Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Vonage Holdings Corp. (NYSE:VG)

Q4 2009 Earnings Call Transcript

February 26, 2010 10:00 am ET

Executives

Leslie Arena – VP, IR

Marc Lefar – CEO

John Rego – EVP, CFO and Treasurer

Analysts

David Kanen – First Midwest Securities

Michael Rollins – Citi

Operator

Good day, everyone and welcome to the Vonage Holdings Corporation fourth quarter and full year 2009 earnings conference call. Just a reminder, today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the conference over to Ms. Leslie Arena, Vice President of Investor Relations. Please go ahead, Ms. Arena.

Leslie Arena

Thank you. Good morning and welcome to our fourth quarter and full year 2009 earnings 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 and review steps we are taking to drive the business forward. John will discuss our financial results.

Slides that accompany John's discussion are available on the Investor Relations website. At the conclusion of our prepared remarks, we will 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 and 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 SEC filings.

We caution listeners not to rely unduly on forward-looking statements and we disclaim any intent or obligation to update them. During this call, we will be referring to non-GAAP financial measures. A reconciliation of these measures to comparable GAAP measures is available on our earnings release, which is posted on the Investor Relations website.

And now, I will turn the call over to Marc.

Marc Lefar

Thank you, Leslie. I'd like to begin with some comments on the year and then I'll talk about our progress in the fourth quarter and our outlook for 2010. 2009 was a remarkable year for Vonage in many ways. In 12 months time, we upgraded our value proposition, enhanced the customer experience, reduced costs, and better positioned the company for future growth.

I am pleased to report that in the fourth quarter we generated positive net income. And for the full year, we reported positive net income excluding adjustments. Ironically, we had a net loss due to non-cash charges associated with our convertible debt because the company's stock price more than doubled over the course of the year.

For 2009, we more than doubled adjusted EBITDA to $119 million. And for the first time ever, we generated positive income from operations for the year. We did this while absorbing the cost of new product launches and significant network and process improvements. We aggressively managed SG&A, reducing expenses by double-digit percentages.

Revenue per user increased every quarter as we improved our pricing and promotional mix. The number of customers taking higher-end rate plans increased, an indication of the appeal of the Vonage World value proposition. We also implemented better processes and controls enabling us to resolve customer issues the first time, which reduced the level of credits.

A good news story, which I'll describe in more detail later, is churn. At year-end, churn declined to its lowest level since the second quarter of 2007. This decline is a result of the additional value provided by Vonage World and improvement in the quality of the customers we are attracting and enhancements in the performance of our network and customer service organizations. We are encouraged by the results thus far this quarter, which suggest that churns should remain below 3% in the first quarter.

We removed litigation uncertainty and took proactive steps to increase the utility of our intellectual property. We successfully resolved the IPO litigation and multistate AG investigation. We also implemented a comprehensive IP strategy to better develop, protect, and exploit Vonage's intellectual property and to focus greater attention on the value of our IP.

We stabilized the business and built a team that is better positioned to transform the company. At the senior leadership level, we hired seasoned executives with experience in wireless communications, technology, and financial services. It already had a meaningful impact on the organization and our results. And we continue to strengthen the layer below these managers by bringing in talented individuals throughout the business. That’s tremendous progress given that we started the year having just refinanced $250 million of debt in the most difficult credit market in recent history and we faced challenges in the recession, intensifying competition, and wireless substitution.

We are redefining the company. We are rapidly evolving into a company that leverages software to deliver high-quality voice and integrated messaging across virtually any interconnect – Internet-connected device over fixed and mobile broadband networks, connecting customers around the world. We have a robust SIP Network that already provides the capability to deliver many of these services with high quality.

Our evolution is supported by changes in consumer behavior and technology. The increase in demand for smartphones and devices including tablets, Blu-Ray players, and gaming consoles that can access the Internet, coupled with the ubiquity of broadband and a progressive regulatory environment creates the opportunity for Vonage to deliver integrated communication solutions across a vast range of devices.

In 2010, we will continue to deliver new products that offer consumers convenience and value that other providers will be challenged to match. I'll talk more about some of our plans shortly. But first, let me pick up on the churn story.

Last quarter, we indicated that success with our new customer onboarding queue, quantitative improvements in call quality and changes in our customer profile resulting from the new calling plans are expected to lead to meaningful improvements in churn, and they have. Customer service representatives in our onboarding queue now support 100% of the new customer call volume. This has helped to reduce early-life return rates and improves long-term satisfaction ratings.

Our ability to access and utilize robust customer-level call quality data allowed us to make investments with greatest impact on network performance and reliability. As a result, we've improved our network capacity and the interconnections with key service provider partners. During the last six months of 2009 alone, the number of impaired calls experienced by customers has declined by nearly 20%.

The Vonage World plan continues to attract customers with a lower propensity to churn. The 30-day return rates for new Vonage World customers have remained at roughly half that of pre-World customers, and our history on the maturation of active Vonage World customers is now long enough to have some confidence that the reduced churn rate, roughly half that of the level of our customers in earlier plans, is sustainable.

The credit quality of these customers is much higher than that of customers we acquired prior to the launch and credit quality has always been inversely correlated to churn. The combined impact of these improvements during the quarter led to a 60-basis point decline in sequential churn to 2.8%, down from 3.4%.

We saw rapid early success with the launch of Vonage World. To date, we have over 645,000 subscribers including migrations from other Vonage plans. While we continue to see customer excitement around Vonage World, subscriber acquisition momentum slowed and in the fourth quarter, we reported gross line additions excluding mobile pay-per-use customers that were roughly flat sequentially. Net line losses narrowed, but fell just short of turning positive, coming in at loss of up to 10,000 customers.

We must improve our ability to penetrate international calling markets to bolster growth and drive acquisition efficiency in our core business. To do this, we are focused on developing and delivering targeted marketing and in-language advertizing to ethnic calling segments, while lowering our mass-marketing spend. You can expect to see much deeper penetration into the Indian and Chinese markets beginning in March.

Additionally, we must continue to support the domestic home phone segment that is highly price-sensitive. This still represents roughly half of our new customer additions. We are developing a number of alternative offers and promotions to attract new subscribers that are still looking for a high-quality domestic service at a great price.

Turning to mobile, we continue to see enormous opportunities to leverage our network, customer support capabilities, and marketing presence. With the launch of Vonage Mobile in October, we took the first step by targeting a subset of the mobile market with outbound international calling needs on a pay-per-minute basis.

In late December, we enhanced our mobile application by adding Vonage World for Mobile, a flat-rate subscription service that mirrors the Vonage World residential plan. Customers who have both home and mobile services receive a discount on their monthly bill. Since launch, we've had more than 120,000 downloads. This is just a start. We continue to aggressively build and test additional functionality for mobile applications to be launched throughout 2010. We are implementing changes in our technology platform to support the rollout of these new mobile offers and other services.

Our previously announced new billing platform is one part of a new strategic imperative that we added this year to transform our technology infrastructure. This imperative is designed to deliver flexibility, improved time to market for new products and a superior online experience for our customers. Our product roadmap included inbound and outbound calling and a full suite of mobile messaging services, integration of PC-based communications, and expanded offers to international callers, including a feature that helps travelers avoid roaming charges.

We continue to see strong opportunities for the use of our services outside of the U.S. and we are increasingly optimistic about the potential to provide wholesale access to our network capabilities and services, allowing developers and corporate partners to innovate with the addition of voice and messaging to products of their own design. Partnerships with Internet companies, wireless carriers and manufacturing – manufacturers of Internet-connected devices of all forms are very interesting to us.

In summary, we delivered record-setting financial performance in 2009. Looking ahead, we expect to deliver revenue growth in 2010, supported by new product launches and mobile applications. And we will continue to aggressively pursue the international long-distance market, while building capabilities to go deeper into these segments where significant growth exists. We expect stable to slightly growing adjusted EBITDA in 2010.

And now, I'll turn the call over to John.

John Rego

So thank you, Marc. Let's start with slide three. We had a very strong year of financially achieving record high performance in many metrics. As Marc mentioned, this is the first year that Vonage has achieved net income excluding charges, which was $3 million, up from a loss of $34 million in 2008.

Additionally, for the first time, we reported income from operations of $57 million, an improvement of $64 million from the prior year. Adjusted EBITDA increased to a record-high $119 million, up 119% from the prior year. While annual service revenue essentially remained flat on lower gross line additions, we grew service ARPU 3% and aggressively managed cost and expenses, which declined 8% from the prior year. Specifically, cost of telephony services declined 6% as we reduced per-line cost through vendor management and routing efficiencies.

SG&A was down 11% or $34 million on productivity improvements and cost management. Marketing declined 10% or $25 million from the prior year as we eliminated redundant cost and focused on efficiency of our acquisition channels. Premarketing operating income, which reflects the cash generated from our existing customer base before marketing, cost of goods sold, and equipment and shipping revenue, increased 12% to $394 million.

Moving to slide four, in the fourth quarter, we generated record-high adjusted EBITDA of $34 million. That's up 72% from the fourth quarter last year and 3% sequentially on slightly higher revenue and a reduction in marketing and SG&A. This is the ninth consecutive quarter of growth in adjusted EBITDA.

Turning to slide five, we generated GAAP net income of $4 million or $0.02 per share, a significant improvement from a GAAP net loss of $41 million a year ago and $55 million sequentially. Excluding adjustments, net income rose to $5 million from a loss of $10 million in the year-ago quarter and was up nearly $1 million sequentially.

So let's review the details behind our results. Beginning with the revenue on slide six, revenue was $224 million, up $2 million sequentially and year-over-year. Telephony services revenue of $218 million was up 1% sequentially and 2% year-over-year, driven by a higher average revenue per user, which increased 9% from the fourth quarter 2008 and 2% sequentially to $29.84. The increases reflect changes to our pricing and promotional strategies and an increase in the number of customers taking higher-priced rate plans.

Customer equipment and shipping revenue of $5 million was flat sequentially and down from $8 million in the prior year on fewer gross line additions, as well as the shift to our no-startup-cost promotion.

Moving to slide seven, direct cost of telephony services or COTS was $58 million, up slightly from the $57 million in the prior year and $52 million sequentially as the anticipated increase in international call volume related to Vonage World drove total cost of termination higher. COTS per line was $7.96, up from $7.02 sequentially. Total COTS is expected to increase in 2010 as customer demand for Vonage World continues to grow. Direct cost of goods sold was $17 million, down from $18 million in the year-ago quarter and sequentially on lower gross line adds. Direct margins of 66% were flat when compared to the year-ago quarter and down sequentially from 69%.

Moving to slide eight, SG&A declined from $69 million in the year-ago to $63 million as we implemented operating efficiencies and productivity improvements. SG&A was flat sequentially.

Moving to slide nine, we continue to generate substantial premarketing operating income or PMOI, which grew to $99 million from $92 million in the fourth quarter of 2008. PMOI declined from $103 million sequentially due to the cost increase associated with Vonage World. On a per-line basis, PMOI was $13.50, up from $11.70 in the year-ago quarter.

On slide 10, marketing expense declined to $53 million from $62 million in the fourth quarter of 2008 and $57 million sequentially. Subscriber line addition cost declined to $281 from $309 in the prior year and $301 sequentially. Going forward, we expect marketing spend will be at the lower end of recent ranges as we do more targeted advertising and reduce our mass-marketing spend.

As Marc mentioned, we saw meaningful improvements in churn as monthly churn declined significantly to 2.8% from 3.4% sequentially. We expect first quarter churn to remain below 3%. Gross line additions were 188,000, roughly flat with last quarter as Vonage World customer acquisitions slowed from high levels immediately following the launch. We lost 10,000 net subscriber lines, an improvement of 40,000 lines from the third quarter on lowering marketing spend.

Turning to slide 11, cash from operations grew sequentially to $22 million. We expect to continue to deliver positive operating cash from operations in 2010. Unrestricted cash in the quarter was $32 million, down slightly sequentially due to the timing of payments to vendors and investments in systems capabilities. Restricted cash increased $4 million sequentially to $44 million, driven by funding into the concentration account. And as expected, capital and software expenditures increased sequentially, driven by investments in the company's new billing platform and other systems capabilities.

CapEx totaled $23 million in the fourth quarter. Now, as many of you are aware, we successfully restructured our debt in late 2008 during one of the most difficult credit markets in history. We are comfortable that we can manage this debt load [ph] through maturity. Of course, with improvements in the debt markets, we have and will continue to pursue opportunities to refinance our debt to reduce the cost of borrowing. In assessing these opportunities, we must take into account the premiums for early retirement and will only pursue a transaction that makes sense for our company and our shareholders.

And now, I'd like to pass the call back to Marc.

Marc Lefar

Thanks, John. Before taking questions, I really wanted to take a moment to thank John for his many contributions to Vonage over the past seven years. And John was one of Vonage's very first employees, helping it raise capital pre and post IPO and to build the financial structure that's in place today.

Vonage is now a stable business with an efficient cost structure, due in part to the financial leadership John has brought to the company. We thank him for his efforts and wish him well in his future endeavors. Thank you, John.

Early this morning, we issued a press release announcing the appointment of Barry Rowan as Executive Vice President, Chief Financial Officer, Chief Administrative Officer, and Treasurer. Barry brings deep wireless industry experience and important leadership skills that will drive the planning and execution of our financial strategies in the future.

In addition, Barry will play a significant role at Vonage as we pursue long-term strategic growth opportunities. I'm personally excited to have him join Vonage and to welcome him to our call next quarter.

And now, I'll turn the call back to Leslie.

Leslie Arena

Thank you, Marc. And now, operator, please open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And we'll pause for a moment to allow everyone a chance to signal. (Operator Instructions). Our first question comes from David Kanen with First Midwest Securities.

David Kanen – First Midwest Securities

Good morning. Congratulation, guys on a great quarter.

Marc Lefar

Good morning, Dave.

David Kanen – First Midwest Securities

First question – I missed part of the call, so perhaps you gave this information, but what do you expect CapEx to be in 2010? And I noticed there was a large drop in churn. What is the driving force behind that and is that sustainable?

John Rego

Yes. Okay, so CapEx should be relatively consistent with this year. CapEx for this year – of 2009 came in at roughly $46 million. So we would probably be pretty much along the same line through next year. So that's the CapEx question. I think there was a churn question.

Marc Lefar

Yes. And the key drivers of churn, to reiterate, were we continued to see increasing quality of customers from Vonage World that place high value on that new proposition. Additionally, we've continued to see exceptional results coming out of our onboarding queue, which helps to bring new customers into service quickly. That actually lowers our return rates and has increased long-term customer satisfaction.

And lastly, our network quality has improved dramatically. We've seen actually the number of call impairments in the back-half of 2009 decline by roughly 20%. All of those factors are having a significant improvement on churn and we do expect that to continue into the future.

David Kanen – First Midwest Securities

Okay, that sounds good. And a quick question on wireless. How many downloads did you have and is it safe to say that most of the customers are paying per minute or are signing up for those – for the $24.99 unlimited plan? What is your limited experience up until this point?

Marc Lefar

Yes, to – just to refresh folks that we only just launched the flat-rate plan the very – just after Christmas, so right before New Year. So it's a very, very limited amount of data. So the actual long-term mix, I think, will be difficult for us to give much guidance to. But we've got over 120,000 downloads to date.

David Kanen – First Midwest Securities

Okay, great. Thank you.

Marc Lefar

Thank you very much, Dave.

Leslie Arena

Thank you. Next question, operator?

Operator

Yes. Our next question will come from Michael Rollins from Citi.

Michael Rollins – Citi

Hi, good morning.

Marc Lefar

Good morning, Mike.

Michael Rollins – Citi

So just following up, just to understand the ARPU, is the ARPU coming from price changes, changes in fees or taxes or is it coming from some of this mobile revenue that's just not broken out yet?

Marc Lefar

So there is very – there is de minimis mobile revenue at this point in time. For the other factors, it's really a pretty large mix. We have a mix of rate plan enhancement that has had an impact as we've had far more of the $25 customers coming in. We've not emphasized the $17.99 plan.

So mix, both in terms of the existing base with folks trading up, as well as mix of inwards, has changed. We have taken pricing actions during the course of the year. You'll recall that we took a significant price increase on our low-end rate plans from $14.99 into $17.99, which had a significant impact and we have done some things around fees where we found ourselves frankly priced well below competitors and we still in many cases are priced below competitors and have not seen any material adverse impact with our customer base as a result of the changes. So it really is mixed. If you want the details of contribution, we need to do that offline and we could work that with you separately.

Michael Rollins – Citi

Great. And then just to follow up on the capital spending, so how should we think about the capital intensity of the business model in 2010 and over time?

John Rego

So we were working with it. I think you can expect that we are working within a pretty stable capital range and the way we manage and we think – I think largely about cycles of investment based upon the overall needs of the business, there will always be some level of capacity investment. That's – but that's the minority of the spending in any – taken over a long period of time.

The back-half of this year, early next year, we are investing heavily in technology transformation around our ordering, provisioning, and billing systems, as well as online sales and service and you could imagine that there are in each year what I'll call significant investment areas to drive the business forward. We'll have a continuous presence on new product investment. So you can think in context of somewhere between 10% and 25% of CapEx over the long haul will probably be tied to new products. The balance will be a combination of network and infrastructure projects.

Michael Rollins – Citi

That's really helpful. Thanks very much.

Operator

(Operator Instructions). We will take a follow-up question from David Kanen.

David Kanen – First Midwest Securities

You guys rolled out World, I think it was like the end of August and I know that it's a flat-rate plan, but for calling cell phones internationally, there is a pay-per-minute charge. Can you give me some sense as to the usage there? Is that pretty good profitable business and is that one of the factors driving ARPU up?

John Rego

So Dave, you are right. It was late August that we launched the plan. It includes calling to 60 countries. Of the 60, 15 of the major countries actually do have termination to mobile phones also included as free. Those include India and China, the complete list is available on our website or we can have Leslie provide that to you.

In terms of the usage on the pay-per-use outside of that plan, it is not a material contributor to the ARPU increase. We do see it, keeping in mind that for the existing base it's migrated to it we already had those customers using those services on a pay-per-use basis. So it wouldn't be incremental. And for the incremental customers we received on Vonage World as a percentage of the base and the smaller number of countries that that pay-per-minute calling would represent, it's not sufficient to actually drive ARPU in a material way.

David Kanen – First Midwest Securities

Okay. So the – but in general, what is your experience in terms of world customers calling cell phones internationally, calling a relative that doesn't have a landline, for example, in the Dominican Republic? Is there a lot of that going on and doesn't that have – doesn't that drive ARPU up and is it profitable?

John Rego

It is – it's highly profitable. It would drive ARPU up. It varies by country and I'm afraid I don't have at my fingertips the split to tell you exactly which countries are calling to mobile phones more or less than the wireline phones.

Keep in mind that the pricing on mobile phones varies dramatically by country and that changes the elasticity of usage. It's largely based upon the termination rates of mobile carriers. Some carriers in some countries are quite predatory in their pricing, others are very open and look to expand usage. So that drives the volume dramatically. As you would expect, where it's included in our plan and where there are favorable rates, we see very high levels of usage as folks call to wireline and mobile, and it tends to be fairly well proportionate to the penetration of wireline and mobile services in the country being called.

David Kanen – First Midwest Securities

Okay. Thank you.

Marc Lefar

Thanks, Dave.

Operator

(Operator Instructions).

Leslie Arena

Okay, operator. There are no more questions. We will conclude the call.

Operator

Great. I'd like to turn the call back over to you for any additional or closing remarks.

Leslie Arena

Nope. That ends the call. Thank you very much for joining us.

Operator

Thank you, ma'am. That does conclude today's conference call. We thank you 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.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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

Source: Vonage Holdings Corp. Q4 2009 Earnings Call Transcript
This Transcript
All Transcripts