Vonage Holdings Corporation Q3 2009 Earnings Call Transcript

| About: Vonage Holdings (VG)

Vonage Holdings Corporation (NYSE:VG)

Q3 2009 Earnings Call

November 4, 2009 10:00 am ET


Leslie Arena – Vice President of Investor Relations

Marc Lefar – Chief Executive Officer

John Rego – Chief Financial Officer


Michael Rollins – Citi Investment Research

[Wayne Martyr - Lowe Capital]

David Cannon – First Midwest Security


Welcome to the Vonage Holdings Corporation Third Quarter 2009 Earnings conference call. Just a reminder, today's call is being recorded. At this time, for opening remarks and introduction, I would like to take the call over Ms. Leslie Arena, Vice President of Investor Relations.

Leslie Arena

Good morning and welcome to our third quarter 2009 conference call. Speaking on our call this morning will be Marc Lefar, Chief Executive Officer and John Rego, CFO. Marc will discuss the company's progress in the quarter and review steps we are taking to drive the business forward. John will discuss our financial results.

Slides for the company for John's discussion are available on the investor relations Web site. At the conclusion of our prepared remarks, we'll be happy to take your questions. As referenced on slide two, I would like to remind everyone that statements made during this call that are not historical facts or information may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These are all forward-looking statements and are based on management's current beliefs and expectations and depend on assumptions or data that may be incorrect or imprecise. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. More information about those risks and uncertainties is contained in Vonage's FCC filings.

We caution listeners not to rely unduly on forward-looking statements and we may disclaim any intent or obligation to update them. During this call, we will be referring to non-GAAP financial measures. A reconciliation of the non-GAAP to comparable GAAP measures is available on our earnings release, which is posted on the investor relations Web site. And now I will turn the call over to Marc.

Marc Lefar

It's an exciting time for Vonage. While the company has its roots in providing low cost replacement for domestic home phone service over the Internet, we are rapidly evolving into a company that provides high quality voice and integrated messaging services on multiple devices over fixed and mobile broadband networks connecting customers around the world.

This transformation is well supported by changes in consumer behavior, advances in technology and a progressive regulatory environment that supports innovation and consumer choice. The extraordinary global demand for smart phones will support third party software and can access wireless and fixed broadband networks via Wife, provides a very rich platform upon which Vonage can extend its brand.

The unveiling of robust forging networks will open the door for communication solutions that are truly integrated and synchronized across all of the consumer devices in real time. And the FCC's proposed rules for open access to Internet content and applications across all broadband networks will stimulate innovation waves we can only begin to imagine.

All of these changes are occurring at a time when international relationships for individuals and businesses are becoming more common than ever. The growth opportunity for nimble consumer focused companies like Vonage has never been better.

Of course, in order for any company to take advantage of these broad marketplace changes, solid financial underpinnings are essential. In the first nine months of 2009, we generated $85 million in adjusted EBITDA, more than double that of last year.

And for the third quarter, we posted another record quarter, generating $33 million in adjusted EBITDA, our eighth consecutive quarter of increases. Pre-marketing operating income, PMOI, exceeded $100 million for the first time ever. Our financial performance has been very strong despite a tough economic environment. John will discuss the detailed results in a few moments.

We're making good progress against the strategic imperatives that I've reviewed on prior quarterly calls. We have more robust data on the frequency and breadth of customer issues at a geographic and a subscriber level. This information has helped us to make improvements in call quality and reliability.

On the marketing front, we're seeing improvements in customer perceptions across almost all important brand attributes, including trust, reliability and value. Our on boarding queue, which provides specialized assistance to new customers, continues to deliver strong results.

These agents now support 80% of the new customer call volume and this will increase further in the coming months. In addition, we have seen better sales performance due to improvements in our Web site and our processes and to our telesales centers.

These improvements enhance the overall customer experience and set the stage for the two new service offerings we launched over the past few months, Vonage World and Vonage Mobile. In August, we improved the value of our core offering with the introduction of Vonage World, a plan that provides unlimited free calling to more than 60 countries along with unlimited readable voice mail, delivered as email or SMS text message for one flat rate of $24.99 with no upfront costs.

Acceptance has been strong. To date, we have over 400,000 subscribers on Vonage World including migrations. During the last six weeks of the third quarter, the period during which Vonage World was available, weekly average gross line additions grew by over 100%.

And while gross additions have eased a bit since the first several weeks, gross line ads are still well above the pre-launch period. As a result of the increased gross line additions, subscriber line acquisition costs, or SLAC, during a third quarter after the Vonage World launch was $235, a significant improvement versus the first eight months of the year.

We will remain focus on the efficiency of our marketing investments. We closely monitor the impact of messaging, media, and direct campaigns by geography and by segment, making frequent adjustments based upon market responsiveness.

We're also encouraged by four key indicators that these new customers may have a significantly better churn profile than customers acquired prior to Vonage World. First, the 30 day return rates for new Vonage World customers are nearly half that of pre-World customers at less than 10%.

Second, customers subscribing as a result of a referral from a friend have quadrupled, third, new customers subscribing through the online channel increased by 50% and lastly, more than 64% of new customers have excellent or very good credit. That's a 33% increase versus pre-World customers. All of these indicators historically correlated to lower churn.

And while it is too early to predict long-term churn profiles from limited data, we are carefully tracking the behaviors of each group of new customers acquired each week. The very first customer groups, those that are now completing their second month of service, are actually churning at a rate that is less than half that of similarly tenured customers that were added in the months prior to the World launch.

It's an encouraging sign. Vonage World drove positive net growth and is attracting a higher quality customer. However, as a result of the launch time in late August, the gains were not sufficient to fully offset line losses incurred early in the quarter. Net line loss improved by 39,000 lines sequentially, to 50,000.

I'd like to take a few moments to talk about Mobile. In October we launched Vonage Mobile, our first mobile calling application for smart phones. This application is focused on the international calling market and provides seamless low cost calling while on cellular or Wife networks.

The service saves customers more than 50% on calls to dozens of countries versus the rates charged by wireless carriers while providing far more convenience in calling cards. Vonage Mobile is currently available as a free download on the iPhone, Blackberry and iPod Touch.

But this is just the beginning. Over the next few months we plan to launch Vonage World for mobile, a flat rate subscription service that mirrors the Vonage World residential plan. Bundle discounts for customers who subscribe to both services are planned. Vonage World for residential has sparked strong interest with incredible value proposition, but to take advantage of it a customer still needs to be willing to change their home phone service.

With Vonage World for mobile, smart phone users will be able to access this service on cellular or Wife without changing carriers or their phone numbers. We routinely receive inquiries from potential customers eagerly awaiting the service.

Looking further out on the road map, we anticipate robust functionality that provides inbound and outbound voice, a full suite of messaging services and readable voice mail from multiple mail boxes. We expect to deliver these services over fixed and mobile broadband networks through downloadable and embedded applications using Vonage numbers or user names.

We also expect to integrate PC-based communication services providing consumers with tremendous flexibility to easily access and manage their communications across any device depending upon their needs at the time.

In summary, we've delivered strong financial performance through the first nine months of the year, focusing on the fundamentals and we're beginning to take advantage of growth opportunities by enhancing the value of our current products and by launching new ones.

Despite continuing competitive pressures, we believe that we are well-positioned for growth in 2010 and beyond. And now I'll turn the call over to John Rego.

John Rego

Let's start with slide three. As Marc mentioned, this is our eighth quarter of positive and sequentially growing EBITDA. Our third quarter adjusted EBITDA of $33 million is a record high, up 127% from $15 million in the third quarter last year and up 7% sequentially. The sequential growth and adjusted EBITDA was driven by growing RPU as well as continued cost management.

Turning to slide four, we generated adjusted net income of $5 million or $0.03 per share, which is improved from a net loss of $8 million a year ago and adjusted net income of $1 million sequentially. GAAP net loss was $55 million or $0.33 per share as a result of certain non cash mark to market adjustments relating to our convertible notes.

I'd like to take moment to explain those adjustments. As a result of the sharp increase in the price of our stock during the quarter, the conversion feature of our $18 million third lien notes increased in value. Generally accepted accounting principles require that we separate our convertible notes into a debt component and a conversion feature component and value them separately.

Under this accounting, decreases in our stock price generate income while increases in our stock price, such as those in the third quarter generate losses. The third increase in our stock from $0.38 to a $1.39 drove a non cash mark to market charge of approximately $63 million.

During the quarter, holders of approximately $12 million of our convertible notes converted them into 40 million shares of our common stock. Under GAAP, we recorded a non cash gain of $3.8 million on the early extinguishment of the notes.

The gain principally represents a reduction in the premium on the conversion feature, which is removed once the debt converts. The nearly 400% increase in our stock price put us back in compliance with the New York Stock Exchange's average minimum stock price listing requirements and additionally drove our market capitalization to $274 million at September 30.

We continue to follow all NYSE requirements to regain market capitalization compliance, including providing quarterly operational updates to the NYSE. The NYSE requires average market capitalization of not less than $100 million over a 30-day trading period and as such, we could regain compliance either at the end of an 18-month plant period or based on two consecutive quarterly monitoring periods in compliance.

So let's take a look at the details behind our results, beginning with the revenue on the slide five. Revenue was $222 million, up 1% sequentially but down 2% compared to the prior year. Telephony services revenue of $216 million was up $1 million sequentially and flat year-over-year.

Telephony services RPU increased approximately $1 sequentially to $29.16, reflecting a full quarter impact of changes in our pricing and promotion strategy, which were put in place in the second quarter.

Customer equipment and shipping revenue of $5 million was flat sequentially and down from $10 million in the prior year on fewer gross line ads as well as the shift to no startup cost, which includes free shipping and a free device.

Moving to slide six, direct cost of telephony services per line was $7.02, up from $6.76 sequentially as an anticipated increase in international call volume related to Vonage World, drove total cost of termination higher. We are expecting higher cuts in Q4 due to World, however, we will continue to leverage this increasing call volume to negotiate lower rates with our carrier partners.

Cost of goods sold increased sequentially to $18 million from $16 million, driven by higher gross line ads. And direct margins were flat sequentially at 69% and up from 66% in the prior year. Moving to slide seven, we continue to aggressively manage SG&A, which declined to $63 million from $71 million in the prior quarter.

Second quarter costs included $5 million in closing cost and litigation cost, which did not recur in the third quarter. Moving to slide eight, we continue to generate substantial, pre-marketing operating income, or PMOI, which for the first time exceeded $100 million. PMOI of $103 million increased from $94 million sequentially and $91 million the prior year.

This number reflects the cash generated from our existing customer base before marketing, cost of goods sold and equipment and shipping revenue. On a per line basis, PMOI was $13.89, up from $11.55 of the year ago quarter.

On slide nine, as projected, marketing expense was $57 million, up from $52 million in the second quarter and down from $65 million a year ago. As Marc mentioned, the launch of Vonage World resulted in significant improvement in gross ad efficiency.

We're also starting to see meaningful improvements in churn. September churn was 3.2% and October churn was 3%. These improvements are being driven by higher credit quality customers coming in through our World offer, our on-boarding work with new customers, improvements in our network and a decrease in customer nonpayment.

Churn did increase to 3.4% for the third quarter from 3.2% in the second quarter. Gross line additions for the quarter increased 33% to $191,000 due to the positive growth over the last six weeks driven by the Vonage World offer. The significant growth in net line additions was not sufficient to offset line losses experienced in the first seven weeks of the quarter and we finished the quarter down 50,000 net subscriber lines.

Turning to slide ten let me now take a moment to talk about our cash position. Unrestricted cash in the quarter was $38 million, down from $56 million last quarter. Restricted cash remained unchanged at $40 million.

Although the terms of our debt financing, unrestricted cash subject to certain adjustments in excess of $30 million would have become restricted effective October 1, 2009. In light of this requirement, we looked for better uses of cash and we're able to effectively utilize our cash position to opportunistically seek discounts from several of our key vendors by making prepayments.

We made prepayments totaling $17 million in exchange for meaningful discounts. Going forward, we will continue to seek prepayment opportunities where meaningful discounts are available. We continue to expect cash from operations to be positive in 2009.

Our capital and software expenditures totaled $9 million in the quarter and $23 million year-to-date. Historically, we spend $40 million annually and believe we will do the same this year. Capital expenditures in the fourth quarter are expected to increase due to the timing of our investments in new billing and other systems' capabilities.

Lastly, I'd like to provide an update on our convertible debt and the impact on shares outstanding. Given the recent increase in our stock price, we have seen converts to common equity of 12 million in the quarter, which increased shares outstanding by 40 million, bringing total shares outstanding at quarter-end to 197 million.

We made solid financial progress this quarter, delivering $33 million in EBITDA. We expect the addition of new products, while adding the Company's cost structure in the short term, will lead to growth and increased profitability over time.

Leslie Arena

And now operator, please open the lines for questions.

Question-and-Answer Session


(Operator Instructions) Your first question is from Michael Rollins - Citi Investment Research

Michael Rollins - Citi Investment Research

Just a couple questions, I was just curious if you can give some more specificity of results with the multiple strategies that you've embarked upon. And then secondly, can you give us - I'm not sure if you gave the number of gross ads or the percent of gross ads that were taking Vonage World versus the Heritage products. But maybe if you can give us some more details along those lines that would be fantastic. Thanks.

Marc Lefar

Mike, its Marc. Let me answer the second question first on gross ads for the period. I'll get you the exact number but the vast majority of all of our ads I believe it is the mid 90% level, 94, 95% are taking Vonage World. It is our core offer and that's with the vast majority of all the gross ads are coming in on today. Relative to mobile results, as I mentioned before the first application that we launched is a straight-forward pay-per-drink, prepaid offering and it has only been out there for about three and a half weeks. We've seen over 50,000 downloads at this point in time.

A lot of the inquiries we're getting are asking for the Vonage World for mobile products. There seems to be a lot of excitement about having that level of flexibility, the full level of service that you get without having to actually change a home phone number, make the change and commitment to putting an adapter in the home, so we're excited about that and the additional functionality that will bring.

Michael Rollins – Citi Investment Research

And then just a follow up, can you talk a little bit more about the RPU strength in the quarter and where you see that going to over time?

Marc Lefar

Sure, as I think you know Mike, we've been taking actions on pricing as well as rate plan mix strategy throughout the course of the year and what you're seeing in this quarter in strength is really just the full quarter impact of all those actions coming to bear.

Some of them in areas of fees, some of them in terms of rate plan mix, to the $25 plan versus lower plans, we've become less dependent as the strength of our value proposition has improved in retention plans, in our save centers and all those things have helped us.

What you see right now is what I would say the full impact of all those over a full quarter and we do not expect, we expect that our RPU, service RPU, going forward will remain in this area. I think you and I have talked about this before. That difference between the $25 rate plan and the roughly $29 in RPU is made up of other fees and charges that are continuing and do not expect to change.

We don't expect any delusion in service RPU as a result of World. In fact, we're actually seeing that the number of migrations, a significant number of our migrations, are people actually moving up from the $17.99 plan as well as off of retention plans to take advantage of the $25 calling package. That could be a possible upside for us in the future.


Your next question will come from [Wayne Martyr - Lowe Capital].

[Wayne Martyr - Lowe Capital]

Can you just maybe sort of enunciate your plan to reduce your debt, how you're going to pay down the first lien and then remind us of the amortization schedule and the debt over the next year and any plans you would have up and above recurring normal amortization to reduce the debt?

John Rego

Sure, this is John Rego speaking, so the debt really breaks up into three pieces. There's a first lien, a second lien and a third lien. As you heard on the call today much of the third lien has now converted and is gone. So getting back to the first lien, the first lien is 16% cash pay note. The second lien is a 20% picking note for three years and then becomes a cash pick blend going forward.

We're always looking out for debt. However, imbedded in the debt are – makes it pretty expensive to try to take those out due to certain make hold provisions and other provisions in the debt so we're obviously always looking at it and if we do something prospectively we'll certainly keep you posted.

[Wayne Martyr - Lowe Capital]

Okay, well I mean that's not much of an answer considering the debt represents most of your enterprise value. I mean what specifically is the amortization schedule on the first lien and what if anything can you do above just the normal amortization?

John Rego

Yes, so the amortization on the first lien debt will come off the books in five years from when we put it on. The second lien debt is a seven year piece of paper, okay, so one can make prepayments if they want on the debt but they come with prepayment penalties.

So again I mean we'll always look at it and if that's the most effective use of our cash at the time that would be the direction we would go in.

[Wayne Martyr - Lowe Capital]

Okay, how much is the amortization on the first lien over the next 12 months?

John Rego

I'll have to follow up with you and get the exact number.

[Wayne Martyr - Lowe Capital]

Yes, that would be terrific.

Marc Lefar

I think I would add to that that obviously the debt terms themselves have make hold provisions. But as has been the case in the current market where their debt holders have a view to wanting to get access to cash earlier, the fact that we are financially quite stable and have generated greater than expected cash this year we would certainly look carefully at any opportunities to refinance and think about early retirement if debt holders were open to that.


Your next question comes from David Cannon – First Midwest Security.

David Cannon - First Midwest Security

Guys congratulations on a solid quarter and improving margins and EBITDA. Can you articulate a little bit more your mobile strategy, can you give me a sense as to how you would price the Vonage World Mobile and then on your initial roll out product the downloadable version onto the iPods, onto iPhones and Blackberry's. How many downloads have you gotten since the launch?

Marc Lefar

This is Marc. I'll take that. So let me just as I mentioned a few moments ago, the first mobile application we launched was a pretty straight forward pay-per-drink, price per minute, price by country, does not require a subscription, launched about three and a half weeks ago, we've seen over 50,000 downloads on that application to start.

As I mentioned, the vision here is now with the penetration of Smartphone devices, the ability to easily put applications on to many of them, the growing accessibility of broadband access not just in 3G but also in 4G LTE in the U.S., YMAX, and other markets as well, we see a tremendous opportunity to take the fundamental strategy that got us popular in home phone, home telephony and move that into wireless.

Within wireless we also see emerging opportunities to do a whole lot more with full range messaging solutions from e-mail to text messaging where we think there is a significant arbitrage opportunity to full voice messaging, voice mail to text and many of the features that you've heard discussed by some other players as well.

I would offer you that the functionality that many people are talking about or launching today we've already had in the market and things like voicemail to text, which we've been doing now for almost two years are significantly higher quality than what you'll see from Google Voice and some of the other players who have already launched this or who are recently launching the product.

So envision an integrated environment where people have access to that information in the cloud, they can access it via mobile phones, via PC's, and of course we'll continue to provide home phone telephony.

The idea here is it's not just a call forwarded number but you have the ability to have inbound and outbound calls to a unique number or user name based upon the customers' needs. You can envision an environment where on net calling would be greatly reduced cost or free, the flexibility of having applications on both end points of mobile phones around the globe.

Provides all kinds of interesting opportunities that will likely accelerate adoption versus what we see on PC's just because you've got a better form factor for use. All of those things are in the works. I won't break them up into specific releases or time frames but they're all over the next 12 month development roadmap. Was there another question underpinning that?

David Cannon - First Midwest Security

Well I was interested in the flat rate pricing model you alluded to in the prepared remarks, how would you roll that out? Would it be like comparable to your World plan, $25 a month, would it be lower, higher and what's about the time frame on that?

Marc Lefar

So for competitive reasons I'm really not going to give the specifics to that but what I'll offer to you is there are plusses and minuses. Obviously, the customer has more hours of the day during which they can actually drive usage, so we get to think about that in our pricing analysis.

But in addition we anticipate that you would have less domestic use than what you might have on our home calling plan. Our cost structure is lower on mobile because we don't have an adapter that we need to subsidize and deliver.

There's no shipping and handling and on the mobile side at least at this point in time it is outbound calling not inbound calling so if we think about the value proposition there are some puts and takes but all in all we think it will be of very similar value to customers.

Additionally, one of the things we've been receiving just incredible requests for is a discount. Folks have an expectation we think it's certainly reasonable as well that the nearly half a million customers we have already on Vonage World for residential would like to be able to extend that use to mobile and have the flexibility to use whichever device they want and we expect to provide a bundle discount for the combination of those two products.

David Cannon - First Midwest Security

Okay, last question is in the prepared remarks you were addressing the return, which is 3.4% for the quarter. Can you just take me through what you've seen recently? I think you had alluded to a decline in…

Marc Lefar

Yes, thank you for bringing that up, yes, the quarter the results frankly don't represent the improvements we've seen in recent months and weeks. The most recent month, month of October was slightly below 3% and we've seen continuing weekly improvement since mid-August.

The month of July was a really poor month for us. We saw a significant increase during the month to non-pay, which is really driven largely by macroeconomic environment that we did not anticipate which caused a bit of a spike. And unfortunately also correlated with the time we were making some changes in our customer service operations that frankly we didn't execute well against and that cost us for a period of weeks.

But we've seen week-over-week improvements and the month of October was encouraging and the profile of World customers continues to be very positive for us. So we are optimistic. Obviously, in the current economic environment it's difficult to have great visibility on it, but the fundamentals are about as strong as we've seen them.

David Cannon - First Midwest Security

I'm not asking you for guidance, but it seems like with churn coming down to like 3% in October and if we pro forma that out and with you guys adding subscribers at a significantly faster rate in the second half of Q3 from the first half, shouldn't we see growth in Q4 and going forward?

Marc Lefar

We're quite confident that we're going to improve sequentially. The visibility to churn combined with overall what we're going to see for the holidays for gross ads makes it difficult for me to give you any kid of forward-looking specifics on the absolute growth. So I'm going to defer from that point. But there's no doubt that, although the gross ads from the initial launch on Vonage World have pulled back a little bit, there's still significantly higher than they were prior to the launch and churn is giving us some cause for optimism.

Leslie Arena

Operator, if there are no further questions we'll conclude the call.


That is the end of our question and answer session.

Leslie Arena

Thank you very much.


Ladies and gentlemen, that does conclude today's teleconference. Thank you all for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!