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Vonage Holdings Corporation (NYSE:VG)

Q1 2011 Earnings Call

May 4, 2011 10:00 AM ET

Executives

Leslie Arena – VP, IR

Marc Lefar – CEO

Barry Rowan – CFO, EVP, Chief Administrative Officer and Treasurer

Analysts

Michael Rollins – Citi Investment

Mike Latimore – Northland Securities

Robert Routh – Phoenix Partners Group

William Vogel – Merlin Securities

Operator

Good day everyone and welcome to the Vonage Holding Corporation First quarter 2011 earnings conference call. This is 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 Leslie Arena, Vice President of Investor Relations. Please go ahead Ms. Arena.

Leslie Arena

Thank you. Good morning and welcome to our first quarter 2011 earnings conference call. Speaking on our call this morning will be Marc Lefar, Chief Executive Officer and Barry Rowan, CFO and Chief Administrative Officer. Marc will discuss the company’s progress and strategic direction and Barry will discuss our financial results.

Slides for that accompany Barry’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, are based on management’s current beliefs and expectations and depend on assumption 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 highlighted on the second page of the slides and 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 to comparable GAAP measures is available on the Investor Relations website. And now I will turn the call over to Marc.

Marc Lefar

Thank you Leslie and good morning everyone. I’m pleased to report the financial and operating performance delivered in 2010 continued in the first quarter of 2011. We generated record high EBITDA of $43 million, grew net income, improved gross line additions posted positive net adds and prepaid $20 million of our debt. Last week we launched Vonage World Premium, an up sell service to the original Vonage World and we expect to introduce two new mobile products during the spring and summer months. We’ve now reported record high positive EBITDA in 13 of the last 14 quarters.

Our performance in the first quarter was driven both by higher revenue per user and continuing efficiencies across our business. The combination of strong operating performance and reduced interest expense from our recent debt refinancing resulted in record high net income of $21 million or $0.10 per share which is up 51% from $14 million or $0.07 a year ago. Our strong cash flow enabled us to prepay $20 million of debt at par and we expect to prepay an additional $30 million before year end which will result in nearly $5 million in annualized interest expense savings. These prepayments are incremental to our scheduled amortization payments and Barry will provide additional details when he speaks.

Gross line additions or GLAs increased steadily during the year and we are up 13% from a year ago to $175,000 on roughly flat marketing investment. As a result customer acquisition cost per line or SLAC fell to $282 the first time SLAC has below $300 since the fourth quarter of 2009. With more than 1 million subscribers or 43% of our base on Vonage World we are making steady progress penetrating international calling segments. Our increased marketing focus on Hispanic segment where we provide in language sales and service drove an increase in account starts for the second consecutive quarter.

Asian Indian subscriber continue to be a loyal and growing portion of our business and growth in Canada continued with GLA increases sequentially and versus the year ago period. Our launch of an unlimited plan for the Philippines drove strong press attention however the retail price of $64.99 made necessary by unusually high termination rates has proven to be barrier to broad adoption. We are considering alternative offers to address the ongoing needs of this heavy calling segment.

While marketing yield improved net line additions of 3000 were bit lower than in the fourth quarter as churn ticked by 10 basis points to 2.5%. The slight increase was due to higher earlier life churn of no contract customers. Our mix of ethnic segments and the one time impact of removing four countries from Vonage World. We anticipated minor pressures from these factors and we continuously evaluate the impact of offers and promotions on churn making changes if necessary.

On balance our strong financial results and progress growing the number of international callers in our customer base provides a solid foundation for driving cash flow and funding our planned investment in new products and services. The recent launch of Vonage World Premium which delivers against the largely unmet needs of customers calling internationally to mobile phones in many countries appears to be gaining traction in our existing base. The results of email up-sell campaigns immediately upon launch are exceeding our early exceptions. It is still too early to evaluate the impact on new sales as advertising has just started airing.

As I mentioned earlier we plan to launch two new mobile services in the coming months, the first is a unique international long distance service for standalone mobile users it will be available in more than 75 countries immediately upon launch. And we believe that it will the absolute most convenient way for customers to avoid high carrier charges. The second new product will be an enhanced to our core Vonage World Service that will extend the utility of our home service plans to multiple phone numbers and devices including most mobiles. With the launch of this extension service Vonage will offer both savings and convenience to customers regardless of device or location as an integral part of our basic service. Not only will this provide a revenue opportunity through usage in our existing base but we believe this will improve the overall value proposition for prospects as well.

As we look to the balance of the year, our financial outlook has improved. We expect to achieve EBITDA of at least $165 million. Recent improvements in ARPU and structural changes in cost have given us more confidence in the full year results. While we continue to expect higher gross line additions for the full year versus 2010 advertising cost which are seasonally much higher in the second quarter may lead to lower marketing yield putting some pressure on gross line additions.

As we continue to expect churn to be relative stable with 2010 level with perhaps a modest impact from selective price increases we plan to implement in the coming months. While there is still much work to be done our results clearly demonstrate that the major elements or turnaround are now behind us. I’m pleased with the company’s solid financial and operating performance and we are working diligently against the execution of our strategies to drive growth in the quarters ahead. And I’ll hand the call to Barry.

Barry Rowan

Thanks Mark, I’m pleased to review our first quarter financial and operating results with you. As Marc highlighted we reported a solid financial quarter as we generated record high EBITDA of $43 million as strong cash flow based on ongoing operational improvement and expense management. We reduce selling, general and administrative expense to a record low percent of revenue lead by continued improvements in customer care cost per line which declined 9% from the prior year.

We reported our fourth consecutive quarter of increasing gross line additions with continued progress penetrating international calling segments with Vonage World. Reflecting the strong performance free cash flow of $30 million increased $10 million sequentially as we produce record high net income aided impart by lower interest expense following our successful debt restructuring last year.

Continuing with the balance sheet improvements begin in 2010 we are utilizing our cash flow to further reduce our level of debt specifically we prepaid $20 million of debt at par which will reduce annual interest expense by additional $2 million. We expect to prepay at least an additional $30 million by year end bringing total voluntary prepayments to $50 million. Combined with $20 million of scheduled amortization payments these results in a total debt pay down of $70 million in 2011. As a result we expect term debt to be less than a $130 million at the end of 2011.

These planned debt reduction would reduce cash interest expense by $22 million in 2011 and at least $27 million in 2012 from the 2010 levels. The resulting cash interest expense would be $42 million 20 million and $15 million for 2010 2011 and 2012 respectively. These reductions in interest expense would have a corresponding positive impact on basic EPS of $0.10 per share in 2011 and $0.12 in 2012. Let’s walk through the details of this quarter’s financial performance. Beginning with slide 3 adjusted EBITDA of $43 million increased 9% from the prior year as we achieved the 20% EBITDA margins for the first time in the company’s history.

Sequentially EBITDA increased 6% as a result of higher service ARPU associated with Vonage World and through continued operating efficiencies. We have opportunities to drive further structural cost reduction and expect strong ARPU during the second half of the year. Based on these expectations we are raising our EBITDA expectation for the year from our previous guidance of more than $156 million we earned in 2010 to at least $165 million for 2011.

Moving to slide 4 we reported net income of $21 million or $0.10 per share up 51% from net income of $14 million or $0.07 per share in the first quarter of 2010 and up from a net loss of $42 million or $0.19 sequentially. Note the fourth quarter of 2010 included $58 million in adjustment related to our debt refinancing. Excluding these adjustments the company increased net income by more than $8 million sequentially with $4 million the gain resulting from interest expense savings. This marks the eighth consecutive quarter that we have achieved positive net income excluding adjustments.

On slide 5, total revenue for the quarter increased to $220 million from $218 million sequentially reflecting our continued progress penetrating the international long distance calling market. Revenue declined $8 million from $228 million in the year ago quarter primarily due to a $6 million reduction in deferred revenues related to legacy activation fees. As a reminder this adjustment is not impact to EBITDA.

Quarterly telephony services was $218 million an increase of 2% sequentially helped by the higher number of Vonage World subscribers. We now have a more than a million subscribers or 43% of our base on this plan. These customers have an attractive lifetime value and more than half of Vonage World customers are international long distance callers who churn out lower rates than domestic callers. Aided by the mix of Vonage World subscribers the first quarter average revenue per user or ARPU increased to its highest level in three quarters. In the first quarter service ARPU increased 2% sequentially to $30.23 due to mix improvements, lower bad debt expense and higher universal service fees which are a pass through.

Service ARPU declined from $30.90 in the prior year primarily due to reduced legacy activation fees and lower termination fees due to no contract plans. Moving to slide 6, during the quarter we added 175,000 gross lines, an increase of 13% from the prior year and up 5% sequentially. This was driven by further progress penetrating the US Hispanic market and GLA growth in Canada. Subscriber line acquisition cost or SLAC improved 11% to $282 down from $318 a year ago. This marks the lowest SLAC in five quarters reflecting continued improvements in the efficiencies of our marketing spend.

Monthly churn declined to 2.5% from 2.6% in the prior year due to lower churn profile of certain international calling segments and improvements in the overall customer experience. On a sequential basis churn increased 10 basis points as Marc mentioned we saw a negative impact in early life churn from the two potential negative factors we mentioned on our last earnings call. The impact of the no contract offer and higher churn rates associated with some ethnic calling segments, the slight uptick was also influenced by some one time actions such as removing the four countries from our Vonage World plan that didn’t meet our profitability goals.

Our higher gross line additions combined with slightly higher churn resulted in 3000 net additions in the first quarter. This was our second sequential quarter of modest net lines growth. Let me take this opportunity to highlight the importance of managing our business based on appropriate economically driven matrices as our business evolves. In the quarters ahead we expect to shift our emphasis away from matrices such as gross and net line additions that may lead to optimization of individual measures at the expense of overall company value.

The introduction of new products sold as add-ons to existing plans and a wider ranging ARPU associated with new mobile products for example make these historical measures less meaningful. We plan to emphasis growth and revenues EBITDA and free cash flow supported by a clear focus on subscriber economics as these new products become a larger portion of our portfolio.

Please turn to slide 7 where we will begin our discussion of our COTS structure. COTS has been a good news story over the past several quarters. Total COTS declined to $60 million from $62 million in the year ago quarter driven by lower domestic termination rates and usage which more than offset the expected increase in international termination cost from higher number of international callers. We continue to reduce non termination cost within this expense category. As I mentioned on last quarters call our consolidation of E91 vendors that will drive $4 million in savings this year some of which we have already seen in the first quarter.

On a per line basis COTS declined to $8.34 from $8.60 in the prior year and rose from $8.06 sequentially due to an increase in USF [ph] which is a pass through. Excluding the impact of USF COTS declined 2% driven by lower domestic termination and other telephony service cost. Cost of goods sold declined $6 million from the prior year to $11 million due to lower device cost as well as the reduction due to the accounting impact of legacy activation fees which are amortized over the life of the customer.

In the past year we have lowered the cost of our devices by more than 25% to $30 and we expect to reduce device cost further by year end. Reflecting the strength in ARPU and reduction in COTS total direct margins rose to 68% up from 65% in the prior year. This matches the 68% level achieved in the fourth quarter of last year.

Moving to slide 8, we reduced SG&A to $58 million an all-time low of 26.5% of revenue from $61 million in the year ago quarter and down from $59 million sequentially. A substantial portion of this savings has come through improvements in our customer care operations. Care cost per line declined 9% from the year ago quarter as we lowered the number of calls into our care centers due to an improved customer experience combined with reducing the average channel time spend with customers who need our assistance.

Moving to slide 9, marketing expense was $49 million down slightly from $50 million sequentially and flat from the prior year. While our total marketing spend has remained roughly flat for the past two years, we continue to shift our marketing mix within this overall spend level. These shifts are toward our targeted international long distance calling segments and to the media channels that most effectively reach these customers.

As Marc mentioned the second quarter tends to be a season of higher media cost. We expect that this factor in combination with a traditional slower April will put some pressure on continued quarterly GLA growth during this quarter. Moving to slide 10, CapEx in the first quarter was $5 million down from $16 million in the fourth quarter which reflected some higher year end capital spending. For the full year 2011 we expect CapEx to come in at or below the low end of the $40 to $45 million range we had previously set. The majority of this investment is to support the development of new products and services, improve the customer experience and drive structural cost reduction in customer care and COTS.

Strong operational results and lower CapEx resulted in $10 million in free cash flow defined as operating cash flow less CapEx to $13 million. As we discussed on our last earnings call working capital is typically negative in the first quarter due to the timing of certain payments. In addition we paid approximately $5 million in ESCROW during the first quarter to fund the cost associated with the previously announced settlement of the consumer class action. While the combination of these factors resulted in the use of $19 million during the quarter we expect working capital to approximately neutral for the year.

We maintained our strong cash position with cash and cash equivalents as of March 31st of $87 million including $7 million in restricted cash associated with the lease on our building. Based on our strengthened operations we can continually improving balance sheet and our $885 million NOL carry forward Vonage is now generating meaningful cash flow. With EBITDA expected to be at least $165 million, cash interest expense of $20 million CapEx of approximately $40 million plus the $8 million annual payment for patent license and a modest $2 million in alternative minimum taxes our expected 2011 net cash flow is approaching $100 million.

Moving to slide 11, as I mentioned we prepaid $20 million of our term debt at par with $10 million paid at the end of the first quarter and an additional $10 million paid early in the second quarter. This prepayment will reduce annual interest expense by $2 million assuming constant LIBOR and combined with our scheduled amortization payment of $5 million for the first quarter reduced the balance of our term debt from $200 million as of the end of last year to $175 million currently. Looking ahead the combination of at least $15 million in expected total prepayment during the year and $20 million in scheduled amortization will result in term debt below $130 million at the end of 2011.

These prepayments represent the first phase of our two part strategy to improve our balance sheet. In addition to these prepayments we will seek to refinance our existing debt at rates below the current 9.75% level as those options become available to us. In summary we are pleased with a solid first quarter to start the year. Thank you again for your interest in Vonage and I’ll now turn the call back over to Leslie to initiate the Q&A session.

Question-and-Answer session

Leslie Arena

Thank you Barry, operator, please open the line for questions.

Operator

Thank you (Operator Instructions) and our first question comes from the line of Michael Rollins of Citi.

Michael Rollins – Citi Investment

Hi, thanks for taking my questions. Good morning just two questions for you first could you get a little bit more specific on the change in USF sequentially just to understand what happen to more of the customer revenue. The second question that I had was can you help us put in perspective the size of the market that you are going after so you are now selling to more locations, more geographic, more customer segment and gross adds went up about 8000 sequentially, 20000 year-over-year. And can you help us conceptualize like you know improvement in productivity relative to the size of the market that you are going after. The final question that I had was on churn? And on the churn front if you look at the overall churn rate whether sequentially or year-over-year let’s just call plus or minus flat but you now got half your customers on Vonage World which has lower churn than the other customers. So what’s happening in the numbers is it that the churn from the non-World customers are going up. Is the churn for the World customers going up but you are still below the customers can you just help us take through those mechanics. Thanks very much.

Marc Lefar

Mike, it’s Marc. Let me take your second question first, in terms of size of market and then can move down the funnel to churn and USF. So from a size of market as we’ve discussed before the international long distance market is sizable we are looking at 12% frequent users of the US in any given month we call frequent users those who use more than 20 minutes a month. In terms of global scale you are talking about a market that is the US market well in excess of $17 billion a year globally it is orders of magnitude we estimate it to be four to five times larger than that.

So relative to the overall market opportunity our growth is very small or we have a very small market share and there remains significant additional opportunity. What we learned in proprietary market research is despite popular belief the vast majority of customers more than 60% still make their international long distance calls directly through their mobile phone or their wire line phone paying very high carrier rates.

We believe we’ve improved applications and reach into those device either by extending to those customer either by extending our Vonage home phone service penetration to new segment or by extending it to additional device mobile specifically and making that a more convenient experience through smart phones. We can increase share and we have virtual limitless up side opportunity on a global basis.

And Mike let me respond to you the other two questions are specifically regarding USF fees, they increased $0.40 from the fourth quarter to the first quarter from $2.07 to $2.47 which in aggregate about a $3 million increase sequentially. And with regard to your question on churn let me take that apart for you a little bit if I can yes churn is a basically flat with last year’s overall level of 2.4%.

There are a couple of drivers there one is as you mentioned the impact of Vonage World now being over 40% of our base but it’s important to point out that approximately half and nearly half of the Vonage World customers use the product for domestic only. So the real spilt in the churn drivers has less to do with specifically the rate plan being Vonage World versus others and more to do with whether customers are meaningful ILD users or not. So those customers that use ILD extensively recap at more than 20 minutes per month and that represent about 25% of our base. So those customers churn at lower rate than the overall domestic user base so that’s the first point is that the ILD user continue to churn at lower rates than other users.

The other factor in this is that and we mentioned this on the last call, we introduced the no contract offer starting in the fourth quarter of last year as the churn had come down. We became comfortable with that we knew going into that experienced that the impact of no contract offer is you expect to have higher churn in the earlier life of the customers because what happens under a contract is that you will get a modest spike in churn in the first month or two then it’s fairly steady state churn through month 12 and then you see churn spike as people come off contract in month 13 to 15. So with our no contract offer the profile of churn changes so that you have and would expect to have a little higher churn in the early months relative to what you would have on a contract. So we continue to evaluate those offers in the market and we will continue to make adjustments as appropriate going forward.

Barry Rowan

Mike, let add to the comment and these revenues give you the specific number. I think I might have misstated the US number, the US ILD international long distance revenue is $19 billion with global ILD revenues we estimate to be $80 billion. So obviously still a small fraction for those markets in which we’ve already entered and as we’ve talked in prior calls the market for international roaming as well as for messaging services our markets were they are equally as large $70 billion on international roaming and about that plus a bit more on SMS. But obviously we have yet to materially enter those markets but you could expect that in coming quarters.

Michael Rollins – Citi Investment

Thanks very much.

Leslie Arena

Next question operator.

Operator

Our next question comes from the line of Mike Latimore from Northland.

Mike Latimore – Northland Securities

Hey thanks, yeah I guess on USF for a second the – it had an impact on cost [inaudible] I guess do you see that repeating in the second or third quarter or how long will that last.

Marc Lefar

We expect it basically to be flat Mike, I mean it tends to be a little bit lumpy but on balance flat a little ironed in the first quarter but of course we can’t predict because it’s set on a quarter by quarter basis but as we look forward we wouldn’t expect a dramatic shift from where things have been.

Mike Latimore – Northland Securities

I guess it looks like your [inaudible] services were didn’t trend up too much despite more international revenue not factoring in that USF function. So I guess are you efforts in that regard continuing do you see the cost plus new services per line continuing to be flat or do they grow a little bit?

Marc Lefar

Yes to a point Mike we actually saw the cost of telephony service come down from Q4 to Q1 if you take out the impact of the USF increase so we’ve been very pleased with the progress we made there. In 2010 the real progress on COTS was on lowering termination rates as you know where we were able to take termination rates down by 25% in 2010. There is still some more room to grow there but there is also room on the domestic side as we look to implement next generation call routing for example. So we would expect to see in the back end of the year assuming continuing penetration of ILD segment that’s going to drive COTS overall but it will certainly be mitigated recently substantially by the improvement we continue to make on especially on the US side during this year.

Mike Latimore – Northland Securities

In terms of the growth adds, what percent of those are signing off as Vonage World and then also I guess what percent are using ILD because ILD I think it’s being 25% of the base now for a few quarters.

Barry Rowan

So about 80% of the gross adds from Vonage World and a little over half of those are ILD users. So it increased it was about 40% of the base as of the end of the year and it’s up to about 43% as of the end of the first quarter.

Mike Latimore – Northland Securities

And I believe on the last earnings call you had discussed second half of the year expecting some revenue more significant revenue growth let say. I believe do you still expect that and what will be the top two drivers of that.

Marc Lefar

So we’ve not changed our guidance around new products and services beginning to impact revenues in a meaningful way in the back half of the year. We’ve launched some new products recently including the Vonage World Premium that I mentioned in my call as well as eminent launches of additional mobile services that we believe can help grow the topline. In addition to that we are seeing up sell in revenue migration for existing base. We are managing our existing base into improved ARPU is contributing to top line growth in the back half as well. Lastly as we’ve done has been our practice in past years we’ve been very efficient at surgically implementing price increases where the value proposition we are providing is exceptional and there is a not a lot of competitive alternatives. We expect to take some pricing actions that will have some impact in the back half of the year and then obviously full year 2012 as well.

Mike Latimore – Northland Securities

It sounds like I know you might emphasize certain methods more than kind of other going forward but sounds like this would revenue would show up more in a ARPU function as opposed to a material change in kind of growth as from earlier?

Marc Lefar

I think you would expect to see a mix, I think you expect see certainly we expect that ARPU will be stable and modestly growing. We also expect to be able to grow absolute revenues either subscriber lines or simply paid per use as might be the case in some kind of mobile application where it’s not an ongoing recurring service contribute to top line.

Mike Latimore – Northland Securities

Thanks a lot.

Leslie Arena

Thanks, next question operator.

Operator

Our next questions – (Operator Instructions) and our next question does come from the line of Robert Routh from Phoenix Partners Group.

Robert Routh – Phoenix Partners Group

Yes, good morning guys the quarter looked pretty good. I have questions about the Spanish product that you guys recently launched. Can you give us a little bit more of an update as to how well that’s doing and where you expect that to go and how big you think that opportunity could be considering that kind of redundant business platform you have established.

Marc Lefar

So let me make sure I’m clarifying for you our Hispanic efforts have really been increasing over the past year. We started in the spring of last year simply targeting that group having identified them as a under serve segment both from a standpoint of international long distance services but also to how basic telephony service has been marketed to them.

During the course of the year we build out essentially an end to end Spanish language experience that included sales and service. Sales being our inbound telemarketing environment as well as online portal and then service both online as well as customer service in language that combined with a shift to very specific marketing efforts not just the Spanish speakers but the Spanish speakers with varying specific countries of origin helped us to grow the number of Spanish language orders in the fourth quarter to record levels.

We’ve continued to accelerate that business and we have with the addition of the Vonage World Premium product which just launched in last week and half it’s very early days but we’ve included some additional Spanish language countries and South American countries which were not included in the original Vonage World.

Beyond that there are far more mobile destination that are included. As you may be aware the price to call to mobile phones internationally is a tiered service for almost all carriers. Mobile termination being more expensive and we think there is enormous opportunity there to meet the needs of folks who are calling to mobile phones in other countries. The world premium product we expect to deliver against that but it’s way too early to be able to think about the overall impact and gross adds for the year. But the early progress has been encouraging and we have seen some early response to Hispanic advertising that launched just a week ago almost immediately after turning it on.

Robert Routh – Phoenix Partners Group

Okay great, and then had a few questions about the balance sheet financial engineering, I mean it seems as though you mentioned that you are looking at your debt and right now you are only levered pro forma year end its about little about one time. It shouldn’t be reasonable given your cash [inaudible] to this company and the visibility of that even if you didn’t grow subscribers at all. I’m just curious as to what the company thinks is a reasonable debt level you can handle because it looks like you could handle two to two and half times and then possibly refinancing your debt.

It have to rate your pay because you are getting tax rate from the interest rate you are paying because of your NOL you could generate significant – you have significant free cash flow from operations and the refinancing of debt. It seems like that would make a lot of sense and then repurchasing share could take the stock materially north of where it is and more fairly valued because the capital structure still isn’t close to optimal. Just from what I see I’m just curious if you could comment a little on that and I know you made a little comment at the end of your presentation but a little more clarity as to what you think is an optimal leverage ratio would be, what could this company handle, what cost to debt and would buybacks make sense at some point given your operational free cash flow as well potential increase in leverage.

Barry Rowan

Let me start by laying out the way we think about this sequentially and as I mentioned in the formal remarks during the course of this year our strategy is first to prepay the debt out of cash flow we think that’s a very good use of cash given that we are paying 9.75% interest currently. We obviously were able to cut the interest rate by approximately half through the refinance so that’s the first priority and that’s why you see us explaining that we plan to continue those prepayments.

In addition we do think there will be opportunities to refinance the debt with continued and sustained financial performance certainly from my previous slide as we are able to do that as the company is successfully improved the performance and we expect that to be the case here. So we will be actively looking at the opportunities to do that and we will certainly be taking advantage of those as they come available.

I think in terms of the priorities of the cash going forward it would be – really in this order prepay the debt secondly is we do think that there are potential opportunities to continue through acquisitions to enhance the value of the company so we would look at that. And then certainly we would consider at the right time returning value to shareholders through but more likely a stock buyback than a dividend.

We have not announced any plans along those lines; I think it’s early to be thinking about that currently. But that’s how we think about the priorities of the cash flow. In terms of the overall targeted leverage ratio for the company certainly we could sustain lot more debt than we have currently when we did the refinancing we made a decision not to leverage up the company as we go forward and go through the course of this year. We will look at what that is but at this point we are not prepared to target what that could be but certainly understand the impacts of that kind of financial engineering on the equity value.

Robert Routh – Phoenix Partners Group

Great, because it seems like your cost of equity your cost to debt are pretty close to parity right now. And your equity is on a little higher it seems use your cash if you are going to really generate $100 million in free cash flow almost this year and going forward with some growth. What seems like you are going to start stockpiling cash, I don’t know how you are going to fund acquisition so the question is what else would you do with it? Do you see a big acquisition on the horizon or you just stockpile the cash and then go from there.

Barry Rowan

We think about it I think as the year unfolds for example as we look at it now with the level of debt that we have at 9.75% interest that’s a very good use of cash flow during the course of this year because you get nearly 10% arbitrage differential there. As we go throughout the course of the year make the planned debt pay downs continue to evaluate other options I think we would look at this holistically in terms of what made sense – in terms of what made sense in terms of an optimal capital structure and what those other options might be. So we haven’t had the ability frankly to look at acquisition under our previous debt was highly restricted essentially precluded acquisition so that is at least an opportunity that becomes available to us can actually.

Marc Lefar

Maybe I can add a little more tops into that so we clearly as expect as we look out over 2 to 3 year time horizon that organic only growth in a technology environment is not something that is likely to occur. We are currently in the process of evaluating acquisition prospectus and the lens through which we look at that is really can we actually acquire technology we are not so interested in buying revenues but technology or concepts are beginning to get traction potentially those have intellectual property or strong technology engineering human resources attached to it.

It’s a great way to be able to scale the business and there is obviously tremendous demand for mobile application developers and engineering so we are consistently on the lookout there. We look at this again primarily to enhance the new product and service areas of the business and accelerate growth there and you can think about them as relatively modest acquisitions in terms of overall size because we are not out there trying to buy huge revenue streams.

Robert Routh – Phoenix Partners Group

Great, and just wanted to follow up on that which I think in terms of acquisitions given where your stock is now would you be more likely to use your stock as your currency or would you use cash.

Marc Lefar

I think we would just have to evaluate it on the facts and circumstance of the time.

Robert Routh – Phoenix Partners Group

Okay, fair enough. Thank you very much.

Leslie Arena

Next question operator.

Operator

Our next question comes from the line of William Vogel from Merlin Securities.

William Vogel – Merlin Securities

Good morning I was wondering if you could just repeat the value proposition for the two new products that you are talking about today. I couldn’t keep up with your – they both sounded excellent but I just was wondering if you could just repeat the value proposition.

Marc Lefar

Sure, and I’ll apologize to the group in advance for competitive reason until we are actually launching I’m not giving all the specific details but to give you the general space so you could understand how they fit within the overall context so the first is a standalone mobile application for smart phones, it address international long distance market and we intend to launch that in over 75 countries simultaneously. It is one that has global reapplication and we think it solves some of the very basic problems about initially establishing service that you are paying for on a mobile phone as well as the way you use it and how fast you can up and running. We think it will be the most convenient way to simply dial an international long distance numbers from anywhere to virtually anywhere and we will be able to see that in the coming couple of months.

The second product is one that is enhancement to the core Vonage Home phone service offering. You can think about it as an extension like product the notion being people our consumers are telling us all the time that they want to be able to take advantage of the Vonage rate plan the relation that they have with us directly now and extend that benefit to other device. And we don’t care where people are sitting or which device they are on and it really actually that core Vonage service to work on mobile devices or other wired phones and to register multiple devices and have that charged to the same account is an improvement value proposition.

The way we are planning to structure that we think it will give us increased usage as there is more availability and access to ILDs if you more phones to our base so there is an ARPU enhancement that we expect over time will be delivered and we also believe that the overall value proposition for our home phone service which is traditionally you have to have the home phone that’s the only place to get to use it. We will be positioned very differently because now you be able to apply for a service plan that you can use on multiple devices your home, your mobile phone, your office phone and get the benefit of the Vonage value proposition across multiple devices no matter where you are so that’s the second of those products which will follow the first one.

William Vogel – Merlin Securities

And this is follow up in terms of the SG&A build for the balance of the year does this fit within the build or are we are going to see a revision to that on the back of this new introductions.

Marc Lefar

I think we would be able to accommodate those within the guidance that we’ve given.

William Vogel – Merlin Securities

Okay, thank you very much.

Operator

(Operator Instructions) and one moment for any further question.

Leslie Arena

Next question, operator.

Operator

And we do have a follow up from the line of Robert Routh from Phoenix Partners.

Robert Routh – Phoenix Partners Group

Hi guys, just one question that you addressed a little bit but given the churn kicked up a little bit because of the no contract which makes total sense. I’m just curious as you roll out these two new products and everything else I’m holding too many things but what are you think about how we should look at churn on a full year basis in going forward. Obviously it’s going to be higher when you don’t have any contracts but I’m just curious different modeling purpose. What would be a good range or number for us to look at long term?

Marc Lefar

Let me that, we maintain our guidance that we believe it’s going to be roughly flat versus 2010 you might get occasional peaks and valleys during the course of the year. But based on our current visibility and trends that’s what we expect in terms of new products that we are launching I should clarify that standalone mobile offering doesn’t require Vonage home phone service.

We wouldn’t expect that to have any impact on churn and since it is going to be a product that is not require an ongoing subscription you will see that as revenues we wouldn’t report specific ongoing subscriber lines or churns associated with the products could be a revenue stream. Vonage extension we would expect that those customers to take it with certainly at a lower churn profile. It increase the utility that they see more poor service and obviously without having the launched it yet we don’t know what the profile of new subscribers would be.

Robert Routh – Phoenix Partners Group

Okay, so it just fair to keep it kind of flat that is what you are expecting based on what you know now that’s safe.

Barry Rowan

I think as Marc point out really essentially stable churn there are some puts and takes going both directions but [inaudible]

Marc Lefar

I think we did mention – so I think we had a one timer this quarter where we had some countries that we took out of the Vonage World plan that weren’t meeting financial objectives. We from time to time do that pricing actions can occasionally change monthly churn trajectory so I would encourage you to keep a range up and down. It’s very difficult to have visibility quarter to quarter beyond the ranges that we have experienced in the last couple of quarters.

Robert Routh – Phoenix Partners Group

Sure and then one last question you did mention how later in the year as new products you might increase prices in some markets in some areas. Can you give us some kind of sense as to degree or magnitude of what kind of price increase you are thinking or 5% 10% and is it across all your products or is it just Vonage World. How should we look at that?

Marc Lefar

Until we announce I’m not going to give specifics on the price changes. Historically when we’ve done this we have done it that are on ranges below 10% so we look at this at the balance of what is opportunistic. We do it in a way that we are obviously attempting to avoid churn and resell the value proposition relative to competitive alternatives. So there is always risk when you take some level of pricing but we have been in this movie before and have successfully implemented that and the kind of increases we are contemplating are similar where they were before and there are in places where consumers are getting significant value today and we think there is not a lot of alternatives to go to.

Leslie Arena

We have time for the last question operator.

Operator

Our final question comes from the line of Michael Rollins from Citi.

Michael Rollins – Citi Investment

Hi thanks, just two follow up can you give us a sense in terms of service revenue what’s not coming from the home replacement market, your traditional subscriber business if you look at what’s coming from the mobile and the application side of the company. Thanks.

Barry Rowan

It really hasn’t changed appreciatory from where it has been Mike. We have said in prior quarters that it was at a run rate just below about $10 million annually so as Marc pointed out in process of introducing some of the new products that will begin to take hold in the back half of the year so that’s where it is currently.

Michael Rollins – Citi Investment

Okay, thank you very much.

Leslie Arena

Okay operator, this will conclude the call. Thank you.

Operator

Thank you, ladies and gentlemen thank you for participating in today’s conference. This does conclude the program and you may now disconnect. Everyone have a good day.

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