Vonage Holdings Corp. (NYSE:VG) Q3 2013 Earnings Call November 6, 2013 10:00 AM ET
Leslie Arena - Vice President, Investor Relation
Marc Lefar - Chief Executive Officer
David Pearson - Chief Financial Officer and Treasurer
Greg Burns - Sidoti & Company
Michael Rollins - Citi Investment Research
Bill Dezellem - Tieton Capital
Good day, everyone, and welcome to the Vonage Holdings Corporation third quarter 2013 earnings conference call. Just as 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.
Thank you. Good morning and welcome to our third quarter 2013 earnings conference call. Speaking on our call this morning will be Marc Lefar, Chief Executive Officer; and Dave Pearson, CFO. Marc will discuss the company's strategy and progress and Dave will review our financial results. Slides that accompany Dave's discussion are available on the IR website. At the conclusion of our prepared remarks, we will be happy to take your question.
As referenced on Slide 2, I would like to remind everyone that statements made during this call 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 expectations and depend on assumptions that maybe 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 slide and contained in our SEC filings. We caution listeners not to rely unduly on these statements and disclaim any intent or obligation to update them. During this call, we will be referring to non-GAAP financial measures. A reconciliation to GAAP is available on the IR website.
And now, I will turn the call over to Marc.
Thank you, Leslie, and good morning, everyone. Today we reported a solid third quarter. Gross line additions of $175,000 were up 12% sequentially and up 2% versus the prior year. This was our best quarter of GLAs since the first quarter of 2011, as we benefited from a stable volume of international callers and a first full quarter of national BasicTalk sales.
As expected, churn increased modestly to 2.6%, due to targeted price increases executed during the quarter, and the early life churn associated with higher levels of new gross line additions. Low seasonal churn during the second quarter also affected the sequential comparison.
Total net lines grew by 11,000, a sequential increase of 8,000, the highest level of net additions since the first quarter of 2008. Revenue of $204 million was roughly flat sequentially and down 1.7% versus prior year due to prior period line losses in our premium domestic customer base, a modest ARPU compression. BasicTalk sales and targeted pricing actions help to offset these factors.
Adjusted EBITDA of $23 million was down sequentially from $27 million, primarily due to the full quarter impact of national launch investments in support of BasicTalk. This investment will begin to ramp down towards the end of the year, as we move to more normalized levels of acquisition cost.
Our steadfast focus on improving efficiency have led to further cost reductions in customer care and telephony services, which are down 14% and 4%, respectively compared to the prior year. We will continue to emphasize structural cost reductions in our 2014 plans, to help offset the cost of investments in growth and domestic pricing pressure. Free cash flow was $20 million, $9 million higher sequentially due to positive changes in working capital and lower capital expenditures.
We are now at the halfway point of the three year plan that I first outlined at a major investor conference in early 2012, in which I elaborated on during our annual earnings call a month later. At that time, I described the strategic operational and financial transformation that we just completed.
That phase of our plan, which took roughly three years, resulted in a swing of nearly $200 million in EBITDA and dramatic reductions in line losses and churn. Our performance allowed us to restructure our balance sheet, lowering interest rates from a high of 20% to less than 4% saving over $40 million in annual interest expense.
Even after the closing of the recently announced acquisition of Vocalocity, our net debt will be 65% lower than at the end of 2009. In addition, we've executed on our early 2012 promise to take a balanced approach to capital management. In August 2012, we initiated our first $50 million stock repurchase program, which we subsequently replaced with $100 million plan. Through the end of the third quarter of this year, we've repurchased 28 million shares for $72 million.
It was also during these early 2012 discussions, I outlined a high level strategy for growth, with the goal of driving substantial new revenue streams to be realized, as we enter 2015. We discussed three strategic areas of emphasis: one, core growth in the U.S. and Canada; two, mobility services, both as a standalone service and as a compliment to all of our offers globally; and three, international expansion.
As we approach the halfway point of our three-year plan, let me touch on each of these strategic areas of emphasis and share our progress towards Vonage's reemergence, as a premier provider of cloud-based communication services. In our first strategic area of emphasis, the U.S. and Canada core business, we established three objectives.
The first of these was to continue to penetrate underserved ethnic segments with aggressive international calling plans, building up on our early success with Vonage World. Since that time, we've established a 36% share of the Asian-Indian segment in U.S., grown our Hispanic international calling customer base to nearly 200,000 households, built an annualize revenue stream of over $10 million amongst Filipino's and a 45% of all of our customers making international calls.
While we have grown share in the Indian calling segment, our results in other segments have not progressed as quickly as we'd expected. During the third quarter, gross line additions from premium plans were roughly flat sequentially as gains in the Indian segment were offset by lower ads in Hispanic and other segments.
In the fourth quarter, we've implemented several initiatives to grow faster, including new advertising, enhanced distribution and limited time local events and promotions that pay sales agents in high-traffic temporary locations. We continue to make progress growing our retail and alternative sales channels. Our assisted selling initiative, in which we placed Vonage representatives in retail locations to engage directly with customers, continues to perform well.
In the third quarter, we increased the number of stores with assisted selling from 550 to 700, and saw an increase in gross line additions from this channel. Sales from our community teams also performed well and we're up over 9% from the prior quarter.
The Chief Generosity Officer, Advertising Campaign, has been working to drive increased awareness and perceptions of credibility and trustworthiness, in both the ILD and domestic calling segments. While we are pleased with the early creative results, we are testing ways to get similar effectiveness from television at lower cost. Our yield on television media simply isn't where it needs to be.
In addition, we are focused on improving the efficiency of our digital advertising. We have tested a broad array of tactics and are now focusing our efforts on consolidating our digital retargeting efforts, building on successful and prospecting tactics and optimizing our display activities.
In the fourth quarter, we are continuing to expand our distribution and assisted sales and community sales teams. Overall, we expect absolute marketing spend on our core business to decline in the fourth quarter, as we adjust our channel mix and improve our efficiency. Our marketing investment television and direct mail will decline, while we increase our use of digital media and search.
The second objective for our U.S. and Canada core business was to meet the needs of light used domestic home phone users with an aggressively priced service without cannibalizing the Vonage brand. After significant research in market testing and discussion with prospective partners, we launched the new flanker brand, BasicTalk, nationally in mid-May, results have been strong. BasicTalk is available in all of Wal-Mart's 3,700 stores nationwide and online through walmart.com and basictalk.com.
While the results are still early, customer satisfaction is high and the churn rates appear to be comfortable to the average of the Vonage customer base in the mid-twos. This is encouraging for our non-contract service. Importantly, we have seen very little cannibalization in the Vonage customer base.
Now, six months into the market, we've established BasicTalk as a high-quality trustworthy brand. Brand awareness is low relative to Vonage, but it is growing rapidly. We will continue to invest in BasicTalk during the fourth quarter. The spending levels will be below those of the third quarter, as SLACs decline on a path towards long-term target levels below 200 hours.
We tested a range of marketing tactics during the third quarter and are scaling the most successful. Aided by new advertising that focuses on the key brand attributes of believability and trustworthiness, along with an expected strong holiday season in retail. We expect BasicTalk to be a meaningful contributor to gross line additions in the fourth quarter.
The third objective outlined in early 2012, for our U.S. and Canada core business, which is to evaluate alternatives to enter the small and medium business market. We considered a range of market entry strategies over the past year and announced our agreement to acquire Vocalocity last month.
The Vocalocity acquisition, which is set to close in the next couple of weeks, provides us with an immediate and significant presence in the high growth SMB hosted VoIP market. For those of you, who weren't on our announcement call last month, Vocalocity is an industry-leading SaaS provider of cloud-based communications to small and medium businesses.
For the first half of 2013, the company grew revenues to $28 million, a 39% over the same period last year. The rate of growth is more than double that of Eight by Eight and comparable to that of RingCentral. Vocalocity also added nearly 500 more net new customers than Eight by Eight during the first six months of the year. Over the same period, revenue per customer per month was $229, an 8% increase over the prior year and more than 5x that of RingCentral.
The total small and medium business markets for voice service in North America is $15 billion and 32 million lines. Vocalocity has focused on companies with 20 or fewer employees, which represents more than 60% of the total market or roughly $9.5 billion in revenue. The opportunity for continued rapid growth in this segment is substantial, given that 85% of SMBs still purchase voice servers from traditional carriers at rates that are frequently 40% to 50% higher than those of Vocalocity.
Vocalocity and Vonage use similar SIP-based VoIP technology, presenting well-defined opportunities from meaningful synergies. An example is in the cost of telephony services, where Vonage has domestic termination rates are one-third of Vocalocity's. The use of technology to service customers is another area where we expect to realized meaningful efficiencies.
This acquisition also provides us with a unique opportunity to leverage our investment in the brand over the last decade to accelerate Vocalocity's growth. Vonage brand awareness among SMBs is nearly 80%, while aided awareness of Eight by Eight and RingCentral is less than 10%
In addition, since any consumer and SMB acquisition channels are similar, we anticipate that we will be able to reapply best practices and realize benefits of scale in our sales and marketing overtime. We planned to transition of Vocalocity brand to Vonage business solutions in the coming months.
Vocalocity also supports our strategy to expand internationally by enabling us to deliver services to SoHo and SMB markets abroad. We also expect that the investments Vonage has been making to build our mobile capability can be leveraged into the SMB market.
We were acquiring Vocalocity at a compelling transaction price relative to other leading hosted VoIP providers. We are purchasing Vocalocity at 2.4 times for last six months annualized revenue. This compares very favorably to Eight by Eight and RingCentral, which traded approximately 6.8 and 8.4 times revenue on the same basis respectively.
Vocalocity will operate as a line of business within Vonage, and will be laid by its experience CEO, Wain Kellum, and many of the members of its existing leadership team. Wain and his team will oversee Vonage business solutions encompassing everything Vocalocity is doing today, as well as the current business customers of Vonage. To be responsible for all of our future expansion plans in SMB, including evaluation of small office, home office customers or SoHo and largely untapped market opportunity that lies between the current Vonage business and Vocalocity's core SMB customer.
Our teams are hard at work preparing for the launch of the combined company. We planned to deliver tangible benefits to customers, prospects and partners immediately. We look forward to updating you on the progress of those launch initiatives on our fourth quarter earnings call. There is much works to do and our teams are excited and invigorated by the prospects ahead of us.
The second area of strategic emphasis has been mobile services. Since the launch of our patented extension feature in August of 2011, and our Vonage mobile app in February 2012, mobile use has grown rapidly among our customers, now representing 31% of all Vonage international calls in the third quarter.
Extensions, our mobile product for home phones subscribers has become a key feature for our customers. With nearly 800,000 customers having registered in extension, representing over 80% of our international callers, and more than 40% of extensions calls are been made over Wi-Fi hinting at an even larger opportunity for traditional mobile displacement.
A growing number of customers are purchasing second line extensions priced at $499, creating further stickiness and enhancing revenue. In the last 30 days, alone over 60% of all extensions owners were active generating 12 million calls and a 136 million minutes of use, clearly demonstrating the convenience and utility of the feature. That's an annual rate of over 1.6 billion international minutes, we've come along way.
Since launch in February of 2012, Vonage mobile app downloads have continued to grow as our features and quality have become more robust. Downloads, accelerated in the third quarter as a result of our April introduction of video calling. In the quarter, nearly 20% of our app calls on Vonage mobile were video calls. And the app continued to receive high ratings maintaining a 4.5 plus rating on iTunes, and a 4.2 plus in Google Play.
Over the next few weeks, we will add to the compelling future set, when we introduced the truly unique version of video voice mail. Vonage mobile will be the first over the top app to enable users to leave a video message instead of an audio VoIP voice mail on the fly, when a traditional voice call has gone unanswered. Nobody else does this.
The number of people leaving and listening to voice messages has declined dramatically over the past few years. Leaving a video message, instead of a traditional voice mail, allows users to breakthrough the voice mail in difference and experience important moments together, even if they can't speak at that moment.
Video voice mail gives users a reason to look forward to voice mail. On the heels of video voice mail, we will launch our patented international roaming feature, ReachMe Roaming. Allows users to save an high cost of roaming fees, when traveling internationally while still receiving inbound calls on there primary phone number, even if the caller is not using our app.
Mobile is also integral part of our growth strategies for small and medium business, as well as international expansion. We planned to leverage our existing platform and development expertise.
Looking into 2014, you would expect to see breakthrough services that create true alternatives to traditional wireless carriers for a certain segments. These offers will make use of second numbers and alternate identities on traditional mobile phones, as well as the enablement of other cloud based connected devices, such as Pads and iPods. A new world of MVNO is truly emerging.
The third area of strategic emphasis has been expansion internationally. Our first international partnership was signed with Globe Telecom in May of 2012. This partnership enabled Vonage to provide Filipinos with cost effective international calls at a fraction of the rate they were accustom to paying. That business is now in excess of $10 million on annualized revenues and growing.
Our second international expansion initiative, the launch of communication services in Brazil, through a joint venture with Datora was signed in February of this year and we're making good progress. The company has completed network testing, finalized plans to host to billing platform and as continue to build-out in experienced local management team with the recent hiring of a Chief Market Officer.
The company is on track for customer and production testing later in the fourth quarter and phased market entry targeted for early in the second quarter of 2014. We remain excited about the Brazil market and the substantial growth opportunity it presents.
In addition to Brazil, we are actually pursuing other international opportunities including partnerships in India and Mexico and are systematically analyzing additional opportunities. At the same time that we are developing innovative products, features and technology especially in the areas of mobile and call quality. We're successfully executing on our strategy to protect our valuable intellectual property.
Thus far in 2013, we have filed our 80 U.S. patented applications compared to 59 applications filed in 2012. And we've been granted 12 patents surprising the seven granted in all of 2012. We now, have 30 issued U.S. patents and more than 200 pending U.S. patented applications.
In summary, we're now at the halfway point of the three year growth plan that I outlined in early 2012. We've successfully pivoted from a strategic, operational and financial transformation, which resulted in a swing of nearly $200 million in EBITDA, dramatic reductions in line losses and churned, restructuring our balance sheet and the implementation of our stock repurchase program to the execution of our strategies for growth.
Now, 18 months into our growth plan we see that the core business remain stable. BasicTalk is enabling us to successfully attack the lower end domestic market and we're making continued progress in international expansion and mobile. With the acquisition of Vocalocity, we have all the right pieces in place.
As we build our detailed 2014 plans, we will be taking a dynamic approach to resource allocation and investment, focusing greatest energy and those initiatives that are generating the greatest risk adjusted return.
Thank you for joining us today. And now, let me hand the call over to Dave to review the details of our financials.
Thanks, Marc, and good morning everyone. I am pleased to review our financial results and provide you with an update on our outlook. Beginning on Slide 3, adjusted EBITDA was $23 million, down from $27 million sequentially reflecting our planned investments to build BasicTalk brand awareness. It's also reflects lower ARPU, which I will discuss in a moment, and $1 million lower net settlements to the company in the period, as we have benefited from the substantial one-time insurance settlement in the second quarter. Adjusted EBITDA was down from $34 million in the year ago quarter, consistent with our previously discussed plans to increase investments in strategic priorities.
I'd like to highlight, two new financial disclosures for this quarter, as we discuss EBITDA, the first relating to the acquisition of Vocalocity. In the third quarter, we incurred one-time cost of $680,000 associated with the Vocalocity acquisition, mostly relating to professional fees. These costs are included in SG&A, but have been excluded from the calculation of adjusted EBITDA in order to maintain period-to-period comparability. We anticipated additional transaction related costs in the fourth quarter, related to the closing of this acquisition.
The second disclosure relates to our joint venture in Brazil, in which Vonage has a controlling interest, and therefore reports on a consolidated basis. Beginning in the third quarter we're reporting on our income statement and add-back of net loss attributable to non-controlling interest, reflecting the interest in this venture owned by our JV partner. For the third quarter this item was $222,000. For the same comparability reasons this item is also excluded from adjusted EBITDA.
Looking to Slide 4. GAAP net income was $4 million or $0.02 per share, down from $7 million or $0.04 per share sequentially. GAAP net income was down from $13 million or $0.06 per share in the year ago quarter. Net income excluding adjustments with $9 million or $0.04 per share, down sequentially from $12 million and $0.06 per share and down also from $21 million or $0.09 per share in the year ago quarter. As with EBITDA, the reduction in net income reflects our planned investments and growth priorities.
Moving to Slide 5. Revenue was $204 million, down $1 million sequentially, primarily driven by the decline in our number of domestic callers on premium plans, partially offset by growth in customers on BasicTalk and lower price retention plans. Revenue decline from $208 million the year ago, due to prior period line losses in the same plan effects.
ARPU was $28.87, down from $29.06 sequentially and $29.31 in the prior year quarter primarily due to the addition of customers of lower priced rate plans, including the impact of incremental volume from BasicTalk.
Moving to Slide 6, we continue to execute on our structural cost reduction programs and further reduce cost of telephony services or COTS and customer care cost per line. We reduced COTS to $53 million from $55 million a year ago, primarily due to lower domestic termination and interconnection cost, which declined by 16% and 39% respectively. COTS declined from $54 million sequentially.
Continued reductions in this key line item have more than offset the effect of customer plan changes on ARPU, resulting in stable direct margin sequentially and an increase in direct margins to 69% compared to 68% in the prior year. Cost per line was $7.48, down from $7.60 sequentially from $7.80 in the third quarter of last year.
I'd like to take a moment to provide an update on our numbering rights trial. In April, the FCC proposed changing its rules to allow VoIP providers to directly access telephone numbers. They granted us authority to do a trial for about 225,000 telephone numbers. In June, the FCC approved our plan for the trial. The purpose of the trial is to demonstrate the absence of technical issues with VoIP providers having direct access to telephone numbers, including issues regarding call routing, local number portability and intercarrier compensation.
After the internal testing phases of the trial, we have started to serve customers with directly-held numbers at the beginning of October in two markets, and have now transitioned all of our customers in these markets to Vonage numbers. Trial, which runs through December, is running smoothly with no significant technical issues thus far in these markets.
If the FCC adopts the proposed rules and allow VoIP providers like Vonage to have direct access to their own telephone numbers, it will facilitate the shift to direct IP-to-IP interconnection, and enable potential long-term structural cost savings for us in the double-digit millions of dollars over the subsequent two to three years.
Moving to Slide 7. Selling, general and administrative expense for the third quarter was $65 million. This is up $4 million form the second quarter, where we recorded the $2 million insurance claim reimbursement I referred to earlier. Incremental $2 million increase in SG&A over the prior quarter was primarily due to expansion, the number of stores in which we provide assisted selling and Vocalocity acquisition expenses, offset in part by $1 million insurance reimbursement associated with Hurricane Sandy.
SG&A increased $5 million over the prior year, also due to the same assisted sales expansion. This year-over-year increase was partially offset by a 14% decline in customer care cost per line, reflecting continued service quality improvements, operating efficiencies and improvements in average handle time. Average handle time declined 7% from a year ago to 677 seconds. The first call resolution improved 1.7 percentage points from a year ago to 80.3%.
Moving to Slide 8. Marketing expense was $59 million, up from $58 million sequentially and $51 million a year ago, reflecting planned investments and growth priorities, including BasicTalk. Subscriber line acquisition cost was flat, decreased to $339 from $375 sequentially, as we began to realize efficiencies in BasicTalk acquisition cost.
SLAC increased from $299 a year ago, partially due to our launch investment in BasicTalk. We expect to continue to reduce BasicTalk SLAC over time as we progress from the early product launch phase to steady state efficiency levels as Marc referenced.
Turing to Slide 9. Gross line additions or GLAs were 175,000, up from 155,000 sequentially, reflecting a full quarter of BasicTalk line additions, and up from 172,000 in the prior year's quarter. Customer churn was 2.6%, up from 2.4% sequentially, primarily due to three factors; the implementation of targeted pricing actions; early-life churn associated with higher GLAs; and seasonally higher non-pay churn.
Churn was up from 2.5% in the year ago quarter. Higher gross line additions more than offset the uptick in churn, resulting in 11,000 net line additions in the quarter and our second consecutive quarter of growth in net lines.
I'll now move to a discussion of CapEx, cash flow and the balance sheet on Slide 10. For the quarter, CapEx, including the acquisition in developmental software assets, was $4 million, primarily for network infrastructure and systems improvements. This is down from $8 million sequentially and up from $1 million in the year ago quarter. Sequential decline is due to several larger projects having been completed in the second quarter.
Free cash flow was $20 million, up from $11 million sequentially, due in part to positive changes in working capital from the timing of payments in the lower capital expenditures and up from $17 million in year ago quarter, primarily due to changes in working capital. Reflecting the strength of our core business cash flow generation, cash and cash equivalents as of September 30 were $104 million, including $4 million in restricted cash.
We ended the quarter with strong balance sheet reflected in total leverage to adjusted EBITDA of 0.6x and with net cash of $34 million. We continued our balanced approach to capital allocation, repurchasing 5 million shares for $15 million during the quarter. This is up from $13 million in the prior quarter.
At the end of the third quarter, we have repurchased 39 million of our current $100 million authorization. Since beginning our buyback in August 2012, we have repurchased 28 million shares for $72 million. We will continue to execute against our $100 million buyback authorization, which funds through the end of 2014.
In October, we announced our agreement to acquire Vocalocity for an $130 million. Under the terms of the agreement, Vocalocity shareholders will $105 million in cash and $25 million in Vonage common stock. Stock component of the transaction and consideration equates to approximately 8 million shares or 3.5% of fully diluted Vonage shares.
We are financing a cash portion of the transaction, the $30 million of cash from the balance sheet and $75 million from our low cost revolving credit facility. Post-close, we will have $74 million of cash, including $4 restricted, gross leverage of 1.2x and net leverage of 0.6x EBITDA, using September's financial data.
After the close of the Vocalocity acquisition, which we expect in mid-November, we will report consolidated financial results for the two company's combined, as of the date of the acquisition. As a result, early report fourth quarter results, they will include only a partial quarter of Vocalocity's operations and reflect impacts from GAAP purchase accounting rule.
These impacts include additional amortization for intangible assets, integration expenses and the one-time exclusion of a portion of Vocalocity's deferred revenue. This latter point will result in a one-time reduction to Vocalocity's reported revenue and cash flow in the fourth quarter, under Vonage's ownership and cause Vocalocity's EBITDA contribution to be negative.
I'll now discuss the outlook for the quarter. For the fourth quarter, excluding Vocalocity, we expect revenue and churn to be stable and adjusted EBITDA to be modestly higher compared to the third quarter. We also expect to report positive net lines for the quarter. As we stated at the end of the second quarter, we expect CapEx to come in below our original guidance of $30 million for 2013.
Net working capital is expected to be positive in the fourth quarter leading to sequentially higher free cash flow, again excluding the effects of Vocalocity. As in prior years, we will provide our outlook for 2014, when we report fourth quarter results in February.
As we have discussed previously, profitable long-term revenue growth remains our top priority, and we believe we have the right assets and team to execute our strategy. We will continue to monitor performance of our growth portfolio and direct investment dollars to the most compelling initiatives. Thank you for your continued support at Vonage.
I will now turn the call back over to Leslie, to initiate the Q&A session.
Thank you, Dave. Operator, please open the line for questions.
(Operator Instructions) Our first question comes from the line of Greg Burns from Sidoti & Company.
Greg Burns - Sidoti & Company
Just a couple of questions around BasicTalk. Could you kind of talk to the linearity that you saw in terms of subscriber growth throughout the quarter? And then also if you've seen any competitive response since you brought that service to market?
So as you know, we actually launched BasicTalk in a direct mail format to those customers that had left Vonage historically or folks who have broken out of the purchase process as part of our trial markets going back as much as a year. We launched nationally with advertising and distribution in mid-May of this past year.
We have seen continuing growth quarter-over-quarter, as you'd expect, and it's accelerated week-over-week. In the most recent weeks, we've seen that flattened a bit as we've got full distribution through Wal-Mart and/or through the initial phase of heavy merchandizing. We do expect some additional merchandizing behind BasicTalk and Wal-Mart coming into the holidays, and the holidays for our retail stores, we expect to get some uplift.
In addition, we have been testing a number of other vehicles to optimize BasicTalk sales that includes a number of different ways to get into direct households from [ph] FSIs as well as other formations. Some of those tests that worked quite well for us. We're in the process of aggressively expanding those nationally in the fourth quarter.
So we're bullish on the long-term prospects for BasicTalk. And as you might expect, one of the key drivers on this business is to evaluate what the right distribution mix is and Wal-Mart has been a great partner for us. We are also looking at how we might expand distribution and improve our self-service capabilities online.
So as we look through 2014, we feel very good about the overall contribution of BasicTalk and the efficiency of the BasicTalk business. Keep in mind we only have aided awareness in the mid-20s of percentages compared to awareness of Vonage in the 80s. We still believe that launching it as a separate brand was critical to avoid cannibalization and that has been the case. We've not seen that. So we're effectively competing at the low end.
We did see initially some competitive response for magicJack and other players at the low end, who changed and rollback some pricing on devices. But we feel like that is largely stabilized at this point in time, we haven't seen additional aggressive activity. So we feel like we're progressing well in the current pricing environment.
Greg Burns - Sidoti & Company
And then in terms of mobile, can you speak to the adoption rates? Are they still kind of below what you have been looking for? And what you need to do to kind of get that viral adoption of the platform?
It's a good question. Relative to the overall expectations, we first launched for the free mobile clients, our downloads are less than we would have expected. We are still in the mid-to-high-single digit millions of downloads. We are seeing solid international usage on those downloads, but obviously scale matters. So we would have like to seen larger numbers at this point in time.
Now keep in mind, mobile lens through which we look at all of our initiatives, the Vonage mobile extensions product has been ragingly successful and a lot of people have actually shifted their usage from their homes and business phones on to the mobile platform.
When we think about our allocations of revenues to mobile, we don't allocate the number of minutes being used on those services. And we are getting incremental revenue on second line extensions that are being sold into the base. As we look at churn levels on customers that are using extensions, we see that to be quite a bit lower and it's also allowed us to take targeted price increases with very modest impacts on churns.
So while mobile's investment spends probably a little bit more transparent, some of the benefits hit our business in many different areas. It's also a core element to our expansion internationally. And we think it will be leverageable in the SMB market with Vocalocity. We've got some plans for mobile client enhancement for Vocalocity shortly after our day one launch.
So I guess in short, relative to the original ongoing assumption, we would have liked to seeing larger viral spread to the point of what will it take to do more. I think it comes to the point of being first and differentiating on a meaningful consumer attribute. We think that the world is quickly moving to some mobile carrier displacement, it goes beyond SMS. It goes to this notion of a Wi-Fi or Wi-Phone based service with a wide area network as a compliment for certain sub-segments.
We think about it as a software virtual network operator, a form of an MBNL, if you will. And we think that for anything from university students to first phones, for youth and integrating this with iPads and any other kind of existing device, an iPod or dead phone that exists and integrating the home service to business service with any number of broadband connected devices is where the market is going and we've got some exciting things for 2014 in that area. I think that combined with some of the features I mentioned during my comments, has the potential to get a significant stimulation.
Greg Burns - Sidoti & Company
I understand, having the features saying the lot, the roadmap you have, they are seemingly pretty exciting, stuff on the horizon to be rolled out, but if no one knows about it, it doesn't do much good. So if you feel like you need to increase marketing around the mobile platform in the future or is it just not the developmental stage yet where it justifies that incremental investment?
As you look at those folks who have gotten viral scale, much of it is referral based. We very much believe in -- can we take a look at the folks who are driving the largest level of downloads and subscription. Many of them are still unprofitable underwater. We're not in the business to drive something, it's going to be patently unprofitable.
We expect that our investment and we've done this thinking about the whole lens is our mobile teams and the development expense we spend must drive benefit for our core businesses, our international business and have a revenue option even in the free downloadable marketplace. So we look at this potentially a little bit differently then some of the venture-funded businesses that we believe are largely trying to build the community regardless, if with there profit outlook is and try to get acquired for that network effect.
We're in the business of really building functionality that people will use that has an opportunity to drive revenues going forward. As we see that revenue opportunity we will invest behind it, but my personal believe and I know that of our marketing and mobile teams, is that the client itself needs to very much be the sales force.
So as you build unique functionality and as you improve, and we do have opportunities for improvement, the referral nature and the ability to recommended and invite friends and the social aspects of the client itself, that's was required in order to really drive rapid spread and downloaded the application. So we are working that as well.
Greg Burns - Sidoti & Company
Just lastly, I saw Straight Path file a lawsuit. Is there any color or commentary you could give us around that?
So what I'll tell you is we have not actually seen the actual complaint that Straight Path has filed. We are aware of Straight Path. We know the suits that they have filed against some other companies that are in the VoIP space. Straight Path is what is called a non-practicing entity, often called the troll. We have had, this is kind of a routine portion of our business, and we have successfully fought many of these kinds of suits over the last several years.
As soon as we get more information about the specifics of the infringement complaint, then we can comment more specifically. But we successfully defended ourselves against many of these and we're going to vigorously defend ourselves in this case. We also have a host of patterns of our own that will need to be evaluated in terms of their utility as well. Unfortunately, lawsuits like this from non-practicing entities have become pretty common place, which is why they are so much focus on patent reform in Washington.
Our next question comes from the line of Michael Rollins from Citi Investment Research.
Michael Rollins - Citi Investment Research
Just a clarification and then a broader question. On the clarification, Marc, I think you were describing earlier the idea of getting the lack down for the BasicTalk to below $200, if I heard you right. Does that include subsidy on the device or is that a separate number that you have to add to that?
We think about that in total acquisition cost, but keep in mind, we've re-engineered our device. So it is a very inexpensive in the $12 to $14 range.
Michael Rollins - Citi Investment Research
So that would be within that $200?
Correct. We're targeting below $200, but at the $200 level we include the device as well.
Michael Rollins - Citi Investment Research
And then just more broadly. So as you're thinking about the growth opportunities in the SMB segment, either before or since announcing the Vocalocity acquisition. Has the board thought a little bit more about the allocation of capital? And whether there could be a greater return earned for shareholders by maybe slowing the buyback and putting more money into, whether it's more scale or someone before was asking about the marketing? Have there been elements of consideration, just in terms of capital allocation, around this expanded strategy in the SMB segment?
Obviously, every time we have a major new initiative consistent with the original growth priorities, we have to make choices about how we allocate resources. It was actually at your conference, year and a half ago, when I spoke to you and you ask me about small-medium business.
At that point, we were still deciding, whether we were going to build on our own or consider acquiring and I kept it pretty open-ended. We have evaluated number of different acquisitions over the past year. We concluded that was the best message to marketplace and we're really excited about the potential of Vocalocity.
At our board meeting, the week before last, we actually did have significant conversation about how big do we think that business could be and it is one that obviously has relatively low awareness, but has a service set or feature set that is ready now, that continues to grow. And so when you look at the risk profile of investing in that business versus some of the other businesses, you have to look hard and trying to accelerate that business as fast as possible.
I think we're, to not to be crass, but a little bit in a land grab phase in that business. And we bought this to grow it and have a long-term aspiration to be a number one provider of business solutions in this SMB marketplace. We do not have any intention of changing our share repurchase program. We fully intend to retire that as expected in the timeframe we've outlined.
However with the cash that we do have available, and the flexibility, which is substantial in our own operating business, we will evaluate once we put the teams together and review the plans with Wain and his team and decide what kind of fuel, we think we can put on that fire and if we believe that we can drive revenues with the better return their versus other alternatives we would do that.
The company's goal is to be the provider of cloud-based connected devices for consumers and businesses. So connecting people across multiple device is squarely inside of our strategy, and management's job is to dynamically reallocate resources. So you can expect to see that in 2014.
Michael Rollins - Citi Investment Research
Last question. Looking at this SMB segment, how do you look at the broadband component of this? The offer that you have or say what Vocalocity has, I guess you could summarize it's like a BYOB, bring your own broadband kind of model it seems. Do you think that's still the best way to go? Do you think that there is ways of trying to partner or being an agent for broadband to make sure that the customer gets the right experience with the products that you're providing, just any thoughts on to that?
You're right, it is primarily you bring your own broadband solution to date. Most of the companies do have broadband, but the quality that broadband varies, so we certainly get at Vocalocity, as I understand it from the team, request for that kind of service. The question becomes one of, can you actually do it in a way that is of quality, that gets you the right kind of financial return and is that really required, given the upside in the marketplace for the core services that exists today.
I don't have an opinion one way or another at this point in time. Post-closing, I'll engage with the Vocalocity team and get their perspective on the subject. There are a lot of people who wholesale broadband, so I think that's a fairly competitive marketplace. I'm not sure there is tremendous margin.
I think the real question becomes one of, does that really facilitate increased penetration and is that across to doing business to accelerate revenues on the core services for which Vocalocity is differentiated. So ask me that question again in February, and I'll give you a more specific personal point of view.
Our next question comes from the line of Bill Dezellem from Tieton Capital.
Bill Dezellem - Tieton Capital
I have a group of questions. First of all, with the investments that you're making to build business, clearly that is having a negative impact on profitability right now which, as you've made very clear it's not your long-term intention. When are you anticipating that we hit that inflection point when the benefits from these investments are no longer are a drag, and in fact, benefit to the business?
First, I want to make sure that as folks are, where the people confuse some of the items. We've certainly seen some ARPU pressure in our business, so that's touch revenue to some extent. We've more than offset that ARPU impact with reduction in cost, primarily in cost.
So we are engineering our business to deal with the pricing compression we see and some of the old premium domestic services, which we considered it will ongoing be a drag, that's the nature of the business that we've got as part of our legacy. And we are building new revenue stream on top of that as we speak.
As we speak to the investments that we're making quarterly this year, as we've talked before, we fully expect that those investments will generate revenues, and certain investments are largely marketing and staff to build out new products and services in 2015. So 2014, you should think about as kind of stable ongoing investment.
The real question becomes one of, as we see additional opportunities for growth in 2015, do we continue to invest? And our philosophy is, we're building this company for long-term profitable revenue growth. And if we can fund that revenue growth at a good return on our customer acquisition investment, we'll continue to do that.
So I don't want to set an expectation. You're going to see some turning off of investment, as we turn the page to calendar 2015, and magically increase EBITDA by $15 million or $20 million a quarter. That could happen, we certainly have the capacity for that, because we spent so much in sales and marketing expense. But we'll be evaluating our approach, largely based on are we getting a reasonable return. We use to expect to see all things being equal improvements in 2015, as the investments for which we're paying today, get a small material revenues.
Bill Dezellem - Tieton Capital
And then two additional questions. First of all, net line addition. You talked that you are expecting those to continue to be favorable. What are you looking for in terms of level relative to where we're at now? Meaning, are you expecting an increase or it to hold steady at the current net line addition rate?
No, we're only five weeks into the quarter, just too early for us to know that with the holiday season, given that we're 11,000 net. That can be made or broken around those numbers with too much of the quarter to go. So it's difficult for me to give you any additional guidance versus what I've already shared.
Bill Dezellem - Tieton Capital
Let me do a follow-up, it might be more difficult to answer than that one even. And over the course of the next year, where would you like to see that number move to?
Well, I'd like to see that number move to dramatic net adds and I have great confidence that with Vocalocity's addition, even beyond their run rate and our ability to accelerate their growth by some of the things, we think we can do under the Vonage brand. I think you should expect that 2015 with the combined companies will be material net adds for the year 2014.
Bill Dezellem - Tieton Capital
And then, income statement question. I don't think this was addressed that the tax rate moved up approximately 10 percentage points to nearly 49%. Would you discuss the dynamics there, please?
It was mainly due to losses in U.K. and Brazil. And so these are one-time items related to our foreign entities.
Our next question comes from the line of Greg Burns from Sidoti & Company.
Greg Burns - Sidoti & Company
Just wanted to follow up on, how the model going forward? In terms of how you're going to be reporting your subscriber statistics? Will you be breaking out Vocalocity from your kind of core business, as you've been reporting historically or is it going to all be reported in one consolidated number?
Greg, we would expect to report it on a consolidated basis. As we do today, we give certain KPIs, which give specifics around our business and we would expect to do that, but generally we expect to report it on a consolidated basis. And I would just note as we said in our script that Vonage Business Solutions will actually have what Vocalocity is doing today, but also what Vonage is doing today in business. So there is going to be -- and then growth initiatives within the SMB business on top of that. So it's going to be some pretty significant mixing there and blending of lines, which is why we're choosing to report it that way.
And we'll provide key KPIs, so you'll be able to compare general performance with competitors, who also quite frankly has a different range of KPIs and information they are sharing even though they are considered peer player. So we'll try you give transparency around how we're performing relative to peers. But because of the numbers of moving parts internally and even some of the support infrastructure, it will be difficult to report that as an individual business in total P&L.
Thank you for joining us. With that, we'll conclude the call today.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.
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