Venture Global Inc (VG) 2007 Q3 法說會逐字稿

Good day, and welcome to the Vonage Holdings corporation third quarter 2007 earnings conference call. Today's call is being recorded.

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

Thank you, operator. Good morning, and welcome to our third quarter 2007 conference call. Speaking on our call this morning will be Jeffrey Citron, Chairman; and John Rego, CFO. Jeffrey will begin by reviewing our accomplishments over the quarter and will discuss the company's strategic direction, and John will review our financial results. At the conclusion of our prepared remarks, Jeffrey, John, and Sharon O'Leary, our Chief Legal Officer, 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. During this call, we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in our earnings release, which is posted in the Investor Relations section of our website. 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 very pleased to announce our results and progress for the quarter. John will go through the financial details, but let me highlight the results.

For the first time in Vonage's history, we generated cash from operations. Cash from operations increased by $12 million this quarter. Current cash, marketable securities and current restricted cash was $356 million at quarter's end. On the top line, total revenue for the quarter grew to $211 million, a 30% year-over-year increase. This marks the 19th quarter of consecutive double-digit year-over-year quarterly revenue growth. Net loss excluding certain charges declined 74% year-over-year to $16 million, the third consecutive quarter of narrowing losses. Adjusted loss from operations for the quarter narrowed to $1 million. Finally, we are on track with our internal goal to deliver adjusted operating profitability.

Now I would like to highlight the progress we've made against our strategy and discuss our plans to adjust the areas where we've fallen short. As recall on the last quarter's call, we outlined our strategy to put the company back on track and position us for future growth. The strategy has three stages. One, fix the fundamentals, two, strengthen the core business, and three, ultimately grow from the core. Fixing the fundamentals is the first and most critical step in our strategy. There are three primary areas of the business we are focused on improving: marketing, G&A costs, and overall customer experience.

First, let's review our progress in marketing. Back in April, the company announced a significant reduction in our planned marketing spend. Then we conducted a comprehensive 90-day review of our marketing programs and strategy with the ultimate goal of increasing our marketing effectiveness. That assessment was completed last quarter and has led to numerous significant changes, many of which have yielded immediate results. As the company pulled back on expenses, we shut down poor performing channels and dedicated resources to the channels that yield the highest returns. We repositioned our products and implemented channel integration to maximize consistency across television, online, direct mail and print advertising. At the same time, we launched a new television and media campaign which differentiates Vonage from both cable and telco competition. This campaign includes a launch of three new commercials: Shell Game, Splitscreen, and Bundled, all of which have been very effective in better educating customers on our products, features and competitive position. More importantly, these adds have driven a higher response rate, better conversion and higher gross subscriber additions. The marketing team has increased the efficiency of our ad placements, optimized spending across all channels and deployed a local market segmentation strategy. We can now target customers more effectively based on regional calling patterns. This, coupled with our recently announced long distance calling plans, are examples of how we've implemented this strategy.

These broad changes have led to a significant improvement in our overall competitiveness in the market and our cost of acquisition. Subscriber line acquisition costs -- SLAC -- for the quarter was $206, the lowest level we have seen since the first quarter of 2005 and the lowest third quarter level since 2004. This follows four quarters of average acquisition costs that were $280, with one of those quarters at $306, which was the fourth quarter of last year. For the third straight quarter, marketing expenses declined, dropping 32% from the same period a year ago. Sequentially marketing expenses fell 9%. Notably the company delivered higher sequential net and gross adds on this lower marketing level. Marketing as a percentage of revenue dropped to a record low of 29% in the third quarter, down from 56% a year ago. As we look towards the fourth quarter, we expect SLAC to increase slightly, consistent with the natural seasonality in our business during the fourth quarter. While this is only one quarter of strong marketing results, we believe the changes will be long lasting. Having achieved solid progress in fixing our marketing fundamentals, we look to Phase II of our strategy to strengthen the core and build on the relationships that we have with our customers to increase loyalty. We will expand their offerings with products and features, such as Vonage Visual Voicemail, international savings plans, and advanced devices which are due out later this year. Our goal is to enhance the relationship of our customers by delivering increasing amounts of value.

The second component of fixing the fundamentals is cost management, and we're making measurable progress in this area as well. When we spoke with you last quarter, we discussed the changes that we've made to run the company more effectively. Reductions in SG&A, combined with the benefits of scale, have helped improve our bottom line performance. SG&A excluding certain charges as a percentage of revenue fell to 40%, its lowest level ever. On an absolute basis, SG&A was in line sequentially at $84 million, or $11.33 per line.

I now want to focus on improving the customer experience across all touchpoints. We continually evaluate why customers choose Vonage, why they stay, and why they leave. We know that roughly 70% of our churn is driven by poor user experience, such as problems with the customer's onboarding process, service quality, or customer care. They are not leaving us for a better deal. They are leaving us because we do not meet their expectations. To address these factors, we've developed a comprehensive plan to fix the user experience. The customer experience begins when a customer purchases our service, goes through installation and continues with the ongoing use for our services. We anticipated that it would take six to nine months before the implementation of this plan was complete and we saw meaningful improvements in our metrics. This work is underway. And while we expect the churn to get slightly worse in the third quarter as a result of the existing user experience problems, and negative press associated with the IP litigation, we did not expect churn to rise to 3%. This number is simply unacceptable.

I want to spend some time talking further about the activity we have underway to reduce churn and why I believe we are focused on the right things. At the highest level, we've identified four critical areas that result in a reduction in churn. First, we have to reduce the rate in which our customers have problems. This will be accomplished by improving the customer onboarding and installation process, to being more simple and intuitive. We will continue to improve the quality of service delivered through our network through investments in technology and processes. Finally, we will continue to improve the general customer support capability. We are starting to see progress in this area, as a number of contacts per customer line has fallen. Secondly, we have to answer the customer's call more effectively. High customer care call volumes and ineffective staffing has led to long hold times. We've begun implementing technology that optimizes call flows and work for staffing and are beginning to see improvements in the average speed of answer and reduced hold times. The third area of focus is to simply solve the customer's problems more rapidly and effectively. Customers sometimes call several times before their problem are resolved. This is unacceptable. This level leads customers to frustration and increases in call volume and care expense. We are rolling out a new agent desktop CRM system to improve first contact resolution and are deploying a global call routing system to enable skill-based routing to our agents.

And lastly, we need to accurately track our progress to drive continuous improvement. As part of this, we've increased call monitoring and tracked call flows to measure results and drive accountability. As we've discussed, fixing the user experience will take time, but when looking at the key internal call center indicators in the third quarter, the metrics suggest that churn is beginning to stabilize. But it's early in this turnaround and we don't expect to see significant improvements for another quarter or two. Given the weakening performance in this area as well as the slow pace of change that has fallen below the company's expectation, we have taken affirmative steps to change the leadership of the care organization. We'll be improving the senior leadership in this area and have already begun to utilize the services of an external [consultants] to help drive change and improvement. While churn remains a problem, we know from our customer survey data that this issue is a poor execution on our part and therefore we believe a fixable one. It takes time to complete the turnaround of any company, but we're confident we have the correct road map in place to accomplish that goal. Now I'll pass the call to John Rego to review the financial results for the quarter. John?

Thank you, Jeffrey. We made solid financial progress this quarter. We increased net adds sequentially, we improved our cost structure, and we narrowed our net loss. Importantly, the company passed a major milestone this quarter, as we generated cash from operations for the first time. Notwithstanding one-time charges for the quarter, the company has made solid financial progress. We are on track to achieve adjusted operating profitability for 2008. Revenue for the third quarter 2007 grew to $211 million, 30% improvement from $162 million in the third quarter 2006, and up 2% sequentially from $206 million Net loss excluding certain charges narrowed to $16 million, or $0.10 from $62 million or $0.40 year-over-year. Our GAAP net loss was $162 million. The company took a number of charges in the quarter relating primarily to IP litigation settlements.

So let's take a moment to walk through the accounting for these charges. In total, we booked $145 million in litigation this quarter, which hit the income statement as follows. $11 million in cost of telephony services representing the third quarter royalty payment to Verizon, and $134 million in SG&A, which is made up of $70 million for Sprint, $33 million for Verizon, $29 million for AT&T, and roughly $2 million for other settlement expenses. We also incurred $1 million in interest on the Verizon charge. We accounted for the settlements as follows. For the $80 million Sprint settlement, we booked $70 million, representing past use as Q3 SG&A. $5 million as an intangible asset, which will be amortized over the remaining life of the licenses, or roughly seven years. $5 million represents a prepayment for business services, which will be recorded as an asset in the fourth quarter, and will be expensed as we use the services.

Now, on October 25, we announced that we had settled our litigation with Verizon. The terms of the resolution depend on how the court of appeals decides Vonage's pending petition for rehearing regarding the 574 and 711 patents. If we win rehearing on either patent, or if the injunction is vacated, the settlement is $80 million. If we do not win rehearing on either patent, or if the stay is lifted, which would reinstate the injunction, the settlement is $120 million. Subsequent to the quarter end, Vonage escrowed the incremental $40 million pending resolution in the court.

Today we announced an agreement in principle with AT&T to settle the IP litigation suit, which was filed on October 17, 2007. Specifically, AT&T filed suit against Vonage in the District Court, Western District of Wisconsin, concerning patent number 6487200, the Fraser patent, which is a patent for a packet telephone system. The parties will work diligently to finalize the specific terms of the settlement agreement. The general terms being discussed would require Vonage to pay AT&T $39 million over five years. The present value of $39 million, or $29 million, has been recorded as a charge to SG&A during the third quarter. The remaining $10 million will be charged to interest expense ratably over the five-year term.

In addition to the litigation-related charges, we took $0.5 million severance charge in the third quarter. Now, when we spoke with you last quarter, we discussed changes we had made to run the business more cost effectively. We announced that expected charge of roughly $5 million associated with the number of cost control initiatives. To date, we have taken a total of $4.2 million in charges, with $0.5 million taken in the third quarter.

Adjusted loss from operations excluding certain charges was $1 million. That number includes $7 million in IP litigation costs, which we expect to decline over time. Average revenue per user remains strong in 3Q '07 at $28.24. That's up 2% from $27.59 in 3Q '06. RPU fell slightly sequentially from $28.38 due to promotional activity. Average monthly telephony services revenue per line for the quarter grew to $27.32, up 3% from $26.52 in the year-ago quarter. We do continue to expect stability in our pricing environment.

In the third quarter 2007, direct cost of telephony services was $55 million, up from $41 million a year ago and $52 million sequentially. On a per-line basis, average direct cost of telephony services was $7.30, up from $7.06 in the third quarter 2006 and $7.21 sequentially. Cost of goods sold increased $17 million from $11 million sequentially as a result of higher gross additions. SG&A excluding certain charges was $84 million, up from $72 million in the year-ago quarter, but in line sequentially. The $84 million includes $7 million in IP litigation costs and $6 million in noncash stock compensation expense. As a percent of revenue, SG&A excluding certain charges fell to a record low 40%, as the company continues to make progress in controlling costs. The company ended Q3 with 1,559 full-time employees versus 1,729 full-time employees at the end of Q1. SG&A per line was $11.33. We will continue to focus on controlling costs to improve our overall business margins.

We also continue to drive marketing expense lower. Back in April, the company deliberately pulled back on marketing expenditures while it retooled its marketing campaigns. While we have made substantial progress in our marketing efficiency, we expect marketing spending to increase slightly from the third quarter. Marketing costs fell sequentially and year-over-year on both an absolute and percent of revenue basis. Marketing expense for the quarter was $62 million, or 29% of revenue, down from $91 million, or 56% a year ago. On a sequential basis, marketing expenses were reduced from $68 million, or 33% of revenue. The increase in net adds on lower marketing spending is primarily the result of the increased efficiency of our marketing investment. As Jeffrey highlighted, marketing cost for gross subscriber line, or SLAC, was $206. That's the lowest level in several years, as we have invested more effectively for acquisition through television and online channels. This is a decline in SLAC from $254 the prior year and an average of $280 over the most recent four quarters. We expect fourth quarter SLAC to increase slightly due to seasonality, but fall within the $225 to $250 range. The company added 78,000 net subscribers, an increase of 37% from the 57,000 subscribers reported last quarter, as the new marketing plans gain traction. Vonage ended the quarter with over 2.5 million lines in service. PMOI per line, excluding certain charges, remain stable at $9.53.

Turning to the balance sheet, current cash, marketable securities, and current restricted cash at quarter end was $356 million. That's up $12 million from last quarter. This includes $78 million of current restricted cash used as collateral for the Verizon bonds and first escrow payment. The changing cash from the prior quarter was driven by cash provided by operations of $22 million and capital expenditures of $10 million. The company's cash requirements in the fourth quarter increased due to the release of $78 million of restricted cash to Verizon, an additional $2 million to Verizon, $40 million placed in escrow and reported as current restricted cash until the Verizon appeal is decide, $80 million to Sprint, and $2 million in other IP litigation settlements. Based on these actions, cash has been reduced from $356 million to $194 million, which is comprised of $154 million in free cash and $40 million in restricted cash. With the litigation now behind us, the company is considering all available options relating to its convertible notes, which can be put to us in December 2008. And now, operator, let's open the line for some questions.

Thank you. (OPERATOR INSTRUCTIONS) We'll take our first question from Clay Moran with Stanford Group.

Good morning. Couple of questions. The working -- can you give us the working capital at quarter end? It wasn't in the press release. Then also the royalty payment, that disappears in the fourth quarter, is that right?

That's correct, Clayton. The royalty payment will no longer be there as the case has been settled. Working capital at the end of the third quarter was $54 million.

Okay, and last question, you mentioned at the end of your remarks you're exploring your options in regards to the convertible debt. Can you just give us an idea of what you consider your options and maybe what you think are the best possible alternatives? Thanks.

Hi, Clay, this is Jeffrey. The company's going to look at all available options with regard to structuring that debt. As you know, that debt is [notable] December 16 of 2008, so we like to start adjusting that issue now that we have the IP litigation behind us.

Okay. (OPERATOR INSTRUCTIONS)

Operator, if there are no other questions, we would like to add some closing remarks.

We have no further questions. Mr. Citron, I'll turn it back to you.

Thank you, operator. Overall, Vonage has made meaningful progress in improving the business this quarter. We will continue to optimize our cost structures, our customer acquisition costs starting to decline and we're making progress in improving the customer experience. Driving the company to a level of performance that we are targeting will take time and we expect there could be small setbacks along the way. That said, we do believe we have the right strategy to make it happen. With a strong quarter of profits behind us, we look forward to continued momentum and improved results as we get closer to achieving profitability. With most of the litigation behind us, let me say we're excited to refocus on running our business. Thank you very much today.

And ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect.