Virgin Mobile USA, Inc. Q2 2008 Earnings Call Transcript

Virgin Mobile USA, Inc. (VM)

Q2 2008 Earnings Call

August 13, 2008 5:00 pm ET

Executives

Erica Bolton - Investor Relations

Daniel H. Schulman - Chief Executive Officer, Director

John D. Feehan, Jr. - Chief Financial Officer

[Steve Koffel] - Vice President and Treasurer

Analysts

[Will Milner – Arid Research]

Richard Prentiss – Raymond James

Walter Piecyk – Pali Research

Presentation

Operator

Welcome everyone to the Virgin Mobile USA second quarter 2008 earnings conference call. (Operator Instructions) Ms. Bolton you may begin the conference.

Erica Bolton

Welcome to Virgin Mobile USA’s second quarter 2008 results conference call. Joining me today on the call are Dan Schulman, Chief Executive Officer, John Feehan, Chief Financial Officer, and [Steve Koffel], Vice President and Treasurer.

Our earnings release went out at 4:15 this afternoon and is available at our investor website www.investorrelations.virginmobileusa.com.

Please note that this presentation of results will include forward-looking statements. These statements which reflect our current reviews with respect to future events are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Further, certain forward-looking statements are based upon assumptions about future events which may not prove to be accurate. We provide a detailed discussion of various risk factors in our SEC filings and I strongly encourage you to thoroughly review these filings. We plan to file our 10Q for the second quarter tomorrow and we encourage you to read this as well.

We’ll refer to several non-GAAP metrics in our call. Reconciliations of our non-GAAP measures to the appropriate GAAP measures for the second quarter and for the first half of 2008 can be found at the end of our earnings release and in our SEC filings.

Today Dan and John will give you an update on second quarter and first half 2008 operating results and the outlook for the remainder of 2008 and then take any questions you may have.

And now I’d like to turn the call over to Dan Schulman.

Daniel H. Schulman

Our results for the first half of 2008 were strong versus our plan and results in the second quarter not only exceeded our expectations but also showed improving trend lines across many important metrics.

We produced 728,000 gross customer additions during the quarter and a net loss of 111,000 customers which was significantly better than our earlier estimates. Our churn results were better than our expectations at 5.6% for the second quarter compared to 5.7% in the second quarter of 2007. In what has traditionally been our highest churn quarter we were able to produce better than expected churn due to ongoing improvements in our value proposition, lifecycle customer management initiatives, and enhancements in our churn segmentation modeling.

Churn for the first half was 5.3% and we are on track to achieve our churn guidance for the full year. We added more than $1.5 million customer gross adds in the first half of the year and recent trends reflect increasing favorable demand. While our gross add-its for the first half are 9% lower than last year, these trends are improving each quarter with the gap in growth steadily narrowing as many of our operational and marketing initiatives have been put into place.

Gross customer additions were down 7% year-over-year in the second quarter compared to a decline of 10% in the first quarter and we expect that the third quarter will show continued improvement. In fact, we expect Q3 gross adds to be roughly equivalent to Q3 2007 gross adds.

We’re very pleased with the early strength and adoption of our new plans as they have been rolled out during the current quarter. Gross customer additions for the month of July hit our expectations and our plans are clearly connecting with consumer demand. Our new offers are extremely competitive and we believe that they offer some of the best value in the industry especially for the more than 80% of consumers that use less than 1,200 minutes per month.

The recent launch of our Totally Unlimited $79.99 calling plan is performing above our expectations. This is the best value nationwide unlimited plan for consumers with no roaming charges and no credit card required. Usage on this plan is trending below our plan levels and therefore these customers are some of our most profitable on an absolute ARPU margin dollar basis.

Another excellent trend we are experiencing is the growth in hybrid adoption with the launch of our new monthly service plans. As these plans roll out across our retail footprint, monthly plan adoption has been steadily growing from approximately 32% of our gross adds in the first quarter to 45% in June. This trend is continued into Q3 as 47% of our gross adds in July were on our monthly plans. This trend is beneficial in two ways. First, increased monthly payments in the base provide consistency and stability to our revenue streams. Second, with our lowest monthly plan priced at $20.00 this strong hybrid performance should improve our overall ARPU trend throughout the rest of this year.

In the second quarter we produced $291 million of net service revenues and adjusted EBITDA of $32 million which was up from $31 million a year ago and handily exceeded our guidance. While net service revenues were down year-over-year reflecting the previously forecasted impact to customer usage, our adjusted EBITDA margin improved to 11.1% from 10.1% in the second quarter of 2007 reflecting ongoing operational discipline. We were able to produce improving profitability even as we spent an incremental $5.8 million in marketing spend during the quarter compared to a year ago in order to support the launch of our new offers.

Adjusted EBITDA for the first half of 2008 was $61 million, again well exceeding our expectations and our guidance for the first two quarters of the year. And we did this while investing an incremental $13.3 million of marketing spend in the first half of the year versus last year, which was actually $3.3 million more than the $10 million we originally guided to.

We’ve continually stressed that the hallmark of an [MV&O] is scale is free cash flow and our results for the first half reflect this key strength of our business model. We are able to produce very strong free cash flow due in part to minimal capital needs. In the first half of 2008 we produced $29.2 million of free cash flow which includes payments for interest expense and capital expenditures. This is up 146% from the first half of 2007 and clearly demonstrates the operational discipline instilled in our business.

Our results exceeded our expectations across the board in the second quarter and for the first half. I’m particularly pleased though with the improving trends in the business we saw in the second quarter and these trends are continuing into the third quarter. These results are a direct outcome of the many initiatives we rapidly implemented in response to a challenging retail environment. The management team put in a lot of hard work and planning, and it is gratifying to see these efforts begin to take hold in the market.

Along with the rollout of new plans during the second quarter, we also launched two new handsets; the Slash and the Arc; and began the expansion of our retail presence into American Wireless and Sears. We also increased our presence at Wal-Mart which began towards the end of the quarter. The Slash is continuing our trend of very strong sales for our higher-end handsets. At $79.99 the Slash joins the Wild Card in our high-end lineup and strong sales of these phones bode well. As we’ve said before the LTV or lifetime value and churn profile for these customers is much better than it is for our low-end phones.

We also made a number of important strategic announcements during the quarter that position Virgin Mobile for growth in 2009 and beyond. The most significant was the announcement of our acquisition of Helio. We remain quite positive about the potential for this acquisition and the implications it has for our customer base, financials and ongoing growth prospects. We continue to expect this transaction to be accretive to adjusted EBITDA in 2008 and to adjusted EBITDA and free cash flow in 2009.

As I discussed on the call in June Helio is contractually required to cut their costs by approximately 70% before the deal closes and they are on track to do this. In the six weeks since we spoke to you in June, Helio has reduced their staff by more than two-thirds and have closed nearly all of their retail stores and kiosks.

Helio is already getting the cost benefit of our network rates. We’re very pleased with the progress being made on the cost side and we remain confident in our expectations for the business. We hope to close this deal in the next few weeks. The Helio acquisition is transformative for us. The addition of a post-paid platform, outstanding data services, and compelling handsets will enable us to offer more value to our entire customer base; prepaid, hybrid and post-paid alike.

Our integration teams are working hard behind the scenes to put together compelling products and services, and we are excited about the prospect of launching differentiated plans, handsets and services over the next several quarters.

During the quarter we also announced an outsourcing agreement with IBM for our back office operations and applications development. This is a significant transaction or us. It provides additional capabilities and improved time to market performance and will also result in significant cost savings. The moves to IBM will allow us to gain the benefit of IBM’s investments in mobile technology to deliver even more reliable service and applications to customers, bringing new products to market more quickly, and dynamically respond to market trends.

This transition which will greatly fortify our technological infrastructure also means we will close our Walnut Creek offices. As a result we will incur approximately $9 million in incremental one-time costs this year and about $2 million next year due to the closing of our offices and the associated headcount reductions. However, this initial investment is expected to produce over $50 million of IT operational cost savings over the next four years.

We are maintaining our outlook for 2008 on all metrics even with the incremental one-time costs associated with our IBM outsourcing which was not contemplated at the time of our original guidance. Furthermore, we expect to come in at the high end of our guidance for free cash flow. The scale and flexibility inherent within our model provides us the ability to maintain ongoing profitability and cash flow generation while continuing to invest in growth.

As I said up front, the second quarter was better than our expectations and we are beginning to see the fruits of our labor across multiple fronts. We’re cautiously optimistic about the remainder of the year and believe the initiatives we have implemented will result in positive growth in the second half of the year and into 2009.

I’ll now turn it over to John to go through the financials in more detail and then I’ll come back and we’ll take your questions.

John D. Feehan, Jr.

We performed better than our expectations in the second quarter across a number of key metrics and produced good profitability along with strong free cash flow while we continued to invest in growth. In the second quarter we produced total net service revenues of $291.4 million, generated adjusted EBITDA of $32.3 million, and produced $18.8 million of free cash flow which includes interest expense and cap ex. Cash flow is the strength of our MV&O business model and our ongoing ability to produce strong free cash flow will only be improved by the upcoming acquisition of Helio and the related investments by Virgin Group and SK Telecom.

The upcoming acquisition is expected to approve our cash flow profile on two fronts. First, through the expected $50 million pay down to our Term B loan, which will reduce our net debt by at least $35 million. We expect our cash flow to improve by about $6 million to $7 million a year from the reduction to our debt service. Second, we expect to enjoy organic cash flow accretion from the contribution of Helio’s customers. This transaction has a multiplicity of very important benefits both strategic and financial, not the least of which are the very clear and substantial improvements to both liquidity and flexibility to manage the business under our debt covenants.

Across all of our key metrics the core VMU business performed well in the second quarter and results came in on or better than our expectations. We believe we have planned well in a year that presents plenty of challenges for everyone, and we are cautiously optimistic about the current customer behavior we’re observing in the base.

Our monthly hybrid plans continue to perform well with gross customer additions from hybrid plans steadily growing from 38% of gross adds in April to 45% of gross adds in June resulting in 24% of our customer base on these monthly offers at the end of the quarter. This trend in hybrid strength has continued in Q3 reaching 47% in July. The trend is very encouraging and we believe will help contribute to an improvement in ARPU trends and help stabilize revenue streams going forward.

We had approximately 111,000 net customer losses for the second quarter 2008 an increase in loss from the second quarter of 2007 but much better than our expectations. The second quarter is our seasonally weakest for net customer additions and negative net customer additions is expected due to the dynamics of our churn rule and normal consumer behavior. However, we were able to produce an improved result due to churn being better than expected for the quarter. Churn in the quarter was 5.6% which was better than our expectations. This churn was due largely to some successes in our lifetime customer management efforts and some excellent predictive modeling put in place to continue to identify high-value customers at risk. We also believe that stronger sales of our high-end handsets during the past few quarters is contributing to the churn improvement. We are very pleased with the Q2 results which bolster our confidence in our full-year guidance for churn in the mid-5% range.

Total operating revenues for the quarter were $317 million down by 3.1% year-over-year. This reflects the decline in customer usage and migration of our higher-end prepaid customers to hybrid partially offset by net additions to our higher ARPU hybrid plans as well as increasing equipment revenues reflecting the popularity of our higher-end handsets.

We are also seeing greater penetration of data services with data growing to 18% of net service revenues in the second quarter. Last year revenues also had the favorable impact of E911 tax refunds and settlements. ARPU for the quarter was $19.32 down slightly from the first quarter ARPU with usage levels on the prepaid side remaining stable albeit at lower than historical averages. These results are right in line with the expectations we modeled and are consistent with our guidance for the full year. The trends we are seeing with hybrid adoption and the uptake of the Totally Unlimited plan are encouraging and we do expect an improvement to ARPU trends in the second half of the year.

We continue to drive more efficiency within the business which reflects our ongoing operational discipline, and we expect to continue to improve efficiencies on a per unit basis throughout the next two quarters. Cost of service was $82.4 million for the second quarter a decline of 8% from the second quarter of 2007 which partially reflects our improving network economics. CCPU for the quarter was $11.71 compared to $13.54 in the second quarter of 2007 resulting from lower usage trends and improved network costs as well as the benefits of our operating efficiencies with our per unit care costs coming down by 29% year-over-year. This was partially offset by the impact of net additions of hybrid customers who have higher usage levels but also have a much higher ARPU margin dollar contribution.

CPGA for the second quarter was approximately $113.00 and represents one of the lowest acquisition costs in the business. There were a couple of dynamics to this CPGA number that pushed it up slightly which we think were all positive. During the quarter we continued to have higher-than-expected handset sales of the Wild Card and our new Slash performed much better than expected which when offset by higher revenues from these phones added just over $1.00 to CPGA. As disclosed on the last call, we also opted to invest more in marketing during the quarter in order to publicize the rollout of the new plans which equated to about $4.50 in CPGA. Overall we are very pleased with the results for CPGA with a slightly higher investment reflecting very positive trends in the base. We remain comfortable with our full-year guidance for CPGA of around $110.00. Our CPGA is consistently one of the lowest in the industry and we expect to remain industry leaders in this metric.

Selling, general and administrative expenses for the second quarter were $106 million a decline from $110 million in the second quarter of 2007 and $219 million for the first six months of 2008 compared to $220 million for the first six months of 2007. This decline actually reflects a few incremental items offset by some of the planned operating expense efficiencies we have discussed over the past couple of quarters. As I’ve mentioned we’ve had an incremental $13.3 million in marketing expense year-over-year in support of our new plans. Even with the incremental marketing spend in the first half of the year, we are on the run rate necessary to achieve our goal of $15 million to $20 million of planned operating expense improvements on an absolute dollar basis in 2008.

A couple of examples of this are an improvement of $9.5 million in customer care costs as we continue to see the benefits of partial off-shoring as well as an improvement of $7.3 million in IT spending as we streamline some of our vendor relationships. This IT savings also includes some initial savings due to headcount reductions with our planned outsourcing to IBM which was offset by about $1 million of costs relating to the transition to outsourcing which we’ve already incurred. With further planned reductions in these areas and marketing in the second half of the year we are confident in the $15 million to $20 million reduction we have outlined to you previously.

We produced adjusted EBITDA of $32.3 million for the quarter versus $31.2 million for the second quarter of 2007. Adjusted EBITDA for the first half of 2008 was $61 million compared to $72.9 million in the first half of 2007. There were a number of items in the first half of 2007 which benefited adjusted EBITDA including a one-time benefit due to the transition to consignment as well as a benefit from E911 tax refunds and settlements. When you exclude the incremental $13.3 million we spent in marketing in the first half of the year, our adjusted EBITDA for the first half of 2008 well exceeded our results in the first half of 2007. In a difficult economic environment we are very pleased with these results and with our ability to make continued operational improvements to produce strong profitability.

Net income for the quarter was $3.5 million or fully diluted $0.07 per share compared to net income of $7.1 million or pro forma $0.11 per share for the second quarter of 2007. The pro forma EPS for 2007 adjusts for the share count only which is a more relevant comparison.

It’s important to note that we had a couple of items in our results that did not exist last year prior to our IPO including $2 million in minority interests and a $6 million accrual for payment of our tax receivable agreement to Sprint and Virgin Group. As we were not taxpayers last year and we are effectively taxpayers going forward through our tax receivable agreements, this is incremental to the year-over-year comparison. In aggregate we had $8 million of effective tax payments and minority interest expense which impacted net income in second quarter of 2008 and is incremental to our financials in the second quarter 2007 pre-IPO.

Going forward with the close of the Helio transaction we expect reported earnings per share to be impacted by non-cash items such as the amortization of intangible assets resulting from the purchase price valuation. Thus, going forward we will report an adjusted EPS number excluding these non-cash items.

Capital expenditures for the quarter were $3.1 million or just 1% of net service revenues. Our consistently low level of capital expenditure is a hallmark of the MV&O business model and its ongoing stable cost efficiency of the business means we expect to continue to produce strong free cash flow as we increase our scale. Interest expense was $7.9 million compared to $13.9 million in the second quarter of 2007 reflecting the benefits of our improved capital structure following our IPO.

With the upcoming close of the Helio transaction and our anticipated $35 million to $40 million reduction to net debt, both our interest and amortization payments will be brought down pro rata. Therefore, we expect interest in future quarters to decline and our cash flows to show the reciprocal benefit. In addition, with the increase to the revolver from $75 million to $135 million we will have an ongoing benefit under our debt covenants to the tune of tens of millions of dollars. This transaction will provide us ample room to make the right decisions for the growth of the business with covenant room effectively being eliminated as part of the equation in our decision-making process.

During the second quarter we generated $18.8 million of cash flow including interest payments and capital expenditures. For the first half of the year we generated $29.2 million of free cash flow and excluding interest payments of $16.6 million the unlevered free cash flow number was $45.8 million. This strong performance gives us clear confidence in our guidance of free cash flow before interest payments for the full year 2008 of $55 million to $65 million. Our better-than-expected cash flow results enabled us to pay down our revolver $5 million from the existing Q1 levels.

Due to this strong performance we expect Virgin Mobile without the Helio acquisition to be at the high end of our cash flow expectations for the year. We are extremely pleased with our ability to generate strong cash flow and the close of the Helio transaction will create a much-improved cash flow profile for the business on an ongoing basis. Given the terms of our agreement with Helio we will see a one-time impact to cash flow in the second half of the year due to our previously-disclosed commitment to certain working capital liabilities and debt payments. However, we expect the transaction will substantially improve our cash flow outlook for the long term.

In the second quarter we continued to invest in the future growth of the business as we fully realized the rollout and launch of the new plans and shipped additional handsets to support our expanding distribution. We now expect to begin to reap the benefits of these initiatives in the second half of the year, and we are already beginning to see this reflected in our current financial results.

We are excited about the future growth prospects of our current initiatives we have in place and we continue to be comfortable with our guidance for 2008 even as we invest in incremental growth opportunities.

With that I’ll turn it back to Dan for his closing remarks.

Daniel H. Schulman

Before turning it over to your questions, I’d like to review our outlook for the third quarter and the remainder of 2008. The economy obviously remains a challenge for everyone but in this context our business is performing well and we are on track and implementing our plans for growth and continued operational efficiencies. We’re seeing the fruits of these efforts with trends across many of our key metrics in the business improving quarter by quarter. We remain confident in our 2008 stand-alone guidance across all metrics. Even with the number of incremental growth opportunities and costs that were not originally in our plan at the beginning of the year, we are comfortable with our adjusted EBITDA guidance for the year and as John mentioned we expect our free cash flow before interest expense to be at the high end of our original guidance. Our original guidance was $45 million to $65 million. Our new guidance is for our cash flow before interest expense to be between $55 million and $65 million.

In the third quarter the impact of our new voice and data plans as well as our expanded retail footprint is expected to continue the positive trends we witnessed in our gross adds from Q1 to Q2 with year-over-year trends further improving to produce flat gross adds compared to the third quarter of 2007. Third quarter net adds are expected to be in the range of -20,000 to +20,000 and we believe our churn estimates for the full-year 2008 will remain at the mid-5% range. Third quarter net service revenues are expected to stabilize versus the second quarter and are expected to be in the range of $285 million to $295 million. Third quarter adjusted EBITDA is expected to show significant growth of about 20% to 40% versus last year and be in the range of $20 million to $24 million and our third quarter EPS is expected to be in the range of $0.00 to $0.03 per share.

I’d like to conclude my remarks by reiterating that our second quarter results reflect the effectiveness of the initiatives we’ve put into place and our ability to plan and execute through a challenging macro economic environment. As I mentioned our metrics are beginning to show improving trends with the negative year-over-year growth subtly narrowing and we expect this to continue. These initiatives along with the upcoming Helio acquisition position us well as we enter the second half of 2008 and position 2009 to be a year of growth. We are highly focused on our customers and the value we provide them. Our cost structure continues to improve and our free cash flow yield is the best in the business and is expected to grow significantly this year. As John mentioned all of us here at Virgin Mobile are focused on executing against our plan, building value for our customers and our shareholders and we’re excited and energized by the opportunities in front of us.

We can start to answer some questions.

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from [Will Milner – Arid Research].

[Will Milner – Arid Research]

A couple of quick questions actually, given the improvements to distribution you’ve talked about they obviously gross out your gain bound year-over-year, when we’re looking out the second half what is your expectation there? Down 7% year-over-year in the second quarter and down 10% in the first quarter so some improvement but still obviously this trend is still down, are you hoping with the distribution that you’re going to be a able to stabilize gross ads at around the level you were at for the second half of 07?

Daniel H. Schulman

Let me jump on that first and then we’ll get back to your next question. I think we just tried to mention in this call that our expectations for the third quarter is that our gross ads for the third quarter of this year will be equal to our gross ads for the third quarter of last year so we do expect to not be negative growth year-over-year but to be the same as we were last year and we expect our guidance which were for overall gross ads to be roughly equivalent to lat year for the full year. We still remain comfortable in that assessment as well as for us to have positive net ads by the end of the year.

[Will Milner – Arid Research]

I just have one follow up, in the past I think you’ve talked about the impacts of the economy being about mid-single digit decline in prepaid usage, is that still the case? Does that go worse, go better over the last quarter and looking into the third quarter?

John D. Feehan, Jr.

We have seen our prepaid usage be fairly stable throughout the first half of the year and right in line with what we projected for the year if not slightly better. So while we did come into the year with that mid-single digit decrease we have seen very slight decreases in usage which is a normal trend as you come out of the first quarter with a lot of new gross ads into the second quarter, it’s very consistent with what we modeled and very stable right now.

Operator

Your next question comes from Richard Prentiss – Raymond James.

Richard Prentiss – Raymond James

Couple questions for you guys, on the ARPU front you mentioned how the unlimited plan seems to be helping also. Can you talk to us about how many people are choosing that unlimited plan and how much benefit that might have on the ARPU books?

Daniel H. Schulman

Rick, as you know we just launched the unlimited plan at the beginning of July so it’s quite early. It’s well above our expectations in terms of the gross ads coming onto it. We’re not releasing those numbers specifically but it’s a number that actually will make a difference in our overall results. I think the more important, Rick, although I do think unlimited is going to make a big difference in our ARPU going forward and as I mentioned it’s quite profitable for us as well, but the more important thing is that our percent of gross ads are now up to in July to 47% of our gross ads on our monthly plans. That’s up substantially from the 32% that we were at in the first quarter and those monthly plans have much higher ARPU levels than our traditional prepaid customers. So if that gross ads continues to be up in the high 40% you will see a much larger percentage of our base on our monthly plans and because they have higher ARPUs that will naturally tend as that base moves up onto monthly plans to increase our ARPU levels. So it’s a combination of both unlimited as well as the adoption of all of our monthly plans that give us a degree of confidence as we look forward in terms of ARPU trends going forward.

Richard Prentiss – Raymond James

I would guess that should also help churn too if you’re getting them on monthly plans?

Daniel H. Schulman

It’s a good question. We hadn’t seen a big difference in churn between our monthly plans and our prepaid although what’s happening is people are now beginning to move to our higher end handsets. We do see substantially improved churn from higher end handsets so I think as we look at it, there may be an improvement but it’s a little bit too early for us to tell right now with the new offer sets that we have out there on churn but certainly as the percentage of our new gross ads moves away from our very low end handsets and more to our mid-tier and high-tier handsets that should begin to have an improvement both in our churn and our overall LTDs for our customers.

Richard Prentiss – Raymond James

And on the marketing front, the marketing initiatives, originally it was going to be $10 million, you spent just over $13 million. Can you walk us through what that extra $3 million was for and do you expect to have any additional marketing initiatives spends as we look in the second half of the year?

Daniel H. Schulman

No, our marketing is pretty well consistent in the second half. We are going to invest overage in our EBITDA [inaudible] invest for growth going forward. We’re still I believe very much in the growth potential of this business and so we’re launching our new offers, we began to see grew demand for them, we decided to put more marketing dollars behind that and as John mentioned in his remarks that pay off in terms of the number of customers moving on to our monthly plans as well as the trends we’re seeing inherent within the business was a good investment of our marketing dollars. We’re basically on plan in the back half of the year as far as we can see right now from a marketing spend perspective.

Richard Prentiss – Raymond James

Final question on the free cash flow guidance and being on the upper end of that range, what do you see happening with cap ex? This quarter was pretty low as far as what we were looking for in the cap ex. Are you still looking for north of $30 million in cap ex for the year or is that looking to be coming down?

John D. Feehan, Jr.

No, Rick, while the cap ex will go up slightly in the second half of the year, we do not expect it now to be North of $30 million. We expect it to be less than $30 million as we continue to see the efficiencies in the infrastructure we’ve already put in place. So we do see that coming down some.

Operator

Your next question comes from Walter Piecyk – Pali Research.

Walter Piecyk – Pali Research

Couple questions, gross ads, I think the last quarter you talked about seeing gross ads being flat year-over-year. What were some of the factors in the quarter that led to gross ads being down 7%?

Daniel H. Schulman

It basically was the Wal-Mart rollout happening later in the quarter than we anticipated. It only began to happen towards the very end of the quarter.

Walter Piecyk – Pali Research

So when you’re going into Q3 obviously you’ll get the full benefit of Wal-Mart, that should help Q3 out?

Daniel H. Schulman

That’s correct, Walt.

Walter Piecyk – Pali Research

G&A was also something that went down sequentially from $84 million to $80 million. I know it was $80 million in Q4 and could you just remind of what are the push and takes in that line item that make it shift $4 million a quarter?

John D. Feehan, Jr.

Walt, the biggest thing we’re seeing is continued improvement in the two line items I mentioned which were IT and care. We continue to see those per unit costs improve quarter-over-quarter and they were down year-over-year about 30% on a per unit basis. We continue to see improvements in our per unit basis even though we’re highly variable, though it’s per unit costs we have room there. We’ve always said we can drive efficiencies in those variable per unit costs and we’re seeing that sequentially quarter-over-quarter in care and IT.

Daniel H. Schulman

On John’s point we do believe there are further operational efficiencies in this business. Our outsourcing agreement with IBM is an example of that. Over the course of the next four years beginning next year we expect to save another $50 million of IT operational costs in that. As you think about how efficient can we get, one you can get more efficient in each one of our line items, IBM being an example of that, but number two our network costs with our Helio deal we also expect for those to come down about 8% or so next year. I think we’re trying to drive as much operational efficiency into the model but at the same time invest in growth going forward.

Walter Piecyk – Pali Research

So then on that operational efficiency in the network costs, I understand the Helio aspect just because they were getting gouged on the rates, but in your model this mix shift that’s going up, is that what’s driving the gross margin down a little bit sequentially? These plans, the hybrid plans which obviously help in ARPU and maybe better churn, should we expect if that mix continues that gross margin levels which is a function of the network expense, should be closer to 70% as opposed to maybe a low to mid 70s?

John D. Feehan, Jr.

Walter, I think that’s exactly right. I think we consistently stated that the ARPU margin percentage on a hybrid plan is lower than on prepaid plans but when you look at the absolute ARPU margin dollars on the hybrid offers they are significantly higher than the prepaid and we’re absolutely willing to make that trade off to get those ARPU margin dollars. So you will see that margin compression on the gross service margin come closer to the 70% due to that continued shift to hybrid.

Walter Piecyk – Pali Research

Last one, the ad costs, I know it’s a very tiny item, but I assume that the reason it was of benefit in the quarter was that one time transition, that consignment. Just from a modeling standpoint, is this basically a non-item anymore or is it still $500,000 a quarter?

John D. Feehan, Jr.

You mean the one time cost benefit that we got last year, Walt?

Walter Piecyk – Pali Research

All I see is there ad costs associated with existing subs is typically like $500,000 to $750,000 expense and it went basically as a benefit this quarter. I assume that that was a one time item that reversed this quarter. I’m just trying to understand what happens going forward. I can take it off line, it’s not a big deal.

Daniel H. Schulman

If you don’t mind, Walt, maybe we can take that one just to make sure we nail that with you so we really understand what you’re getting at on that as well.

Operator

There are no further questions at this time.

Erica Bolton

Thanks everyone for joining the call and we will speak to you next quarter.

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