Venture Global Inc (VG) 2007 Q1 法說會逐字稿

Good day, and welcome to the Vonage Holdings Corporation First Quarter 2007 Earnings Call. Today's conference is being recorded.

At this time I would like to turn the conference over to Leslie Arena, Vice President of Investors Relations. Ms. Arena, please go ahead.

Thank you, operator. Good morning, and welcome to our first quarter 2007 conference call. Speaking on our call this morning will be Jeffrey Citron, Chairman; John Rego, CFO; and Sharon O'Leary, Chief Legal Officer. Jeff will begin by reviewing our accomplishments over the quarter and describe our current outlook, and John will review our financial results for the first quarter.

Following that, Sharon O'Leary will discuss the status of our appeal on the Verizon suit. At the conclusion of our prepared marks, Jeff, John and Sharon 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 the 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 cautious listeners not to rely unduly on forward-looking statements, and we disclaim any intent or obligation to update them.

And now I will turn the call over to Jeffrey.

Thank you, Leslie. Good morning, everyone, and thank you for joining us on the call. We are now five months into 2007, and needless to say it has been a very challenging year. While our primary focus is running our business, the Verizon lawsuit has consumed significant financial and human resources, and the associated media coverage has had an impact on our business.

The litigation has clearly taken center stage, overshadowing our financial and operational results. While we understand why, we believe the end of this difficult period is in sight. I am pleased that the Court of Appeals granted our request for an expedited appeal. The accelerated timeline however has caused us to re-examine our schedule for the design, development and deployment of our workarounds.

As you know, our workaround process has been ongoing for some time now. I'm happy to report that we believe we have workable designs for the 574 and the 711 patents and intent to begin deploying the solution to our customers shortly. In addition, we are continuing our development efforts of the workarounds for the 880 patent which covers wireless technology.

Now, turning to the company's operating performance. We continue to assess our operating position and our competitiveness, or our competitive effectiveness. As a result we have had to make some difficult choices. We will continue to evaluate how best to segment the marketplace, market to customers, keep existing ones and configure our network to deliver the highest quality phone service to help people communicate on their terms.

To achieve our goals, we need to run the business at an improved cost structure. We recently announced the $140 million in cost savings and spending reductions of which approximately $110 million will come from the -- will come from marketing and remaining $30 million will come from reductions in compensation, benefits and other administrative areas.

While cost cutting is critical to our success, it does not stand on its own. We must reduce our marketing cost per gross ad by marketing more effectively. Thus we are now in the midst of a comprehensive review and an overhaul of our marketing strategy, which will transform us from being a highly national advertiser in orientation, to one that is more targeted to the regional, local and even individual level.

As part of this new strategy, we have announced the appointment of Jamie Haenggi to the newly created position of Chief Marketing Officer. Jaime will lead our global sales and marketing organization, and will focus on bringing our subscriber growth and cost of acquisition back to the levels we believe are appropriate.

While we expect these changes will lead to improvements in the level of subscriber additions, we believe it will take time before we see notable improvement. Clearly the next several quarters will be critical as we implement the workarounds, while effectively adding and retaining subscribers, all [through] focus of achieving profitability in the future. We will also continue to fight Verizon in the courts, and remain confident in the strength of our legal appeal.

Now, I will like to pass the call to John Rego our Chief Financial Officer.

Thank you, Jeffrey. Results in the first quarter show a big step on a year-over-year basis and our progress towards achieving profitability, as we grow revenues and manage our cost structure. Revenue for the first quarter 2007 grew to $196 million, a 64% improvement over the $120 million in the first quarter 2006, and up 8% sequentially from $181 million.

Let me note that the company strongly believes that the Verizon decision will be overturned on appeal. We have included the royalty in our results. It is shown as a separate line item and a component of cost of telephony services. The royalties will be paid quarterly and held in escrow. In the event of a successful appeal, the royalty will be returned to Vonage. Where appropriate, I have highlighted the results with and without the effects of that royalty.

The company's net loss for the first quarter 2007 was $72 million, a 15% improvement versus $85 million in the year ago quarter. EPS in 1Q '07 was $0.47. Now excluding the impact of the royalty and associated interest, the year-over-year improvement in net loss was even more dramatic as losses narrowed by $24 million to $61 million, a 28% improvement.

EPS excluding the royalty and interest was $0.39 in 1Q '07. Sequential net loss excluding the royalty and interest narrowed to $61 million, from $66 million in the fourth quarter 2006. Adjusted loss from operations narrowed to $58 million, a 20% improvement from $73 million in the first quarter 2006. Excluding the royalty, adjusted loss from operations narrowed to $48 million, down 34% from $73 million in 1Q '06, and 10% from $53 million sequentially.

Over the past 12 months, the company added 792,000 net lines, 166,000 of which were added in the first quarter 2007. This compares to 957,000 net subscribers the previous 12 months, and 328,000 in the first quarter 2006. The company ended the quarter with 2.4 million lines in service. Average revenue per user in 1Q '07 was $28.31, up $0.46 from $27.85 in 1Q '06, and roughly in line with $28.25 reported in 4Q '06.

Average monthly telephony services revenue per line for the quarter grew to $27.36, up 5% from $26.17 in the year ago quarter. In the first quarter 2007, direct costs of telephony services increased to $56 million, up from $38 million year-over-year, and $52 million sequentially driven by higher subscriber lines.

On a per line basis, cost of telephony services fell to $8.03 down from $8.94 in the first quarter 2006, and $8.13 sequentially as the company continues to benefit from cost savings associated with traffic flow optimization and supplier management. Total direct cost of telephony services was $66 million, which includes a $10 million royalty.

In 1Q '07, SG&A rose to $91 million, a 72% increase from $53 million in the year ago quarter, as the company scaled to support the growth in subscribers. Sequentially, SG&A rose 11% from $82 million, driven by $10 million in IP litigation costs, as well as timing on compensation and benefit expenses. As a percentage of revenue, SG&A was 46% in the first quarter 2007, up slightly from 44% in 1Q '06 and 45% sequentially.

Managing SG&A remains a top priority for our business. While the business is becoming more efficient as it scales, our overall cost structure was not optimal. SG&A had risen to a level above what was required to support Vonage's existing business. And as such, we put a number of cost controls in place, which have an immediate financial impact on the business and will result in lower SG&A as a percentage of revenue in the future.

Driving this improvement is the fact that we have implemented our previously announced $140 million reduction in costs which includes a reduction in marketing expense of $110 million, and savings of $30 million in workforce and other SG&A cuts. In order to realize these cost savings and opportunities, we will take a one-time charge of roughly $5 million in 2Q '07 associated with these changes.

While these decisions were difficult, they were necessary as we focused on bringing the business to profitability. Marketing spend for the first quarter of 2007 was $91 million or 46% of revenue, versus $88 million or 74% a year ago. Sequentially, marketing expenditures fell 5% from $96 million, as the company deliberately pulled back on marketing expenditures while it retools its marketing campaigns.

Marketing costs per gross subscriber line addition or [SLAC] was $273 in the first quarter 2007, a reduction of $33 from $306 last quarter, and up $64 from $209 a year ago. As Jeffrey discussed, we announced that we will reduce marketing expenditures by $110 million, and expect to spend roughly $310 million for 2007. As previously mentioned, the reduction in marketing will result in fewer line ads, and thus revenue than previously thought in 2007.

Premarketing operating income per line for the first quarter 2007 fell year-over-year to $5.68 from $5.97, as a result of $1.50 royalty and $1.45 in IP litigation expense. Turning to the balance sheet, our cash and marketable securities at the end of the quarter were $410 million.

Of the $90 million change in our cash position, $59 million was used to fund operations, $14 million was capital expenditures, and $17 million was used for restricted cash. We believe we have sufficient cash on hand to continue to fund our business needs through profitability.

Subsequent to the March 2007 quarter end, the company posted a $66 million bond as part of the Verizon litigation. The bond will be released in the event the Verizon judgment is substantially reversed on appeal.

In summary, the company has taken a number of steps, which we believe will increase our ability to reach profitability. But given the uncertainties surrounding the Verizon litigation, we are not going to comment on previously issued guidance.

Now, I would like to pass the call to Sharon to provide an update on the Verizon litigation.

Thank you, John. Let me start by providing a status on the Verizon appeal. As most of you are aware, on April 24th, oral argument was heard on our stay motion by the United States Court of Appeals for the Federal Circuit or CAFC. The CAFC issued an order on the same day granting Vonage's request for a stay permitting us to continue to sign up new customers through the appeals process.

In addition, the CAFC set an expedited briefing and oral argument schedule for our appeal that called for the filing of our initial brief yesterday, May 9th. Verizon has until May 23rd to file its response and we file our reply to Verizon's response on May 30th.

Oral argument is scheduled for 10.00 A.M. on June 25th. The CAFC also informed us in the same order that the panel of judges that heard our motion for a stay would also be the panel that hears the merits of our appeal. We are pleased with the court's order granting our stay and assuring that our appeal will be heard by a panel familiar with our case in an expeditious manner. We believe the CAFC could issue a decision in our appeal as early as July of this year.

Now let me talk a little bit about our motion regarding the KSR case. On May 1st, Vonage filed a motion to vacate the U.S. District Court's entry of judgment on the merits, its related damages order and its order issuing a permanent injunction. And to send the case back for a new trial on the validity of the Verizon Patents in light of the U.S. Supreme Court's recent decision in KSR versus Teleflex.

Our decision to file this motion was based on the Supreme Court's rejection of the use of a rigid approach in determining whether a patent is invalidate as obvious under the patent act. The District Court's use of this rejected approach in its instructions to our jury on obviousness.

We elected to file this motion in advance of our opening brief and our appeal because we believed and continue to believe that the KSR decision is sufficient grounds for a new trial wholly apart there the trial court's erroneous interpretation of the patent claims at issue.

The CAFC ultimately rejected our motion but did not rule on the merits of our argument. Instead, the CAFC gave us the opportunity to reassert our arguments concerning KSR in our opening appellate brief. So our appellate brief argues for a new trial based on both KSR and the erroneous claim construction of the trial court. And if you are interested in understanding the essence of our appeal, I encourage you to read this brief.

That being said, we remain confident that we have not infringed and are not infringing Verizon's Patents today, and we believe we will win on appeal.

And now, I would like to pass the call back to Jeffrey.

Thank you, Sharon. As Sharon said, we believe that in a relatively short period of time we will know the outcome of the Verizon appeal. We look forward to a positive outcome and are eager to focus all of our efforts in improving our business and growing our subscriber base.

We are committed to balancing growth and profitability and believe that reduction in marketing spend, [while leading] to slower growth will improve our ability to reach profitability in the future. I look forward to providing you with an update on our progress as we move forward and now we will be pleased to take your questions.

And operator, if you can open up the call now, that would be great.

Thank you.

(OPERATOR INSTRUCTIONS)

We will take our first question from Michael Rollins with Citigroup.

Hi, good morning.

Good morning, Mike, how are you doing?

Good, good. Just a question on the workaround solutions, if you can give us a little bit more color as to what is required to convert a customer. Is it just a software load into the device? Do you actually have to touch the customer, their equipment in some way? And then also, is there a cost to deploy this solution that we should be thinking about? Thanks.

Sure, Mike. So, as it relates to most of the workaround work for the two patents mentioned, that is mainly a software load that is required on the customers' devices. It actually requires no customer interaction. Although along the way we have also augmented our network to handle these changes and we have deployed some extra amount of capital. We are not exactly sure how much that will cost, but it should not be a very large figure.

And just to follow up. Is there -- what is the risk that this workaround is then litigated against? Are there certain things that you could share with us to help us frame the litigation risk as you deployed these workarounds and what timeframe we should think about the workarounds being fully installed on? Thanks again.

Sure. I think it's hard for us to comment on all those points, but we have stated today that we will begin rolling these workarounds out shortly, so hopefully over the next few weeks. And we believe they will work.

Thank you, very much, I appreciate it.

You are welcome.

We will take our next question from Qaisar Hasan with Buckingham Research.

Hi, good morning. I guess a couple of questions. One was around the marketing costs and the new campaign to move away from sort of the national push to (inaudible) sort of a local or regional one.

I was just trying to reconcile this statement with I think the conference call that you guys held back in April where I think you had suggested that the marketing spend reduction will be around some of the marginal channels and should lead to sort of an improvement in the economics of the lines you bring in, which sort of implied hopefully lower SLAC on a going forward basis. Does this sort of differ out those improvements in SLAC per gross adds towards the back of the year?

Sure. Okay. So the first question, with regards to marketing costs, we do expect that as we transition to the new marketing campaign which will take a couple of quarters to fully roll out, implement and roll out, that it will yield a lower cost of acquisition and thus allow us to accelerate our growth. And Jamie of course is heading up this effort and she is fantastic and we are really excited about the work that she is doing.

With regard to the cost reductions, we did state on our previous call that we were going to reduce our marketing spend. It's really part of a comprehensive review. That review is ongoing right now. We have been doing it for the past four weeks. We will continue to review all of our spending and our acquisition programs. And then, yes, we will start to cut those marginal ones and we expect to start cutting those marginal programs a bit in this quarter and of course a bit next quarter as well.

But is it fair to say that the improvements in terms of the SLAC per gross add probably wouldn't be evident at least in the short term while you implement the changes away from the national sort of approach?

I think as I said -- as I noted in my commentary today, I think it's going to take a little bit of time before you see the full improvement of those changes that we are making.

Okay. The other question I had was again, sort of related to the litigation with Verizon. Just one clarification. I think was it $58 million, which was the initial jury award. Have you -- you don't seem to have taken a charge against that in 1Q, is that right? Will that show up in the second quarter?

I'll let John answer that question.

Yes, Qaisar, the $58 million was the jury award. A large portion of that amount, about $54.5 million, was taken in the fourth quarter and you can see that if you reference our 10-K, the balance of that was taken in the first quarter as well as the start of the 5.5% royalty which started roughly around March 8th. And that's where the $10 million comes from.

Okay, great. And then just finally the $66 million that you've had to sort of put into escrow, would you get that back if the -- if this case is sent back to the lower court by the appeals panel or would that have to remain in escrow while the lower court, should it go back to the lower court until it finally makes a ruling?

If the case is overturned, Qaisar, the money comes back to the Company.

If the case is overturned at the appeals level.

That is correct.

Great. Thank you.

We will take our next question from John Hodulik with UBS.

Hi, this is Batya Levi from UBS. I actually had two questions. One of them on the pre-marketing cash cost per user. Adjusting for the royalty fee, I think it dropped slightly sequentially and I understand there is the $1.45 in IP litigation expense. Can you just remind us what that number was in the fourth quarter and what are the drivers of the sequential decline?

Also, have you started to incur any cost for the workaround that also lowered that number? And separately, given that you have a month-and-a-half of data in terms of gross additions that you see and churn, could you just give us an update on how we think -- how we should think about those going forward?

Batya, this is John. I will take the first part, which was IP litigation costs in Q1 of '07 ran us about $1.45 per line. In the fourth quarter of '07 where we saw the first big pick up it was $0.92 per line. So, obviously it went up.

And related to that was there any additional workaround cost that also impacted that line?

The IP litigation cost that we would have had, Batya, would have been in the CapEx line item and is not terribly significant.

Okay.

Okay.

(OPERATOR INSTRUCTIONS)

And we will go next to Richard Greenfield with Pali.

Hi, a couple of questions. One, to the extent that you actually do roll this out in terms of the workaround over the course of the next few weeks. The minute you have it rolled out to a subscriber, do you stop paying the royalty to Verizon or into escrow immediately?

And then two, I think you mentioned, Jeffrey, that the $140 million of cost savings would only result in a $5 million charge, I'm assuming that's an all cash charge. But maybe just give us a sense of how obviously the marketing, maybe that doesn't involve a lot of cash outlay or charge, but how do you get the rest of it now that it's translating to a bigger upfront cost as you reduce the infrastructure? Thanks.

I guess, Richard, to the first one which was about the royalty to the extent that the customer lines are no longer infringing, the royalty would stop.

And as it relates to the charges, I believe you are correct that the charges taken in the second quarter were mainly cash charges relating to the compensation elements due to the workforce reduction. The rest of the reductions for the year are going to be the benefit from that workforce reduction, the reduction in costs and expenditures in the G&A areas along with the $110 million reduction in marketing.

But we should think about a $30 million savings from a $5 million up front cost?

Yes.

(OPERATOR INSTRUCTIONS)

We will take our next question from Clay Moran from Stanford Group.

Thank you, good morning. Can you update us on churn, the churn rate since the end of the first quarter?

Sure. This is Jeffrey. For the first quarter the churn was as you know 2.4%, relatively unchanged from the prior quarter. At this time it's too early to provide any guidance as to churn for the second quarter.

Okay. And since the Verizon litigation and the patent was interpreted pretty broadly, can you give us more -- can you share with us more on what the difference is between the workaround and your prior solution?

I think that the workarounds are relatively technical in nature, but if you want to get a better understanding of them we encourage you to read the filing briefs that we made with the Court of Appeals.

Okay, thanks.

You're welcome.

We will take our next question from Daniel Berninger with Tier 1 Research.

Thanks. I was interested in the pricing environment and pricing flexibility. Price has been pretty stable over the past couple of years and you've been able to pass along to customers costs associated with E911 and USF, and can you talk a little bit about any reason why you can't pass along some of the royalty cost or what sort of pricing pressure is out there and what your competitors, both independents and the incumbents, are doing in the pricing?

Sure. It's a very good question, Dan. It looks like the pricing environment, as we discussed at great lengths over the past four calls, has remained stable and continues to remain stable. We've seen no major wholesale changes from the incumbent players or the new cable entrants into the marketplace. So we think the pricing dynamics remain relatively favorable and we think they should remain relatively stable for the foreseeable future.

With regard to passing on additional expenses to our customers, we surely have had good success in passing on the new universal service fund contributions to our customers. We would hope that the FCC or the Congress would reexamine that fund and not burden customers with it any longer. But at this point in time, they continue to maintain that fund.

As it relates to the royalties, we are very confident on our appeal and of course the success of the deployment of our workarounds, I would expect that as we roll those workarounds out that the royalty would no longer be an issue.

Okay. And just one follow-up. You have had promotions on international for one penny a minute, et cetera, but I guess that doesn't factor materially into lowering the per line price.

That is correct.

Right. Okay, thank you.

You're welcome.

And we do have one -- we have time for one more question.

(OPERATOR INSTRUCTIONS)

And it appears that we have no further questions. At this time I would like to turn the conference over to Jeffrey Citron for closing remarks.

I want to thank everyone for joining us in today's conference. And of course as noted, we are extremely excited about the prospects for our business, and the successful appeal of the Verizon matter. Thank you again.

Thank you, ladies and gentlemen. Once again that does conclude today's conference. We do appreciate your participation.