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magicJack VocalTec Communications Ltd. (NASDAQ:CALL)

Q2 2012 Earnings Call

July 30, 2012 10:00 am ET

Executives

Andrew MacInnes – President

Daniel Borislow – Chief Executive Officer

Analysts

Timothy Horan – Oppenheimer & Co.

Ryan MacDonald – Northland Securities, Inc.

Operator

Good day ladies and gentlemen and welcome to the magicJack VocalTec Q2 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions)

With that, I would like to hand the call over to the magicJack President, Andrew MacInnes. You may begin.

Andrew MacInnes

Thank you, Mime. Good morning to you all and thank you for your interest in magicJack. Firstly, let me introduce Dan Borislow, our CEO who is also on the call. For the structure of the call, I will present some prepared remarks about the company’s financial results in the most recent quarter, and then Dan will answer some questions from our analysts.

Firstly, let me read the company’s Safe Harbor statement. This presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act given to the company’s expectations or predictions of future financial or business performance or conditions. Forward-looking statements are typically identified by words such as believe, expect, anticipate, intend, target, estimate, continue, positions, prospects or potential by future conditional verbs such as will, would, should, could or may or by variations of such words or by similar expressions.

The forward-looking statements in this presentation are qualified by the factors affecting forward-looking statements identified in our SEC filing, available at sec.gov or on our own website. These forward-looking statements are subject to numerous assumptions, risks and uncertainties that change over time. Forward-looking statements speak only as of the date they are made and we assume no duty to update forward-looking statements.

Okay, now that we have got that out of the way. I will go over some of the major items in the most recent quarter. Firstly, the company reported revenue in Q2 of $38.6 million compared to $28.8 million in the same period a year ago representing growth year-on-year of almost 34%. Sequentially, compared to Q1 2012 revenue growth was almost 10%, if one excludes the approximately $2.5 million in revenue associated with the implementation of international prepaid billing rules from the Q1 numbers.

Secondly, reducing costs is a [man] curve at the company. So let me discuss improvements in several of the cost categories. Advertising expenditures have been reduced over the last few quarters, we continue to use very cost effective remnant TV advertising and the efficiency of these short form TV swaps is clear from our ongoing sales volumes.

With respect to network costs. As we expected, we have been a beneficiary of the recent FCC access charge reforms. Net-net the cost per customer is about $1.50 per year, while our renewal rates might be the best in the industry. On the G&A line item, we did also share improvement here mainly due to reduced legal expenses. As a result operating income for Q2 was $10.3 million up from $3.3 million in Q1 2012 again excluding the IPP one-time items in Q1.

Next, let me turn to our share repurchase program. Our share repurchase program continues to be very successful and we are now down to 19.4 million shares outstanding at the end of the quarter. In terms of our new product pipeline, let me discuss a few of the exciting items we are focused on here. So as many of you know, we are gearing up for the production of the magicJack WiFi for fourth quarter introduction. The company is also completing the rollout of the magicJack APP for the Google Android platforms. We have been very pleased with the success of the magicJack APP on the Apple iOS devices. We will also be adding texting to our apps later this year and at that point, we will really start promoting the apps. We will seek ways to monetize the apps next year in 2013.

Finally, [someone] may want to walk down about the number inventions. Let me wrap up with a couple of general points. Firstly, the company has now built out the infrastructure to handle hyper growth. And secondly, what many of you don’t know if we are the only company to have the largest reaching CLEC, our own chip design company, our own Softswitch and Session Border Controller company and we even write all our own softphone software. All of these subsidiaries continue to contribute to our overall success.

With that summary of recent results, let me turn the call over to Dan to answer questions.

Daniel Borislow

Good morning everybody. Thanks Andrew and thanks for contributing to the success of the company since you started this year. Before I get into the questions, I just want to go over a couple of things very briefly.

Early this morning, we announced a patent field that I have been personally working on for quite a period of time, and the patent world is not a very well-known industry except for quite a few people, and you could buy 5,000 patents, a 5,000 patents might not be better than just one patent I think you could purchase alone.

In this case, this is a very valuable patent that we purchased. It will be revenue and income producing, and it will be very accretive to our numbers in the future. The other thing as far as patents cover, still on the look, this particular patent that we did buy as the foundational patent, as far as our concern. And it happened would be the reason – the largest reason by far of why we merged with VocalTec and besides the people that we got and the technology that the patent was something I was absolutely terrified about research, all the patents that were outstanding and when I found that VocalTec patent I know I have to get used with that patent.

As far as the fourth quarter introduction of the WiFi product, we’re making some modifications to it now. So the Telecom world is a very unusual world and things go full circle in this business, and what we’re doing with the WiFi magicJack. We have a little invention that we adding to this, but that’s giving us the ability to not only protect phones and use it with Internet directly instead of over WiFi, but one of the things that you are going to find very important next year and I think the marketplaces could be surprised is LTE Femtocells are going to become very popular next year and I think you’ll see Verizon Wireless taking the lead in that and we’re going to do some things that, but the patent that we just recently got and the technology that we have in our cost structure, we intend to be on LTE Femtocells in a big way.

Another thing that we did recently in the last six weeks, the app on the iDevices has been very popular and one of the reasons it’s been very popular in the next six weeks, we’re actually growing traffic by whole percentages on a daily basis right now. As that we have a capability on a patent that we filed for about four months ago and when someone uses the app right now, they actually leave back a call back number for everybody that they call and without going into too much about this. Essentially, we could download 10 million apps and only use 30,000 phone numbers and nobody would know that they are even sharing phone numbers and it’s something that will be extremely popular but not only for our base, but the whole industry and we’re pretty happy that we invented this. We put it out, we’re actually making it work and we’ve filed for the patent.

With that little bit being said, if 10 more mikes available, I’d like to take your questions now. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Tim Horan of Oppenheimer. Your line is open.

Timothy Horan – Oppenheimer & Co.

Well thanks, great quarter guys. Andrew just a couple of housekeeping items to get to the $0.51 in earnings this quarter, I think there is probably some minor tax impact and maybe, are you using average shares outstanding to get to that $0.51 in the quarter?

Andrew MacInnes

Tim, I’ll answer that, we were using average to the company such a massive buyback program go on compared to for most dollar companies that the number that we’ve put out in the press release was the ending number, so people announce would have a good indication of what might happen in the future. But we – I think we purchased about 1.8 million shares this quarter and that number is earnings based on our GAAP numbers like everybody else does it and that was $0.51 per share GAAP numbers using the proper allocation of shares.

Timothy Horan – Oppenheimer & Co.

All right, Got you. Thanks for the clarification. And can you maybe say how much you actually spent on stock buybacks on the quarter and maybe roughly and the same thing on CapEx on the quarter?

Andrew MacInnes

Yeah, I believe the repurchased amount was $30 million to $40 million in cash for the stock repurchase. I’m sorry, so what was the second part of the question?

Timothy Horan – Oppenheimer & Co.

How much you spent on CapEx?

Andrew MacInnes

Our CapEx is being minimal in this company for a long time. And there was minimal and it will be minimal in the future. We like to build things for huge growth and we’ve done that from day one and we’ve never really needed to add that much to it. We did add some fusion cards at very, very high speed, data cards for various service and our database. We added some things for the UFC to speed things up, but CapEx is very minimal.

Timothy Horan – Oppenheimer & Co.

Thanks. And then on the related products revenue were up fairly substantially, can you talk about what’s driving that and is that kind of a good run rate?

Andrew MacInnes

A large part of that is the reporting of phone numbers that’s been, I think on the last call, I feel that it’s been doing better than what I thought and not only is it driving revenue and income, but it will – in the future it will substantially, it will keep people on the service and continue to renew their licenses. So it’s been a very successful program and that’s the bulk of it and obviously we continued to do well in Canada as well and we charge for phone numbers in Canada.

Timothy Horan – Oppenheimer & Co.

And just remind me, sorry, on the phone numbers, is it a $20 one-time upgrade fee and $10 a year. Do you think that’s kind of good way to think about it?

Andrew MacInnes

So that’s rate on the money.

Timothy Horan – Oppenheimer & Co.

Great. And can you then talk a little bit about volumes. It looks like your deferred revenue was relatively flat. So I’m assuming the sales or devices were kind of similar to the first quarter and maybe you can talk about just a total sales and how the (inaudible) between?

Andrew MacInnes

Yeah, I mean…

Timothy Horan – Oppenheimer & Co.

Yeah.

Andrew MacInnes

Keeping deferred revenues as good as the first quarter is a good thing. We introduced the product magicJack PLUS, which we do about 10 magicJack PLUS for the original magicJack right now, and it’s substantially greater margins, greater sales, greater revenue – produce a greater revenue. And the larger sales that we produced in the fourth quarter turned into revenue in the first quarter. So being that that was such a terrific quarter in sales, I’d be happy this could be, if I can keep deferred revenue as high as we did in the first quarter. So I’m very pleased with the deferred revenue and the continued strong sales of magicJack Plus.

Timothy Horan – Oppenheimer & Co.

And then on the renewals, obviously you’ve taken a fairly large price increase here. I know it’s just kicking in. And you had decent growth there 20%, but I think the price increase blended is kind of well over 30%, I know for the annual product is close to a 50% price increase. Should we see the license renewals continue as the price increases kick in? Should we see that growth accelerate up to the 30% to 40% price increase?

Daniel Borislow

Right. So a large reason why I had such a large growth of income from first to second quarter, and it’s because the substantial margin improvement of the renewal licenses going up by 50% and what happens, you have a certain amount of costs if you would charge $20 out for renewals and you have a $17 of costs, you only have this is not what we had, I’m just using this as an example, you have $3 there, but when you go from $20 to $30 and I have $13 that’s not like you just run out 50%, now you got [dribbled] your net income margins. So that the price increase was big that was accepted there very well and a large part of the income we are producing is because of the increase in price.

Timothy Horan – Oppenheimer & Co.

Okay. And then just three expense questions and I’ll hand over the mike. With the access revenue, obviously, there is a lot of concern out there with all the regulatory changes that it could impact you in terms of expenses going up and maybe revenues going down, but it sounds like you were never too concerned about that. Is it just kind of a good run rate now, where you getting in terms of access revenue and your network and carrier charges, do you think this is a good run rate or could there going to be any major changes for the second half of the year, I know a lot of the SEC rules are really getting implemented towards the second half?

Daniel Borislow

I believe that the numbers that we have now are actually the minimum numbers that you’ll see, we’re in litigation with two large carriers. And in those numbers, you don’t see the additional revenue when it come that we could make it for successful Oncor or the PUCs, which I think we will be. And as far as access charge reform the more calls that go to wireless subscribers they now allocate their access charges, so our fees for them are zero. They were from zero to a small number. And so net-net, the cost of access has gone down for us, our collections have remained stable and I expect them to increase in the future. And I believe that Andrew mentioned and when he first started that access or net-net telecom costs per customer are only a $1.50 per year. So it’s not the minimus, but it’s a very small amount compared to some other expenses that we have it starts to be a smaller number. So we’ve made a very efficient nationwide CLEC and we have great deals with various carriers, the rules going forward really suited us, and when people look at the cost structure and its business, incredibly we’ve sold over $9 million magicJacks and we have all these active customers, but incredibly it’s just not a large part of our cost structure.

And the other thing Andrew touched on was that we have a very, but let me say this way, we have since beginning of time, we have over 60% of the people who signed up for service were eligible to make a phone call today. So we don’t have, we don’t run historical term models like telecom companies, they look at monthly numbers, they look at ARPU. In our case, people sign up for a year, two years, five years at a time. So we don’t look at those type of metrics, that we are more concerned about who is eligible to make a phone call. If you look at that metric, I think that we might be the very best and doing the best in the business.

Timothy Horan – Oppenheimer & Co.

And so Dan just a clarification, the $50 per year per subscriber, is that all in costs both network and access charge costs?

Daniel Borislow

That’s all and like if you were to look at our immediate costs and some other costs that that are actually much higher than what it costs per customer. We’re striving to get to a net-net cost of zero for telecom and we had some recent hires over the last six months, I had some new guys that they’re hiring. And we’re just doing a terrific, terrific job of control on our costs and collecting our access charges.

Timothy Horan – Oppenheimer & Co.

And lastly, a lot of a beat in the quarter was on the advertising revenue was kind of $3 million below what we were looking for. Should you expect that’s a pickup or do you have the WiFi device and the text messaging as you start advertising the apps?

Daniel Borislow

Well, I can’t say the direct decision I made was a perfect one in the last seven years. I think one of the mistakes that we made was porting. And fortunately, I’m not too stubborn not to go ahead and do the right thing and I think actually as the timing work down, it got a lot more efficient to put numbers and the FCC came out with rules. So it’s worked, it’s actually worked out pretty well. I think the other thing that I was – I was stubborn about was texting, I’d always thought well, if you just press one more button on your phone and you will be in the texting app it takes a second that was my belief, I believe my I was – my thinking was wrong about that and I think when we add texting to what I believe is the best voice app on the iPhone is of course probably easy to use. You now have a call back number, the cost. I think when you add texting to the mix, I think it’s going to be an incredible opportunity, and we will spend money on that. So those are the two larger mistakes I made in this business. Hopefully, they won’t cost me at all and we’ve corrected them and we’re moving forward. So in the fourth quarter, we’re going to have the texting available probably in the third to fourth quarter. And we’re going to commercialize the apps sometime in the first half of next year. And then of course in the fourth quarter you will have the WiFi and the accessory products that start to kick-in in the fourth quarter and the first quarter of next year.

Timothy Horan – Oppenheimer & Co.

So, I mean given where your profit margins are and the cost per subscriber. Should you be spending a lot more on advertising with these new products coming out?

Andrew MacInnes

Yeah, I’m sorry Tim, I never answered your questions…

Timothy Horan – Oppenheimer & Co.

Yeah.

Andrew MacInnes

Yes, so anyway, yeah, we’ll spend more money, yeah. The cost of the product is greater, the margins are greater, it will be a longer lasting product, it’s a best Louis quality you ever heard. People will keep the product forever. So when you have all those great things that come along with the product and the service, yeah, you want to spend more money on media and advertising and get out as many product into the population as we can.

Timothy Horan – Oppenheimer & Co.

Great, thanks a lot. I might queue back in (inaudible).

Daniel Borislow

Okay. Thanks Tim.

Operator

Thank you. Our next question comes from Mike Latimore of Northland Securities. Your line is open.

Ryan MacDonald – Northland Securities, Inc.

Hi, guys, this is Ryan MacDonald on for Mike. Just want to start out with the WiFi product, what gross margins look like for that or and maybe how does that compare with the PLUS?

Daniel Borislow

Well, with the PLUS the margins are similar, possibly a little bit more, but then you have to have other products backphones and things like that, and that will produce revenue, actually lower margins, but margins nonetheless and it’s found money. But we will be getting rid of the original magicJack, when the WiFi magicJack comes out and the margins on the PLUS and the WiFi, the magicJack over the original magicJack is pretty huge. Again we have two large reasons of the income that you are seeing. One is the higher margins in the PLUS and the renewal revenue and the price of that going up.

Ryan MacDonald – Northland Securities, Inc.

And so then, with the other kind of you talked about with the new app coming on for Android, will that also have the texting feature on it or is that going to be simply for the iPhone, right, app for the iPhone, right?

Daniel Borislow

The section would be across all our platforms and we’ll probably keep the original app out there without texting. And that actually goes under a different [monocratic] that’s under top three and then we have testing, we’re going to have an additional app and it will be serve the name of magicJack.

Ryan MacDonald – Northland Securities, Inc.

Okay, got you, got you. And then any new distribution partners or, are there marketing initiatives for the second half of 2012?

Daniel Borislow

That’s a good question. We expect to have the wholesale cloud or clouds online and then we’ll be coming out with business, and enterprise type products and we would expect our business with the business towards to pick up as well.

Ryan MacDonald – Northland Securities, Inc.

Okay.

Daniel Borislow

And the other thing that we are looking at is a network marketing of form of Amway, (inaudible) that type of marketing. And we expect in the fourth quarter or first quarter that we’ll be trying that out as well. It’s been very successful in the Telecom in the past, a company called Excel, which actually one of the directors was a part of a very successful, very successful business mix and MCI started out that way. So we expect with, we have a product and service that nobody else has in the monopoly and the proper patent. We expect that we could do very well on a network type of marketing.

Ryan MacDonald – Northland Securities, Inc.

I know you said kind of a CapEx is always seems to minimal. Do you have kind of an estimate for that for fiscal ’12?

Daniel Borislow

I think, I’ve spent more money on taking someone out for (inaudible) and CapEx, it’s just not a – it’s just not a number for this company. It just doesn’t compute.

Ryan MacDonald – Northland Securities, Inc.

Okay. And then just one quick clarifying question. What was again the kind of mix in units for the PLUS versus the standard during the quarter in terms of…?

Daniel Borislow

Yeah, I estimated to be about 10 PLUS to one original magicJack. And WalMart still does exceptionally well with both products. And there they continue to order the original magicJack. They do again, they do very well with it. But we expect in October that we won’t be supplying September, October that we won’t be supplying anymore orders for the original magicJack. And it will just be the PLUS and the WiFi magicJack going forward.

Ryan MacDonald – Northland Securities, Inc.

Got you, got you. All right. Well, thanks very much guys.

Daniel Borislow

Okay. Thank you.

Operator

Thank you. We have a follow-up question from Tim Horan of Oppenheimer. Your line is open.

Timothy Horan – Oppenheimer & Co.

Thanks guys and just a couple follow-ups questions. Dan, can I – I might have been able to do texting from my magicJack at my computer on the softphone there and other people…

Daniel Borislow

You will be. Yeah, you’ll be able to use a Mac or PC. Obviously, you’re looking at a different type a little bit different, looking still on the app on a iPad, iTouch, so across all devices you will be able to text.

Timothy Horan – Oppenheimer & Co.

And do you have to pay the carriers any kind of terminating or access to group texting, texting of Verizon or AT&T?

Daniel Borislow

Well we expected to be at the minimus cost.

Timothy Horan – Oppenheimer & Co.

Got you. And when you’re going to rollout with the WiFi and I think you’ve the ability to do like a cordless phone, like you buy COSCO or other places and with a…

Daniel Borislow

Yeah, so what we’re going to build is, we’re going to the thing for the last couple of years has been the high quality [desk phone] they have great range, great voice quality, but we’re going to be manufacturing, the WiFi has high definition voice on it, wideband codecs. We’re going to have batteries that are two to three times more capacity than what you typically buy out there. We’re going to have a special button on the phone, where you could do some provisioning things, you could do customer care. I’m not going to call that stereo like button, it’s more of a [contiers] type button, where you could be able to interact with our database and take care of it and add a lot of things that you wanted to.

We could be able to keep the cost very low on it. We’re going to have better screens on it. So it’s going to be the best at home phone and one of the things that are crucial that we look at, that I don’t think anybody else is even playing the texting to. And that’s for instance interfacing with, like Google voice recognition and 16 kilohertz voice where every part of app is using eight. So there is certain things that we’re doing that were going to bring up the accuracy, a voice recognition and that’s crucial to what’s going to happen in the Telecom space on the going forward basis, and we want to make sure that we’re going to be the leaders out there again.

Timothy Horan – Oppenheimer & Co.

Are you going to put the ability to do texting off of this device, right on the device?

Daniel Borislow

Where were we could be doing texting and that’s why you have to change that screen on only, your typical home device, the other thing which we’ve talked interim to March and it’s going to be a large part of our future, I believe, is LTE Femtocell and that’s going to produce a lot of smartphone like features that you’ll be able to do with various devices.

Timothy Horan – Oppenheimer & Co.

Got you. And when you think you’ll have the cordless phone?

Daniel Borislow

We probably in the first quarter of next year, it has to be build to make sure that we get the highest accuracy for voice recognition and that’s what we have an advantage over a lot of different instruments out there, whether it’d be smartphones or iPads, which by the way are very difficult to better. When you look at the iProduct, their audio quality and microphone are just absolutely phenomenal. And that’s a large reason why the app is doing so well. Google sort of certify a lot of their equipment manufacturers that they just in most cases, they don’t measure out to what Apple they will do. So Apple is great for voice recognition, but we actually think we’ll be able to better it.

Timothy Horan – Oppenheimer & Co.

Sorry two more questions. Do you measure the voice quality in your network in terms of maybe drop calls or echoing or delays? And maybe how is that improved there over the last year or two?

Daniel Borislow

All right. Well, as the Internet gets a lot better and people’s connection for the Internet gets better, which is obviously happening in a good way in the last couple of years, everything about the Internet gets better. With the new magicJack WiFi, I’m definitely buy it, but I got a pretty good year for the stuff. And there is no voice quality as that’s going to be better and we’re going to have a very best voice quality in magicJack WiFi. And sometimes it feels to be lucky and I think we got lucky here a little bit, and [Y.W.] our chip, one of our directors and the one who designs and built our chips, he got very fortunate this time and he built the (inaudible) chip on the magicJack WiFi.

Timothy Horan – Oppenheimer & Co.

And just last housekeeping, where there any promotions in the quarter that maybe help sales at maybe volumes or revenues could tick down a bit in the third quarter versus promotions either and in anticipation maybe some of these new devices are coming up?

Daniel Borislow

Actually we did a promotion and the revenue won’t kick in until the third quarter. So I don’t believe that we did any promotions in the second quarter that kicked right into revenue. So I actually think we did a small promotion towards the end of the second quarter and that might have an effect for the third quarter.

Timothy Horan – Oppenheimer & Co.

Can you describe what the promotion look like?

Daniel Borislow

It was kind of interesting. We’re trying to get everybody from the original magicJack to the magicJack PLUS for various reasons. One is that to renew the product, it’s the quality of the product the small (inaudible) coming out. So we actually gave people the ability to take it and we still have the ability today. We kept it in place. We gave them the ability to take their old term plans from their original magicJack and to take it to a new magicJack. So what we did is we for the original base at a very high margin, we sold the magicJack processor that have priced for the original base. And then we were able to move their old plan into the magicJack PLUS. So it was pretty successful. I think we did about $5 million in sales and we’ll see how that affects the third quarter.

Timothy Horan – Oppenheimer & Co.

Thank you very much.

Andrew MacInnes

Thank you. Thanks Tim. Thank you everybody for joining the call today and we look forward to speaking with everybody soon again. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes the conference for today. You may all disconnect and have a wonderful day.

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