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magicJack VocalTec Ltd. (NASDAQ:CALL)

Q1 2014 Earnings Conference Call

May 12, 2014 5:00 PM ET

Executives

Jose Gordo – CFO

Gerald Vento – CEO

Tim McDonald – COO

Analysts

Tim Horan – Oppenheimer

Operator

Good day and welcome to the magicJack VocalTec’s First Quarter 2014 Financial Results Conference Call. Today’s conference is being recorded. Joining us today on the call are Gerald Vento, President and CEO; Jose Gordo, Chief Financial Officer and Timothy McDonald, Chief Operating Officer. At this time, I would like to turn the call over to Mr. Gordo. You may begin sir.

Jose Gordo

Thank you, operator. Good afternoon and welcome to the magicJack’s first quarter 2014 earnings call. I’m Jose Gordo, CFO. With me on the call today is Gerry Vento, President and CEO, and Tim McDonald, Chief Operating Officer. During the call, we will make statements related to our business that may be considered forward-looking in nature under Federal Securities Laws. These statements reflect our current views regarding the future only as of today and should not be reflected upon as representing our views as of any subsequent date. These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations.

For a discussion of the material risks and other important factors that could affect our actual results, please refer to our Annual Report on Form 10-K which was filed with the SEC today on March 12, 2014. Also during the course of today’s call, we will refer to certain non-GAAP financial measures. There is a reconciliation table showing GAAP versus non-GAAP results currently available in our press release issued after the close of the market today, which is located on our website at www.vocaltec.com.

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

Gerald Vento

Great. Thanks, Jose. Good afternoon everyone. We’ve got a lot to cover today, so let’s get started with our key financial and operating metrics. Our revenue for the quarter was $35.3 million. We grew renewals which were categorized as access rights to revenue to $15.4 million. This represents a 14% increase on a year-over-year basis. Renewals now represent 44% of our revenue base, up from 39% in the last quarter.

We generated $14.2 million in operating cash flow for the quarter, a significant increase compared to the $6.4 million last quarter. We continued to grow our strong balance sheet with $67.3 million in cash, investments and no debt. We have 3.1 million active device users, a 3% decline from $3.2 million active users in the prior quarter. We define active users as subscribers of our magicJack device that are under an active subscription contracts and we’ve reduced the average monthly churn to 3.3% from 3.6% from the prior quarter, remained at the quarter was 8.4 million registered app users, an increase of 21% quarter-over-quarter.

As we said in our last call, we had a near-term focus of presetting our brand, product and operational platform in order to enable greater flexibility to expand our product offers and distribution opportunities for the long-term. We are moving rapidly implementing changes that affect every dimension of the business. You’ll see us continue to invest in people, infrastructure, product development, customer care, creative and media. We are recruiting strong people with extraordinary skillsets to supplement our outstanding team and to bring upon the company the opportunity we seek to grow the business.

We are introducing a newly simplified device as a competitive price point with features designed to appeal to both our core customer base as well as newly targeted consumer, freelancer and small business segments. We are targeting customers at home and on-a-go and in-an-office who have high interest in magicJack but to-date have low awareness of our offer. We are on the eve of launching this new device and Tim McDonald will provide greater detail for you today.

The in-store merchandizing experience is set to roll out during each of our retailers spring and summer planogram resets. We are working with our existing big box retailers and our new value channel partners whom we announced on the last call to deploy new sales training programs and tools. The online customer shopping process is being streamlined as well.

Our newly introduced magicJack app is now under a rapid release development cycle and you’ll be hearing more about that and the monetization features shortly. And for those frustrated with the legacy customer care experience, we have substantial improvements on the way. We have identified and are addressing high-volume carriers use such as enhancing floor protection, increased presence of first-time call resolution and identified and implementing new call center provisions.

We advised on our last call that, when ready with substantial change, a new device launch app redesign attribute to a better customer care experience, we would invigorate our television and digital marketing campaign. We’re close to completing that chapter. By the end of Q2, the last wastage of the old magicJack will be behind us. The total refresh of magicJack brand and product platform will see expand our marketing to a broader set of customer segments that the company has ever done in the past and we’re committed to meeting the demand of customer seeking compiling, value-price calling services and extending the reach of our offerings to a broadening market of global customers.

Now let me turn to some existing news that we believe demonstrates the expanded value we’re creating with our people, new brand platform and validates the new direction of the Company. As I indicated on our last call, we’ve been in discussions with certain global mobile operators regarding international distribution opportunities. We see growth for our Company’s products and services coming from both domestic expansion with the developments and improvements that I’ve briefly outline today and to complement those initiatives, we believe international distribution both the device and the app represents significant potential opportunity for growth.

To begin our international expansion, today we announce the strategic commercial agreement with Telefónica, S.A. to sell magicJack products and services in Latin America. This agreement provides a framework for entering into multiple Latin American markets and contemplates the sell both the magicJack device and the app. This agreement is subject to the completion of a pilot trial, which we anticipate will commence late in 2014. The offering will be co-branded with a new magicJack brand platform and with specific marketing strategies to be set on country-by-country basis.

While there is certainly much work ahead of any market launch, we view this as a substantial opportunity to penetrate Latin American markets and we’re confident that we and Telefónica can introduce strong offerings into the market place at compelling price points. This agreement to partner with and jointly market our device and app to an existing Tier 1 carriers customer base and distribution channels is a significant first step in implementing our international distribution strategy and it comes to our longstanding relationship with senior leadership at Telefónica.

So the work ahead will be intense with additional people and resources required to operationalize this exciting opportunity before the end of the year end. With that, let me turn the call over to Tim McDonald, our Chief Operating Officer who will provide business update.

Tim McDonald

Thanks Gerry and good afternoon everyone. As Gerry indicated, we’re in a process of fundamental transformation of the magicJack service, one that touches on one every dimension of our platform. This transformation was long overdue. We’ve made a great deal of progress over the first 120 days of this transformation and the hard work of our dedicated team will become increasingly visible to the market over the course of remainder of Q2.

As discussed on our first quarter call, in the second quarter, we will reintroduce the magicJack brand to consumers with top-to-bottom redesign of our offer. By the end of Q2, this transformation will largely be complete. As we’ve discussed in our first quarter call, the central element of this repositioning of magicJack service is creating a tighter linkage in the mind of the consumer between the device and the app. The mobility provided by the app is a key feature of our service. For consumers, that maybe one of our compelling features of our offer.

Our new service will be marketed under the name magicJack GO, reinforcing the at-home and on-the-go positioning of our offer. The new GO features enhanced core quality, simplified device design, updated packaging and quick start guide both in English and Spanish, free conference calling for family and business and importantly the GO enable subscribers to have one number accessible via both the device and their mobile phone.

Third equate we discussed was call quality. Due to software performance enhancements the new device software provides higher voice quality improving the already top quality voice of the magicJack today. This highlights the Company’s dedication to continuously improving our service quality. This improvement in voice quality will also be incorporated in previous generations of magicJack including the magicJack PLUS and the magicJack 2014 offer the benefit of our existing loyal customers.

The new magicJack GO will be priced at $59.95 and will include one year of service. One year renewals will be priced at $35 and we’re introducing a six month renewal priced to $20. Our initial launch partners Wal-Mart, RadioShack and Best Buy will be rolling out the GO in June and July coinciding with their previously planned store updates.

We have planned to time the GO launch in retail to coincide the some of our larger retail planogram reset dates, which had originally been schedule in May. Retailer changes those department-wide dates have us now launching the GO in our major retail partners between early June and mid-July. Our retail launch partners have indicated initial orders totaling over 100,000 units we’ve already received purchase orders for over 60,000 with additional orders coming in every week and we’ve recently began shipping of the new magicJack GO. Our retail partner strongly believe the $59.95 retail price for one year of service provides a compelling value over the current $49.95 for the six months of service for the magicJack 2014. Over the last few months we’ve shared the new design, packaging and linkage with the app with our retail partners. We’re excited by the new offer and believe it would be well received in the market place.

Our retail partners are particularly excited about our refreshing approach to a product design, packaging, in-store merchandising and new advertising messaging. Further, our retail partners believe that, the one number anywhere magicJack GO service provides a compelling new value proposition in the market. The initial retail orders are the most relevant validation of our new offer. A further indication support by our retail partners for our new offer is the expanded in-store merchandising opportunities we’ve been provided. These expanded retail merchandising will be seen as our partners roll out the magicJack GO over the next few months.

The introduction of the magicJack GO will be supported by an aggressive media campaign that includes new creative for both television and digital. The new free-your-phone add campaign include a 60 second product centric spot that will feature the magicJack GO device along with a magic app companion and expands magicJack from a pure consumer offer to additionally appealing to entrepreneurs and small business owners. These new apps address core new segments for the Company, female, head of household, freelancers and small business. Many of these customers are bilingual and the spot will speak to multi age audience across the America.

We’re also currently working with several value-oriented retail partners to craft the unique incremental offer to capture this end of the market. Such value price offers will come with a lower price tag and shorter initial term of service. We’re pleased that our team has delivered the new device and packaging costs that are in line with the current 2014 device and packaging. We believe that it’s possible to deliver on our value pricing and at the same time present quality branding to the market place.

Now let me briefly touch on customer acquisition costs. In Q4, we spend $3.7 million in our hard media spend which is defined as television and digital advertising expense. As previously discussed in the fourth quarter, this figure included significant legacy media spend associating with our prior ad campaign. In Q4, we reported 216,000 activations and this resulted in a media cost per acquisition of $17.

In Q1, we spend approximately $2.4 million in our media spend and generated a 196,000 activations. This resulted in a media cost per acquisition of $12.24. This reduction in the cost per activation demonstrates the increasing effectiveness of our advertising strategies. While these figure will fluctuate quarter-to-quarter, we’re maintaining a disciplined approach to customer acquisition.

As discussed on our last call, our cash renewal cards will be released Wal-Mart the magicJack GO in June. We expect further integration to be complete in early Q3 for an additional cash play platform, getting magicJack access to enable the sales of renewals in thousands of the incremental locations nationwide. This service is a particular appeal to our indirect channels, in which many of our potential locations are already integrated with our partners or other services. Beyond providing our customers with the ability to purchase renewals with cash at the point-of-sale, in the future, customers will be able to purchase other enhanced services such as dedicated mobile numbers, international calling and other packages with cash at the point-of-sale.

Now let turn briefly to our mobile services. As noted above, the mobile is both a feature of our core service as well as a standalone revenue opportunity. We are able to monetize our mobile services in three ways. First, through selling incremental devices based on the utility of the at-home and on-the-go nature of our magicJack GO offering. Second, selling mobile-only services to our app users.

And third, cross selling devices into our growing base of mobile customers. In April, we’ve invested in the growth of our mobile development team in order to provide effective management of our ongoing application development efforts. Over the remainder of the year, our expanding global mobile development teams will be focused on implementing or preexisting mobile roadmap.

In Q1 our total monthly active unique app users increased to 3.5 million, up from 3.3 million in Q4 2013. Once again, our growth of monthly active unique users on the app exceeded the decline in users on the magicJack device, indicating a continued growth in users on the magicJack network.

We have released new rebranded versions of both the iPhone and Android apps. The releases include significant branding, design end user experience updates as well as simplified registration process. The iPhone update was released this morning. Our updated registration process has increased our percent of daily registered users calling from the app from 60% in February to 84% today. This is an important shift as we move to up sell services to our growing base of registered users.

Over the next few months, we’ll continue to improve and better highlight existing features such as international dialing and purchasing pay-per-use credit to drive additional usage and enhance magicJack’s ability to monetize the app-only users. We expect to begin generating app-only revenue during the second half of 2014.

To-date, we have neither advertised nor promote the app in anyway and this is changing. Nearly 60% of our users today are located in North America. We see an opportunity to significantly expand beyond North America and believe we’re only scratching the surface of this global opportunity.

As a part of our recent Android update, we have participated in an internationally-focused Intel-funded social media campaign to promote app downloads. Performance has exceeded expectations with positive response in India among other regions. This program will provide a blue print for our direct digital media and create a planning for all of our app versions going forward. Asia currently represents our largest numbers of monthly active users outside North America.

We are expanding our digital marketing team to provide dedicated resources to target the growing international opportunities to mobile. We will soon begin marketing our app to users in high-value markets in Asia and Latin America, where we see significant demand for our offer. Going forward, we intent to drive a higher volume downloads around revenue generating opportunities by focusing on messaging on specific calling and other value-added offers.

Now let me turn to some exciting news. Following on the heels of the release of the new magicJack GO, we intent to launch a compelling new offer in the third quarter. For the first time, customers worldwide will be able to purchase a package that includes a dedicated U.S. number, unlimited calling into U.S. and Canada and texting into virtually any mobile carrier in the United States.

We will sell these packages with both monthly and annual plans. The pricing of this offer is still being finalized. This offering has been in development for some time and we believe that it provides an attractive value proposition particularly in the international markets, which is a growing target of opportunities for the company.

As Gerry indicated, to support our growth strategy, we continue to invest in four key areas, people, infrastructure, production and customer acquisition. In terms of people, over the last 120 days, we have expanded our marketing, sales and distribution, care and retention, mobile and international capabilities to capitalize on the scale of opportunities we see in the marketplace.

In terms of the infrastructure, we’re investing in retooling in our web and mobile e-commerce platforms simplifying web and mobile activation process, streamlining subscriber account management tools and enhancing our customer care platform. In terms of production, we’re investing in an updated device industrial design with secured incremental production partners and updated our retail and direct packaging.

In terms of customer acquisition, we developed new TV and digital creative specifically for the new magicJack GO and developed enhanced search engine marketing to drive increased volume of high-value direct sales.

Q1 was a period of significant work behind the scenes. Over the remainder of Q2, the fruits of these efforts will become visible to our investors and the marketplace. We’re confident in the progress we have made and our performance over the course of the second half 2012 will demonstrate the success of our plans for returning the company to growth.

With, that let me turn the call over to Jose.

Jose Gordo

Thank you, Tim. Good afternoon everyone. Our first quarter financial performance was highlighted by record sales and access rights renewal revenue, growth in deferred revenue, strong free cash flow generation, reduction in customer churn and app user growth to 21% from the prior quarter.

Starting with the P&L for the quarter, we generated total GAAP net revenues of $35.3 million, a decrease of 8% compared to the fourth quarter of 2013. The quarter-over-quarter decrease was primarily due to a decrease in device revenues as we begin to wind down sales of the new magicJack PLUS in preparation for the new device launch in Q2. Revenues from magicJack’s sales in the quarter were 12 million, a 21% decrease from $15.1 million last quarter.

Access rights renewal revenue was $15.4 million, an increase of 4% quarter-over-quarter and up sequentially from $14.8 million we generated in the fourth quarter. As a percentage of total revenues, access rights renewals accounted for 44% of revenue, up from 37% for the same period last year. In fact, sales from access rights renewals from the quarter represented the second highest quarterly renewal sales in the history of the Company. We are pleased that access rights renewal revenue which represents recurrent portion of our business has continue to grow and become a stronger component of our overall revenue.

As Tim mentioned, we’ve recently recruiter a Director of Customer Attention to manage our customers renewal program and to further expand our renewing customer base. We will be making a conservative effort to increase our renewable capture rates including making cash renewals easily purchasable and proactively communicating with our customers prior to contract expiration. We believe the cash renewal program and customer outreach initiatives will begin to favorably impact our churn starting in the second half of 2014.

Network expense for the quarter was $5.5 million, flat from the prior quarter as we continue to negotiate better rates and groom our network to drive increased cost efficiencies. Total operating expenses remains flat for the quarter at $14.7 million, primarily due to a $2 million increase in G&A expenses, which was offset by $1.6 million decrease in advertising expense and a decrease of $300,000 in R&D.

G&A for the quarter was approximately $8.6 million and was impacted by $1 million one-time stock-based comp expense and $600,000 of increased legal and accounting fees. When taking these two items into account, our current G&A run rate is in the range of $7 million per quarter. This increased G&A run rate as compared to last year is largely attributable to higher personnel expense as we make impactful additions to the magicJack team. The decrease in advertising spend is largely attributable to a $1.4 million decrease in media compared to last quarter as we anticipate an aggressive media campaign tied to the new device launch in the latter part of Q2.

For the quarter, we had pro forma CPGA of $5.71 excluding one-time app spend of $715,000. We currently calculate CPGA as marketing spend which includes media spend, marketing related SG&A and marketing investments such as web, mobile and other activities divided by total unit and renewal sales. Going forward, we will also report media cost per activation which is defined as total media spend divided by unit activations. Using this approach we had CBGA of $12.24 for the quarter based on a media spend of $2.4 and 196,000 device activations.

Turning to profitability. GAAP operating income was $7.6 million for the quarter. Our income tax expense was $2.3 million compared to our significant income tax expense up $35.4 million for last quarter. As you may recall, in our last quarter we had a significant one-time income tax benefit from the valuation allowance release of $40.5 million. GAAP net income for the quarter was $5.3 million as compared to GAAP net income of $45.3 million for the fourth quarter after taking into account the Q4 tax benefit.

GAAP diluted earnings per share for the quarter was $0.30 based on 17.8 million weighted-average diluted shares outstanding as compared to $2.50 based on 18.1 million weighted average diluted shares outstanding for the fourth quarter. First quarter GAAP diluted earnings per share would have been $0.26 without the one-time tax benefit. Operating cash flow for the quarter was $14.2 million, as compared to $6.4 million for last quarter with the increase being primarily attributable to an increase in total sales and the use of less cash on market expense.

Now turning to our results on a Non-GAAP basis. For the quarter, we’ve reported adjusted EBITDA of $11.6 million, a decrease of 17% from last quarter. A reconciliation of GAAP to Non-GAAP financial measures have been provided in the financial statement tables included in our earnings press release from earlier today and is available on our website.

Turning to our balance sheet, as of March 31st we had cash, cash equivalents and investments of $67.3 million, an increase of $12.5 million over the last quarter and no debt. We increased our deferred revenue slightly to $114.9 million form a $114.5 million quarter-over-quarter. This represents our first increase in deferred revenues since Q1 of 2013. We continue to generate great operating cash flow and believe we have one of the strongest balance sheets in our industry. Our ability to consistently generate cash, provides us with substantial flexibility to enhance shareholder value.

In 2014, you will see us invest our cash in all areas of our business across the board. These expenditures will concentrated in following years. First, personnel expense, in the areas of product development, operations, marketing, customer retention and customer care, as we continue to add count that will help to support current and future direction. Second, marketing expenses that for further implementation of our brand design including our website upgrade and the production of new ads and media. And third, significantly increase media spend for the second half of 2014 to promote the new magicJack GO and our related product offerings.

We will also have flexibility to use cash to invest in the implementation of our new partnership with Telefónica in Latin America. We will continue to place a particular emphasis on using our cash flow our own customer base. We have a favorable CBGA and have our customer life time value levels spending on the addition of new customers clearly continues to be a very good investment to our shareholders.

Turning to our financial outlook for the full year. We have no changes to our previously issued 2014 financial guidance. We are projecting 2014 revenues in the range of $158 million to $163 million and 2014 adjusted EBITDA in the range of $48 million to $52 million. We expect that our revenue growth in the second half of the year will come primarily from three sources. First, increased device sales, when we launch the new magicJack GO. Second, continued strong renewal sales as we implement our churn reduction program. And third, the various app monetization initiatives we have planned to launch starting in Q3.

We expect second quarter revenues and adjusted EBITDA to decrease as we ramp down sales of the existing device and prepare for the launch of the new magicJack GO. Specifically, we project Q2, 2014 revenues to be slightly below Q2 revenue for 2013 when we were in a similar position of transitioning to a new device launch. We expect our affective 2014 tax rate to be approximately 30% to 31%.

With that, I’d like to turn the call back to Gerry.

Gerald Vento

Thanks, Jose. Well we’ve outlined today is the progress we’ve made over the last 120 days to transform the Company. We are building an infrastructure to scale this business to take advantage of the significant market opportunities we see today and beyond. We are expanding our capabilities in key areas such as marketing, sales and distribution, mobile, customer care and retention, product development and international.

And for the first time in our history, our company has been viewed as a legitimate co-branded counterparty to a global mobile operator. Our [acquisitions] are significant and you see the first indications of where we intend to take this business. And there will certainly be fluctuations in the short-term as we execute against this and this is planned, but make no mistake about it, we intend to put this company on a trajectory of growth coming out of 2014 that will reward our investors.

And with that, I am happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). And we’ll take our first question from Tim Horan with Oppenheimer.

Tim Horan – Oppenheimer

Hi. Good afternoon guys. Thanks for all the info and congrats on the texting. We launched the texting outside the United States, will that also be available inside the United States? I wasn’t really clear on that.

Gerald Vento

Yes, Tim. It will be.

Tim Horan – Oppenheimer

Okay, great. And you will also be charging a monthly fee for that?

Gerald Vento

Yeah. It will be offered both in monthly fee and an annual fee. So annual fees would be discounted for the monthly fee, but we want to offer both.

Tim Horan – Oppenheimer

Got you. Great good luck. And then can you just run through the pricing changes? Again sorry I don’t know if I’m clear on that.

Gerald Vento

Yes. The new offer, the magicJack go is priced at $59.95 with a one year plan and the renewals are price at $35 for one year plan and $20 for six moth plan.

Tim Horan – Oppenheimer

Great, congratulations. So that’s obviously the price increase from $30 to $35.

Gerald Vento

Correct.

Tim Horan – Oppenheimer

Great. And when does that take effect?

Gerald Vento

It takes effect with a launch of GO in June.

Tim Horan – Oppenheimer

So anyone renewing after that would pay the higher price. Okay, great. And then, can you just talk about the churn within that? Can you talk about the six month renewals, what you are seeing there? There are people who bought the six month plans, are they renewing a kind of rates above or a below historical averages?

Jose Gordo

This is Jose. Yes. In the first quarter, we did experienced a higher than historic averages on the most of the six month plan. It will be for advertising in our budgeting also.

Tim Horan – Oppenheimer

And the G&A, the $7 million run rate that’s kind of a good run rate for the second quarter also, right?

Jose Gordo

Yes, it is.

Tim Horan – Oppenheimer

Got you. Well, obviously reiterating your guidance suggests that, we’re going to see very, very strong fourth quarter. I’d love to kind of if you can give some color on what the new rate plans are going to be for texting and also for international plans? So just to be clear, kind of what’s the game plan for launching the texting and may be updates on the international calling plans and updating the app itself to have kind of full launch on the app. Is that the third quarter all of the same time?

Jose Gordo

Yes. I mean, that it’s actually sequential. We are going to be beginning the marketing of the international offers to coincide with a launch of the GO and the update of the commerce experience in June. We’ll be making improvements to the ability to purchase services through the app in sort of that timeframe last Q2 or the Q3 and then will be releasing texting that will follow-on the international. So, the really sequence first for international and then for the texting.

Tim Horan – Oppenheimer

And in international, would you have a unlimited rate plan or may be can you talk about what the rates might look like because right now they are still relatively expensive that looks to me?

Gerald Vento

Yes and you are right. They are relatively expensive and there are high margin. So, we’ve got a little room there. We are not ready to announce plans with unlimited. We want us to be very focused on managing usage, so we are not saying no but we are not saying yes on unlimited.

Tim Horan – Oppenheimer

Got you. Thanks for the time and good luck.

Operator

(Operator Instructions). And it appears, there are no other questions at this time. I’ll go ahead and turn the call back over to management going any additional of closing remarks.

Gerald Vento

Thanks everyone. We will talk to you next quarter.

Operator

Ladies and gentlemen, this concludes today’s conference. We thank you for your participation. You may now disconnect.

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