Venture Global Inc (VG) 2006 Q2 法說會逐字稿

Good day and welcome to the Vonage Holdings Corporation Second Quarter 2006 Earnings Conference call. Today's conference is being recorded.

At this time I'd like to turn the conference over to Craig Streem, Senior Vice President of Investor Relations.

Mr. Streem please go ahead sir.

Thank you, Cecilia.

Good morning and welcome to our Second Quarter 2006 Conference Call, our first ever as a public company. Our call this morning will be lead by Jeff Citron, Vonage Founder, Chairman, and Chief Strategist, joined by Mike Snyder, CEO, and John Rego, CFO.

Jeff and Mike will begin by reviewing our accomplishments over the quarter and describe our current outlook. John will then discuss our second quarter results, and will describe the forward-looking performance metrics that we are establishing today. At the conclusion of prepared remarks, Jeff, Mike and John will be happy to take your questions.

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 necessarily depend on assumptions, data, or methods that may be incorrect or imprecise. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. More information about those risks and uncertainties is contained in Vonage's SEC filings. We caution listeners, not to rely unduly on forward-looking statements, and we disclaim any intent or obligation to update them.

Before we begin I also want to introduce [Leslie Arena] who joined us just yesterday as Director of Investor Relations from Comcast. I'm sure many of you have worked with Leslie in the past and we are delighted that she is with us.

And now I will turn the call over to Jeff for his opening remarks.

Thanks, Craig.

Good morning and thank you for joining us. Let me begin by saying that we are very pleased with our results this quarter, both in terms of the principle underlying trends, as well as the very meaningful improvement in our operating income.

Our results this quarter represent an important step along our path to profitability, and we believe demonstrates our ability to grow subscriber lines at a consistent level of marketing efficiency, and to achieve scale and benefit from our operating platform.

Our results this quarter clearly demonstrate the very real progress that we are making in our business. Our adjusted loss from operations which excludes the non-cash effects of depreciation and amortization and stock based compensation narrowed sharply to $60 million. We view this as an inflexion point on our path to profitability.

John and Mike will go through the operating and financial metrics, including guidance, in greater detail during their comments. And now we believe that our business model will lead us to positive adjusted operating income as early as the first quarter 2008.

Over the past 12 months we have added over one million net subscriber lines, and are very proud of reaching this milestone. In five-short years we commercialized an unproven technology and business model, pioneered a broadband telephony industry, and emerged as a leading provider in the US, with over 1.8 million lines in service today.

It's amazing to realize that it was just this past September that we reached the one million subscriber line level. We are now well on our way to hitting our second million mark. Testimony to the quality of our products and the value we deliver to our customers.

Our marketing investments, clearly, plays a critical role in our success in the market place. Through integrated marketing techniques and analytics, we have focused not only on acquiring and keeping customers, but also in building a world class brand.

Part of this growth is a function of the broadband and VoIP adoption trends seen in the marketplace. But beyond that our growth has been driven by our marketing and the exciting mix of products and services we offer.

Looking out to the second half of this year, the company is looking forward to launching a number of new revenue-generating products and features that enhance people's ability to communicate and simplify their lives, with the objective of enhancing Vonage's customer value proposition. We will continue to pursue our strategy of investing and marketing consistent with our goal of reaching profitability. We will likewise invest in research and development, and strategic partnerships to drive continued growth and to build long-term shareholder value.

We are excited about the -- by the tremendous opportunities ahead of us, and look forward to updating you over time.

And with that I'll turn the call over to Mike.

Well thanks Jeff, good morning everyone. Jeff noted that we anticipate generating positive adjusted operating income as early as the first quarter 2008. And I want to focus my comments on the principle building blocks for that achievement. That is delivering value to our customers and achieving operational excellence. These are simple concepts but they're fundamental to our success. And you'll continue to hear us focus on these over time as we update you on our performance.

Now to start, the second quarter of 2006 was a period of strong competition, particularly from the cable companies. Even with this, Vonage did quite well, adding 377,000 gross subscriber lines, our second-highest quarter ever and 44% above last year's performance. At the same time our marketing class for gross addition remained relatively flat at $239, up about 1% from the same period in 2005.

Now, on a net basis, we added over 255,000 new subscriber lines in the quarter. That was our second-highest production of net additions in the history of Vonage, the impact of subscriber line additions and stable average revenue per user, or ARPU, produced revenues that more than doubled year-over-year to $143 million.

Lastly, benefiting from the increased revenues and a quarter in which the scale-end of the business accelerated, Vonage sharply narrowed our non-GAAP adjusted loss from operations to $60 million from $73 million in the first quarter.

Now, our success in this highly competitive environment is based on the investment we've made in our brand, it's also based on a national distribution platform, and most importantly the compelling value we deliver to our customers. Our record customer acquisition performance for the first half of this year was driven by our advertising and brand building efforts and we will continue to make tactical adjustments to ensure the efficiency of those programs.

Now that's been a very effective approach for us. With marketing costs per gross ad in the second quarter only slightly higher than a year ago, but producing a 44% increase in gross subscriber line additions. We'll continue to follow our strategy of using diversified customer acquisition channels, which include direct response television, direct mail, retail, and of course the Internet.

Now, our sponsorship activities also play an important part in this and in the second quarter we had great success with events like the World Cup, The Preakness Stakes, the Tribeca Film Festival, and the WNBA All-Star game among others.

As we've look to the second half of the year, we'll expand these sponsorships to enhance our brand building, and reach in the key in critical demographics.

And next, in terms of incremental distribution, we launched a relationship with Walmart this quarter, which not only gives us significant incremental distribution, but enhances our potential for penetrating the mainstream market.

Another positive for us this quarter was the introduction of free International calling to five major European countries for our Premium Unlimited Plan. These customers can now call any land-line number in the UK, France, Italy, Ireland, and Spain at no additional cost. And our strategy is to use the value of this feature to migrate customers up from basic plans to unlimited plan.

Now, not everything this quarter was perfect. Our most significant challenge has been churn which was unacceptably high. Looking back, the primary cause was six months of unprecedented growth, where we added approximately 800,000 gross lines causing a great deal of strain on our customer care.

Now, that strain affected our key service metrics, including call abandonment rates, average speed-of-answer rates, first call resolution, and overall customer satisfaction.

Now in addition, when we experience rapid growth, such as we did in the first half of the year, the average customer life of the base is shortened, because churn is always higher among customers in the first six months of tenure. If we were to dis-aggregate churn by tenure, you would see that the average customer life is now close to five years.

Now still, improving our performance in customer care is the single most important priority before us. We implemented a comprehensive plan to improve our performance beginning with new leadership in customer care, and going on in changes in work flow, staffing, training, and quality assurance.

We began implementation of this plan late in the second quarter. We will continue to work on improving customer service over the second half of this year, and we have already begun to see measurable improvement the month of July. However, please understand that improvements in churn will lag improvements in customer care statistics.

We believe that we have the right plan in place and we are committed to executing that plan. Given the time to see these improvements take hold, we expect churn to increase slightly before we start to see improvements.

Now, before I turn the call over to John, I want to mention additional highlights for the quarter. First, we strengthened our management team with the recruitment of key executives with proven experience. Second, we launched the Vonage V-Phone, one of the most exciting and innovative products our industry has seen.

And third, for the first time in our company's history our results this quarter clearly demonstrate the benefits of achieving scale and operating leverage along with the great rates of growth you've come to expect from us. As a management team we are excited and energized by the improvement in our results this quarter, and more importantly by the visibility we have in some favorable trends in cash flow and operating profit.

Now I'd like to move on to John Reno.

Thank you Mike. And good morning everyone.

Today I'm going to review our results for the quarter, and focus on the key drivers of our performance. I'll also spend some time walking through the financial statements in order to help you understand the factors behind the improvement in our business. And lastly, I'll take you through some metrics that you will be able to use as guidance going forward.

On a GAAP basis, our net loss was $74 million, an improvement of $11 million, or 13% from the first quarter. Over the same time period, our loss adjusted for FASB 123(R) as well as depreciation and amortization with $60 million compared to a $73 million loss in the first quarter of this year. This reflects an improvement of $13 million or 18% from the first quarter, and $3 million or 5% better than the $63 million loss in last year's second quarter.

For the first time in the company's history, our adjusted operating loss has narrowed on both the sequential quarter, and the year-over-year basis. And we are now starting to achieve the benefits of scale and operating leverage that will allow us to project adjusted operating profits as early as the first quarter of 2008.

Vonage achieve record revenues of $143 million in the quarter, a 141% increase from $59 million in the year ago quarter. Driving this success was growing our subscriber lines to over 1.8 million, coupled with an increase in ARPU, to $27.70 from $26.63 in last year's second quarter.

This quarter we added over 377,000 new gross lines, an increase of 44% from the 262,000 gross lines added in last year's quarter. On a net basis, we added 256,000 new lines versus 208,000 in last year's quarter, an increase of about 23%.

Our line additions in the second quarter represented the second best quarterly performance in the company's history. In all we added approximately 800,000 gross lines over the first six months, more than in any six month period in our history.

Driving the sales increases was our investment in marketing, which totaled $90 million in the quarter. Up 46% from the $62 million in last year's quarter, with a per line acquisition cost of $239.00, relatively unchanged from the prior year.

The second factor in our revenue growth was the improvement in ARPU, which came in at $27.70 for the quarter, more than one dollar higher than in the year ago quarter. This reflects success in shifting our plan mix towards a greater proportion of our new customers to premium calling plans.

Additionally we did not experience any downward pricing pressure on ARPU levels, and this reflects six quarters in which our ARPU has remained relatively stable or has grown.

Now I'd like to focus your attention on direct margin, which is defined as operating revenue less direct costs. Our margin, for the second quarter of this year, grew to 62%, our highest ever. And that was up from 55% a year ago. The two elements of direct cost are the cost of telephony services, and the cost of goods sold.

Cost of telephony services, principally represents the cost of operating our network, and connecting calls to and from the public switch telephone network. The cost of telephony services in the second quarter was $39 million, up 120% from $18 million in the year ago quarter.

Driving the increase in total dollars was the build-out of our national E911 network, and growth. At the same time, the cost-per-subscriber line as a percent of revenue, decreased to 27% from 30% in last year's quarter. The decline resulted from operating efficiency, and the addition of new partners which has allowed us to diversify, and optimize our traffic flows.

Cost of goods sold, principally represents the cost of custom premises equipment, installation, provisioning, and shipping. It is important to note that Vonage generally does not pass on to our customers the total cost of equipment.

For the second quarter the CPE subsidy per new line was $24.68 down 12% from $28.00 a year ago. Driving this improvement was the availability of premium equipment and the impact of our relationships with key providers including Motorola, Texas Instruments, and Broadcom. In periods of high growth, such as the first and second quarters of this year, the CPE subsidy can negatively impact our margins.

SG&A expense, which primarily consists of compensation and benefits, stock based compensation, corporate overhead, and research and development, was $66 million in the quarter versus $33 million in last year's second quarter. While higher in dollar terms, SG&A has declined to 46% of revenue versus 56% of revenue in the year ago quarter.

Now we expect our investment in R&D and customer care to pay financial dividends in the future through the introduction of new products and features, and through a reduced cost to service our customers.

Stock based compensation expense better known as FAS 123(R), was $8 million in the second quarter, and accounted for about 25% of the year- over-year increase in SG&A. Driving our success in bringing down SG&A, as a percentage of revenue, has been the positive impact of operating leverage and scale. Interest income for the quarter was $4 million, roughly three times the level in last year's second quarter. This increase was attributable to the cash and cash equivalents generated through our $250 million convertible note offering in December 2005, and of course our IPO which generated net proceeds of $496 million.

Interest expense for the quarter was $4.5 million, primarily attributable to our convertible notes. The convertible notes total $253.4 million at June 30th, 2006.

Our GAAP basis net loss for the quarter was $74 million, or $1.16 per share, based on 63,995,000 weighted average shares for the second quarter. Prospectively, we estimate that weighted average shares outstanding for EPS purposes in the third quarter, and for the nine- month's end at September 30th, 2006, will be approximately 155 million shares, and 74 million shares respectively.

Turning to the balance sheet, our cash and cash equivalents position at June 30th, 2006 was $598 million, which reflects the net proceeds of our IPO.

During the second quarter, we utilized $44 million to fund our operations, $11 million to fund capital expenditures, and $12 million to fund the purchase of treasury stock.

Now, looking at the quarter it was clearly one where we reached a turning point in our business. The company continued to execute on its business plan and continues to achieve key milestones along the path to profitability. The benefits of growth, as well as leverage from operations created by a business strategy based on scale are certainly apparent from our performance.

And finally, our SG&A as a percentage of revenue has shown significant improvement with over half SG&A costs now reaching levels that will be relatively fixed in nature.

Now I'd like to reiterate the guidance that we provided in our press release. We expect to generate adjusted operating income, as early as the first quarter of 2008. We expect to have between 2.3 and 2.45 million subscriber lines by year-end 2006. We anticipate revenues for the year in the range of $600 to 615 million. We reaffirm marketing spend for this year at $360 to 380 million dollars. We anticipate direct margins for the second half of the year between 62% and 65%.

And finally, we project adjusted SG&A for the balance of the year at 39% to 41%. We believe that meeting these targets for 2006 will result in overall improvements in operating leverage and continued progress toward our goal of bottom line profits.

And now we would be very pleased to take your questions.

Thank you.

[OPERATOR INSTRUCTIONS]

And we'll go first to Clay Moran with the Stanford Group.

Thank you, good morning.

Good morning Clay.

A couple questions, can you give us an idea of what you're assuming for the price of the Unlimited Plan and direct margin in the first quarter of 2008? And could you also talk about what's driving SG&A here in the second half of the year? I understand as a percent of revenue it's stabilizing, but on an absolute-basis it looks to be going up pretty rapidly. Can you talk about those things? Thanks.

Sure Clay. As regards to pricing in 2008, well we're not prepared to give any forward on pricing changes. Our assumptions that we've used in terms of guiding towards adjusted operating income for Q1 '08, would represent no changes to our $24.99 Unlimited Plan.

With regards to SG&A, I'll ask John to comment on that.

Yes, with SG&A Clay, clearly in absolute dollars the figures are going up, but again as a percentage of revenue as we see the leverage and scale come into the business, that number is coming down and it's coming down rather consistently.

So is it the customer service that's adding to an absolute basis? Is that one of the things that's driving it?

Yes, Clay, we got in through Mike Snyder's portion of the call that he's making investments now in customer care, and in research and development to help us to offer a better service and serve our customers better. So I think that's clear.

Okay, can you also just give us the CapEx for the quarter and the working capital at the end of the quarter? Thank you.

Yes, CapEx for the quarter Clay was roughly $11 million, and the working capital, we'll have to follow up with you.

Okay.

And our next question comes from James Breen with Thomas Wiesel.

Good morning, guys. Just had a couple of questions, one on the wholesale side of the picture, meaning the people you use that directly connect to PSTN, can you talk about the pricing environment there? And also can you just talk about the competitive environment with some of the other -- you know, SunRocket and the effect that the Skype has potentially had on the business over the last quarter? Thanks.

Sure. In terms of the cost of the carrier relations I think one thing that we've demonstrated in the cost of telephony service is our ability to clearly bring that number down as a percentage of revenue. Mainly driving those factors, really, is our ability to continue to add additional partners given our size and scale, and then to optimize the traffic mix. Even at the same time while occurring additional costs for the national build-out of our E911 network.

In terms of wholesale pricing, we've seen nothing but favorable trends or stability along most of our terminating routes and for interconnection services.

The second half of the question as it relates to competition, we really haven't felt an impact on the players like Sun Rocket. As it related to Skype and a couple of other players, frankly our market is land-line replacement and they don't have a directly competing profit -- product, excuse me. So it really has not an impact on our business nor do we envision one moving slightly forward.

Okay thank you.

Thank you, James.

Our next question comes from [Todd Rethemeier] at [Solay Securities].

Thanks. Good morning everybody, one quick housekeeping, the 911 cost-recovery fee, is that a pass-through that you pay on as a tax to the government, or is that just to recover your own costs?

And then the second question, you've been doing this for several years now, have you seen -- do we have enough data to suggest that there's any seasonality in either gross adds or disconnects that maybe summer quarters are a little higher? Is that the case?

Sure, I'll take the first part of the question. With regard to the E911, just for -- to be very clear on the housekeeping item, there are really two E911 fees that could appear on a customer bill. One is our pass-through charge that is levied by a municipality or by a state, and that does not show up in our revenue figures.

And the other one, that I think you're referring to, is the 911 cost- recovery fee, and in that case that is an item that is in our revenue, and of course has associated expenses with it.

With regards to the second item --.

Yes, we do believe that there is certain amount of seasonality in -- built into the business. You certainly saw that, we believe, in our cost per gross addition and our slack in the second quarter, and to a very small degree, our churn. And so, yes, I believe there is a degree, you will see it in the business.

Okay thanks.

Thank you, Todd.

[OPERATOR INSTRUCTIONS].

And we'll go next to [Munjal Shaw] with Piper Jaffray.

Hey guys, this is Munjal for Troy Jensen. A couple of questions on subscriber additions, in terms of seasonality, you mentioned that you do see some seasonality in the summer months, do you expect any kind of back-to-school seasonality that could favor you?

And if you could tell us what kind of -- if there is a lag between marketing and advertising spend or campaign, and subscribe -- if you could give us more color as to how that correlates with the subscriber additions? And is there a sublevel that you're targeting for Q1, 2008 profitably?

Hello Munjal, so you've got three questions there.

I'm going to start on the -- giving a little more feedback on the seasonality. I think if you look back on our business over the past few years, there's certain areas where we feel comfortable about the seasonal trends. Particularly the changes between the Q1 and Q2 environment, which typically we see it more difficult to acquire customers and an up-tick in churn. With regards to seasonality around back-to-school period, I don't think we have enough data to really draw permanent conclusions.

On the second question, regarding if there's a lag between when we spend marketing dollars and when we would see cost results, absolutely. In any business where you go out and you have advertisement, while you will get some initial response right away that response might lag. The lag in the response vehicle is really dependant on the different medium types. TVs lag is relatively short, print's lag is relatively longer, direct mail probably one of the longest lags you will experience.

And with regards to 2008 profitability sub-guidance, we are not divulging that kind of -- that level of guidance at this juncture.

Okay thanks a lot. And just one housekeeping question. What was the share count for Q3 that you're -- that you gave?

Yes, the share count for Q3 or for Q2?

For Q3, for September.

Yes, for Q3 September, for the quarter on a weighted-average basis to come up with EPS you'd be using 155 million shares.

Okay.

And you'd be using 74 million shares for the nine-month period.

74 for the nine-month. Okay, thanks a lot guys.

Thank you, Munjal.

Next we'll got to John Hodulik with UBS.

Hi good morning this is actually [inaudible] for John Hodulik.

Just wanted to ask about churn again, could you give a little bit more detail on the drivers of the increase in the quarter. Do you think that the customer service issues are fixed now?

And just one clarification, do you expect churn to go higher for the second quarter level into the third and the fourth quarter?

So let me just make sure I've got the question right, it's the drivers of the increase of churn, is care fixed, and what we expect it to now look like on churn?

And I'll let Mike Snyder handle those questions.

Yes, as I said there are really two reasons for the up-tick in churn in the second quarter. The first was the strain on our care capabilities that was replaced by the huge growth we saw in the first six months.

And the second was a technical issue, as I said, as a larger proportion of our base was new under a year, with the higher churn rates that you experience in the first six months of customer life that was causing an inflated number as it related to churn.

To get to the -- and now to get to, is churn fixed? We have built a plan. The plan focuses on a number of areas which include work flow, proper staffing, training and development, quality assurance. And those take a while to root and really start to see benefit. We have seen improvement in July, we believe the proper plan is in place. However we do believe because of that lag effect you will see possibly additional increases in churn before you start to see improvement.

Okay, thanks.

We'll go next to [William Mansfield] at [Millenium].

Hi guys, can you hear me?

Yes, how are you doing today?

I'm doing great. I was wondering if you could talk about competition over the last couple of months vis-a-vis the cable operators. You know, seen Comcast's digital telephony ads I think were announced last week. And Cablevision has been running this $15 promotion on the VoIP side as well.

Do you guys keep track of where your net ads are coming from sort of in the nation-wide cable footprint? And do you see shifts occurring in how you're doing in regions that are Cablevision regions versus Time Warner, versus Comcast, versus Charter regions?

Well we do obviously see what regions of the country our ads are coming from and those correspond to certain cable territories. Our strategy is not to focus on a single competitor. Our strategy is really focused on market development and our ability to capture customers that are under VoIP space.

And lastly, and quite frankly, some of the successes in some of the market development they're doing really has benefited us and we are -- because we believe it accelerates the adoption of VoIP as a primary telecommunication transport medium.

And so, overall all beneficial.

But in, specifically, over the last several months, do you notice effects when people ramp up their marketing that that hurts you in that region? Or do you not see those effects? And generally the ads that you're getting in a Time Warner footprint are as you would have expected three or four months ago?

Yes, we have made no changes in any of our strategies or our tactics because of any deterioration in any specific cable territory. So the answer to your question you know, we see really no effect.

Okay.

And we'll go next to Richard Greenfield at Pali Research.

Hi, just a few questions. One, could you just give us a sense of what churn looks like on a subscriber-line basis versus on the customer basis. Two, could you just give us a sense of what would your churn look like if you didn't exclude customers that connected and disconnected within 30 days?

And then just a broad question for Jeff, you made the comment that you -- when you think out to 2008 you are assuming that the current Unlimited Plan stays at $24.99. Just given what's already happened over the last couple of years with Vonage reducing price over that period, and seeing the competitive players out there, why are you assuming it stays flat into the first quarter of '08? Thanks.

Sure Richard, those are three interesting questions. I'm going to try and tackle all three of them for you. First, we measured churn on a per-customer basis, so it's really the customer relationship that matters. And why customers might add or decrease the number of lines, that's really the consistent metric that's required and also consistent with how others report churn.

In regard to the second question, what happens if we didn't exclude returns within the first 30-day period of time? Well we do exclude returns within the first 30-day period of time, as if those customers had never existed.

So, by doing so it gives us a cleaner read, and removes any sort of order cancellation, or buyer's remorse that might be experienced during that time window.

Just for a note of housekeeping clarity, those same customer adds are not included in a subscriber line acquisition cost, meaning that those are not part of the denominator when we divide out it across the entire marketing spend. So of course that is pre-factored into those numbers.

The third question is really around ARPU and why it will remain flat. And this has actually been a very good story. You know when we first entered this market a long time ago, it was very unclear of what the long-run cost elements would look like, and what the proper level of pricing would be, particularly given the elasticity that's inside the marketplace.

So if you look at the price changes that occurred in the very early beginnings of Vonage, it wasn't the marketplace that was driving those changes, it was Vonage. We led every single pricing change in order to determine the most appropriate level of elasticity to garner the greatest level of customers at the greatest level of profitability to drive overall shareholder value.

Since we stopped changing our price almost seven quarters ago, last time was in the fourth quarter of 2004, we've seen not only price stability across those four quarters -- or sorry, those now, six quarters, we've actually been able to increase our ARPU levels during that period of time which John Rego has also mentioned. As a matter of fact our ARPU levels are actually $1 higher today than they were a year ago.

Now, the company has a relatively large installed base. It's our job to start figuring out ways of delivering further value to those customers, and in return continue to drive ARPU levels higher by bringing out additional revenue generating products and services and intending to build new plans that will continue to deliver a greater value to our customers. And in return will deliver greater value to our shareholders.

Just as a quick follow up could you just give us a sense of what the lines per customer was in Q2?

Sure, the lines in -- per customer, in Q2 has remained relatively consistent for quite some time at roughly the 1.2 line to customer mark.

Thanks.

[OPERATOR INSTRUCTIONS]

And we'll pause for just a moment.

And it appears no one has signaled at this time so I'd like to turn the conference back over to Mr. Streem for any additional or closing remarks.

I just want to thank you all for your interest and your participation this morning and any follow-up questions you may have I would encourage you to get back to me and we will endeavor to take care of whatever those might be.

Thank you again and have a good day.

This does conclude today's conference ladies and gentlemen. We thank you for your participation. And you many now disconnect.