (they lost a tad less) in Q1, then we are looking at $8M of net profit for the year. That is roughly 73 cents a share of profit. Taking today's stock price of $15.50 and backing out the cash, you get to a stock price of $11, an enterprise value of roughly $120M and a P/E of about 16 on this year's earnings.

If you believe, like I do (and someone should ask management this on a call), that CALL's flywheel is turning and you took 25% growth in net profit QoQ, you would see $3M in Q2, $3.75M in Q3, and ~$4.75M in Q4 (not including any meaningful growth in the Vocaltec business). That would be almost a dollar a share in earnings and a PE around 11.

When I first heard the news of the deal, my initial instinct was to sell right away since I am in the stock from a split adjusted price of approximately $7 and this was a handy double plus. However, on further analysis, I am sticking with it, and I think we could see meaningful appreciation from here with an aggressive CEO, consumer brand in high-growth, and a business that is throwing off increasing amounts of cash.

Financials

Fiscal Quarter Ended
March 31

Three Months Ended
March 31, 2010
Compared to

(in thousands)

2010

2009

March 31, 2009

(Unaudited)

(Unaudited)

Total operating revenue

$31,397

$26,552

18.2%

Total cost of revenues

$15,238

$14,352

6.2%

Total operating expenses

$19,243

$20,699

(7.0%)

Net loss

($2,081)

($10,253)

(79.7%)

Operating Revenue

Fiscal Year Ended

December 31,
2005 (1)

December 31,
2006

December 31,
2007

December 31,
2008

December 31,
2009

(in thousands, except earnings per share)

Statement of Operations:

Operating revenues

$ -

$ -

$375

$33,089

$117,812

Cost of revenues

-

-

$3,880

$27,434

63,109

Gross (loss) profit

-

-

($3,505)

$5,655

$54,703

Operating expenses

$495

$4,165

$9,682

$55,132

$79,398

Operating loss

($495)

($4,165)

($13,187)

($49,477)

($24,695)

Interest expense

-

-

($801)

($982)

($1,180)

Other income (expense), net (2)

-

$6

$36

($1,314)

$3,898

Loss on extinguishment of debt

-

-

-

-

($563)

Loss before provision (benefit) for income taxes

($495)

($4,159)

($13,952)

($51,773)

($22,540)

Provision (benefit) for income taxes

-

-

-

$63

($9)

Net loss

($495)

($4,159)

($13,952)

($51,836)

($22,531)

Loss per share of common stock - Basic and Diluted

($0.01)

($0.08)

($0.23)

($0.69)

($0.26)

Weighted average common shares outstanding - Basic and Diluted

50,000

50,973

60,391

74,986

87,999

Unaudited pro forma loss per share of common stock - Basic and Diluted

($0.10)

($0.82)

($2.31)

($6.94)

($2.63)

Unaudited pro forma weighted average common shares outstanding - Basic and Diluted (5)

5,000

5,097

6,039

7,499

8,800

Balance Sheet Data:

Total assets

$236

$6,503

$15,227

$47,407

$77,009

Property and equipment, net

$28

$2,072

$2,133

$2,532

$2,034

Goodwill and other identified intangibles, net

$17

$98

$6,445

$15,466

$20,598

Total debt, net of discount (3)

$724

$8,446

$12,705

$10,695

$4,915

Redeemable comon stock (4)

-

-

-

$5,193

$5,764

Total capital deficit

($494)

$(2,794)

($679)

($33,924)

($49,047)

Other Data:

Depreciation of property and equipment

-

-

$490

$1,010

$1,457

Amortization of intangible assets

-

-

$514

$699

$1,405

Unaudited Pro Forma Condensed Combined Statement of Operations

For the Year Ended December 31, 2009

(in thousands, except per share data)

VocalTec

YMax

Pro Forma

Adjustments

Pro Forma

Combined

Revenues

$6,407

$117,812

$ -

$124,219

Cost of revenues

$2,337

$63,109

$434

$65,880

Gross profit (loss)

$4,070

$54,703

($434)

$58,339

Operating expenses:

Advertising

$3,020

$32,104

-

$35,124

General and administrative

$2,147

$41,811

-

$43,958

Research and development

$2,080

$5,483

-

$7,563

Total operating expenses

$7,247

$79,398

-

$86,645

Operating loss

($3,177)

(24,695)

($434)

($28,306)

Other income (expense):

Realized gains (losses) on marketable securities

-

$4,298

-

$4,298

Interest and dividend income

$132

$708

-

$840

Interest expense

-

($1,180)

-

($1,180)

Loss on extinguishment of SJ Labs Note

-

($563)

-

($563)

Investment advisory fee

-

($1,115)

-

($1,115)

Other income (expense), net

-

$7

-

$7

Total other income (expense)

$132

$2,155

-

$2,287

Net loss before income taxes benefit

($3,045)

($22,540)

($434)

($26,019)

Income tax benefit

($590)

($9)

-

($599)

Net loss

($2,455)

$

($22,531)

($434)

($25,420)

Loss per share of common stock - Basic and Diluted

($0.41)

$

(0.26)

($2.54)

Weighted average common shares outstanding - Basic and Diluted

6,001

87,999

(84,000)

10,000

Disclosure: Long CALL. Was long VOCL until the merger

Source: Why I'm Sticking With VocalTec After the Ymax Merger