Venture Global Inc (VG) 2011 Q1 法說會逐字稿

Good day, everyone, and welcome to the Vonage Holdings Corporation First Quarter 2011 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 First Quarter 2011 earnings conference call. Speaking on our call this morning will be Marc Lefar, Chief Executive Officer, and Barry Rowan, CFO and Chief Administrative Officer. Marc will discuss the Company's progress and strategic direction and Barry will discuss our financial results. Slides that accompany Barry's discussion are available on the investor relations website. At the conclusion of our prepared remarks we will be happy to take your questions.

As referenced on Slide 2, 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 depend on assumptions or data 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 highlighted on the second page of the slides and contained in Vonage's SEC filings. We caution listeners not to rely unduly on forward-looking 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 comparable GAAP measures is available on the investor relations website.

And now I will turn the call over to Marc.

Thank you, Leslie, and good morning everyone. I am pleased to report that the financial and operating performance delivered in 2010 continued in the first quarter of 2011. We generated record high EBITDA of $43 million, grew net income, improved gross line additions, posted positive net adds, and prepaid $20 million of our debt.

Last week we launched Vonage World Premium, an upsell service to the original Vonage World, and we expect to introduce two new mobile products during the spring and summer months. We've now reported record high positive EBITDA in 13 of the last 14 quarters. Our performance in the first quarter was driven both by higher revenue per user and continuing efficiencies across our business. The combination of strong operating performance and reduced interest expense from our recent debt refinancing resulted in record high net income of $21 million or $0.10 per share, which is up 51% from $14 million or $0.07 a year ago.

Our strong cash flow enabled us to prepay $20 million of debt at par, and we expect to prepay an additional $30 million before year-end, which will result in nearly $5 million in annualized interest expense savings. These prepayments are incremental to our scheduled amortization payments and Barry will provide additional details when he speaks.

Gross line additions, or GLAs, increased steadily during the year and were up 13% from a year ago to 175,000 on roughly flat marketing investment. As a result customer acquisition costs per line or SLAC fell to $282, the first time SLAC has been $300 since the fourth quarter of 2009. With more than 1 million subscribers or 43% of our base on Vonage World, we are making steady progress penetrating international calling segments.

Our increased marketing focus on the Hispanic segment where we provide in-language sales and service drove an increase in account starts for the second consecutive quarter. Asian Indian subscribers continued to be a loyal and growing portion of our business, and growth in Canada continued with GLA increases sequentially and versus the year-ago period.

Our launch of an unlimited plan for the Philippines drove strong press attention. However, the retail price of $64.99 made necessary by unusually high termination rates has proven to be a barrier to broad adoption. We are considering alternative offers to address the ongoing needs of this heavy calling segment.

While marketing yield improved, net line additions of 3,000 were a bit lower than in the fourth quarter as churn ticked up by 10 basis points to 2.5%. This slight increase was due to higher early-life churn of no-contract customers, our mix of ethnic segments, and the one-time impact of removing four countries from Vonage World.

We anticipated minor pressure from these factors and we continuously evaluate the impact of offers and promotions on churn, making changes as necessary. On balance our strong financial results and progress growing the number of international callers in our customer base provides a solid foundation for driving cash flow and funding our planned investments in new products and services.

The recent launch of Vonage World Premium which delivers against the largely unmet needs of customers calling internationally to mobile phones in many countries appears to be gaining traction in our existing base. The results of email upsell campaigns immediately upon launch are exceeding our early expectations. It is still too early to evaluate the impact on new sales as advertising has just started airing.

As I mentioned earlier, we plan to launch two new mobile services in the coming months. The first is a unique international long-distance service for standalone mobile users. It will be available in more than 75 countries immediately upon launch, and we believe it will be the absolute most convenient way for customers to avoid high carrier charges.

The second new product will be enhancement to an our core Vonage World service that will extend the utility of our home service plans to multiple phone numbers and devices including most mobiles. With the launch of this extension service, Vonage will offer both savings and convenience to customers regardless of device or location as an integral part of our basic service. Not only will this provide a revenue opportunity through usage in our existing base, but we believe this will improve the overall value proposition for prospects, as well.

As we look to the balance of the year, our financial outlook has improved. We expect to achieve EBITDA of at least $165 million. Recent improvements in ARPU and structural changes in costs have given us more confidence in the full-year result. While we continue to expect higher gross line additions for the full year versus 2010, advertising costs which are seasonally much higher in the second quarter may lead to lower marketing yield, putting some pressure on gross line additions. And we continue to expect churn to be relatively stable with 2010 levels with perhaps a modest impact from selective price increases we plan to implement in the coming months.

While there is still much work to be done, our results clearly demonstrate that the major elements of our turnaround are now behind us. I am pleased with the Company's solid financial and operating performance and we are working diligently against the execution of our strategies to drive growth in the quarters ahead.

And now I'll hand the call to Barry.

Thanks, Marc. I am pleased to review our first quarter financial and operating results with you. As Marc's highlighted, we reported a solid financial quarters as we generated record high EBITDA of $43 million and strong cash flow based on ongoing operational improvements and expense management.

We reduced selling, general and administrative expenses to a record low percent of revenue led by continued improvements in customer care costs per line which declined 9% from the prior year. We reported our fourth consecutive quarter of increasing gross line additions with continued progress penetrating international calling segments with Vonage World. Reflecting this strong performance, free cash flow of $13 million increased $10 million sequentially as we produced record high net income aided in part by lower interest expense following our successful debt restructuring last year.

Continuing with the balance sheet improvements begun in 2010, we are utilizing our cash flow to further reduce our level of debt. Specifically we prepaid $20 million of debt at par which will reduce the annual interest expense by an additional $2 million. We expect to prepay at least an additional $30 million by year-end, bringing total voluntary prepayments to $50 million. Combined with $20 million of scheduled amortization payments, this results in a total debt paydown of $70 million in 2011. As a result, we expect term debt to be less than $130 million at the end of 2011.

These planned debt reductions would reduce cash interest expense by $22 million in 2011 and by at least $27 million in 2012 from the 2010 levels. The resulting cash interest expense would be $42 million, $20 million and $15 million for 2010, 2011 and 2012 respectively. These reductions in interest expense would have a corresponding positive impact on basic EPS of $0.10 per share in 2011 and $0.12 in 2012.

Let's walk through the details of this quarter's financial performance. Beginning with Slide 3, adjusted EBITDA of $43 million increased 9% from the prior year as we achieved the 20% EBITDA margin for the first time in the Company's history. Sequentially, EBITDA increased 6% as a result of higher service ARPU associated with Vonage World and through continued operating efficiencies.

We have opportunities to drive further structural cost reductions and expect strong ARPU during the second half of the year. Based on these expectations, we are raising our EBITDA expectation for the year from our previous guidance of more than the $156 million we earned in 2010 to at least $165 million for 2011.

Moving to Slide 4, we reported net income of $21 million or $0.10 per share, up 51% from net income of $14 million or $0.07 per share in the first quarter of 2010 and up from a net loss of $42 million or $0.19 sequentially. Note the fourth quarter of 2010 included $58 million in adjustments related to our debt refinancing. Excluding these adjustments, the Company increased net income by more than $8 million sequentially with $4 million of the gain resulting from interest expense savings. This marks the eighth consecutive quarter that we have achieved positive net income excluding adjustments.

On Slide 5, total revenue for the quarter increased to $220 million from $218 million sequentially, reflecting our continued progress penetrating the international long-distance calling market. Revenue declined $8 million from $228 million in the year-ago quarter primarily due to a $6 million reduction in deferred revenues related to legacy activation fees. As a reminder, this adjustment does not impact EBITDA.

Quarterly telephony services revenue was $218 million, an increase of 2% sequentially, helped by the higher number of Vonage World subscribers. We now have more than a million subscribers or 43% of our base on this plan. These customers have an attractive lifetime value, and more than half of Vonage World customers are international long-distance callers who churn at lower rates than domestic callers.

Aided by the mix of Vonage World subscribers, first-quarter average revenue per user, or ARPU, increased to its highest level in three quarters. In the first quarter service ARPU increased 2% sequentially to $30.23 due to mix improvements, lower bad debt expense, and higher universal service fund fees which are a pass-through. Service ARPU declined from $30.90 in the prior year primarily due to reduced legacy activation fees and lower termination fees due to no-contract plans.

Moving to Slide 6, during the quarter we added 175,000 gross lines, an increase of 13% from the prior year and up 5% sequentially. This was driven by further progress penetrating the US Hispanic market and GLA growth in Canada. Subscriber line acquisition cost or SLAC improved 11% to $282, down from $318 a year ago. This marks the lowest SLAC in five quarters, reflecting continued improvements in the efficiency of our marketing spend.

Monthly churn declined to 2.5% from 2.6% in the prior year due to the lower churn profile of certain international calling segments and improvements in the overall customer experience. On a sequential basis churn increased 10 basis points. As Marc mentioned, we saw a negative impact in early-life churn from the two potential negative factors we mentioned on our last earnings call, the impact of the no-contract offer and higher churn rates associated with some ethnic calling segments. The slight uptick was also influenced by some one-time actions such as removing the four countries from our Vonage World plan that did not meet our profitability goals.

Our higher gross line additions combined with slightly higher churn resulted in 3,000 net line additions in the first quarter. This was our second sequential quarter of modest net lines growth.

Let me take this opportunity to highlight the importance of managing our business based on appropriate economically driven metrics as our business evolves. In the quarters ahead we expect to shift our emphasis away from metrics such as gross and net line additions that may lead to optimization of individual measures at the expense of overall Company value.

The introduction of new products sold as add-ons to existing plans and wider-ranging ARPUs associated with new mobile products, for example, make these historical measures less meaningful. We plan to emphasize growth in revenues, EBITDA and free cash flow supported by a clear focus on subscriber economics as these new products become a larger portion of our portfolio.

Please turn to Slide 7 where we will begin our discussion of our cost structure. Cost has been a good news story over the past several quarters. Total costs declined to $60 million from $62 million in the year-ago quarter, driven by lower domestic termination rates and usage which more than offset the expected increase in international termination costs from higher numbers of international callers. We continue to reduce non-termination costs within this expense category.

As I mentioned on last quarter's call, our consolidation of E91 vendors will drive $4 million in savings this year, some of which we've already seen in the first quarter.

On a per-line basis, cost declined $8.34 from $8.60 in the prior year and rose from $8.06 sequentially due to an increase in USF which is a pass-through. Excluding the impact of USF, costs declined 2% driven by lower domestic termination and other telephony services costs.

Cost of goods sold declined $6 million from the prior year to $11 million due to lower device costs as well as a reduction due to the accounting impact of legacy activation fees which are amortized over the life of the customer.

In the past year we have lowered the cost of our devices by more than 25% to $30, and we expect to reduce device costs further by year-end. Reflecting the strength in ARPU and reduction in costs, total direct margin rose to 68%, up from 65% in the prior year. This matches the 68% level achieved in the fourth quarter of last year.

Moving to Slide 8, we reduced SG&A to $58 million, an all-time low of 26.5% of revenue from $61 million in the year-ago quarter and down from $59 million sequentially. A substantial portion of these savings has come through improvements in our customer care operations. Care costs per line declined 9% from the year-ago quarter as we lowered the number of calls into our care centers due to an improved customer experience combined with reducing the average handle time spent with customers who need our assistance.

Moving to Slide 9, marketing expense was $49 million, down slightly from $50 million sequentially and flat from the prior year. While our total marketing spend has remained roughly flat for the past two years, we continue to shift our marketing mix within this overall spend level. These shifts are towards our targeted international long-distance calling segments and to the immediate channels that most effectively reach these customers.

As Marc mentioned, the second quarter tends to be a season of higher media costs. We expect that this factor in combination with the traditionally slower April will put some pressure on continued quarterly GLA growth during this quarter.

Moving to Slide 10, CapEx in the first quarter was $5 million, down from $16 million in the fourth quarter, which reflected some higher year-end capital spending. For the full year 2011, we expect CapEx to come in at or below the low end of the $40 million to $45 million range we had previously set. The majority of this investment is to support the development of new products and services, improve the customer experience, and drive structural cost reductions in customer care and COTS.

Strong operational results and lower CapEx resulted in a $10 million increase in free cash flow defined as operating cash flow less CapEx to $13 million. As we discussed on our last earnings call, working capital is typically negative in the first quarter due to the timing of certain payments. In addition we paid approximately $5 million into escrow during the first quarter to fund the costs associated with the previously announced settlement of the consumer class action.

While the combination of these factors resulted in the use of $19 million during the quarter, we expect working capital to be approximately neutral for the year. We maintained our strong cash position with cash and cash equivalents as of March 31st of $87 million, including $7 million in restricted cash associated with the lease on our building.

Based on our strengthened operations, a continually improving balance sheet, and our $885 million NOL carry-forward, Vonage is now generating meaningful cash flow. With EBITDA expected to be at least $165 million, cash interest expense of $20 million, CapEx of approximately $40 million, plus the $8 million annual payment for patent licenses and a modest $2 million in alternative minimum taxes, our expected 2011 net cash flow is approaching $100 million.

Moving to Slide 11, as I mentioned we prepaid $20 million of our term debt at par with $10 million paid at the end of the first quarter and an additional $10 million paid early in the second quarter. This prepayment will reduce annual interest expense by $2 million assuming constant LIBOR, and combined with our scheduled amortization payment of $5 million for the first quarter, reduced the balance of our term debt from $200 million as of the end of last year to $175 million currently.

Looking ahead, the combination of at least $50 million in expected total prepayments during the year and $20 million in scheduled amortization will result in term debt below $130 million at the end of 2011. These prepayments represent the first phase of our two-part strategy to improve our balance sheet. In addition to these prepayments, we will seek to refinance our existing debt at rates below the current 9.75% level as those options become available to us.

In summary, we are pleased with a solid first quarter to start the year. Thank you again for your interest in Vonage, and I will now turn the call back over to Leslie to initiate the Q&A session.

Thank you, Barry. Operator, please open the line for questions.

Thank you. (Operator Instructions) And our first question comes from the line of Michael Rollins of Citi.

Hi, thanks for taking my questions. Good morning. Just a few questions for you. First, could you give a little bit more specificity on the change in USS sequentially just to understand what happened to more of the customer revenue?

The second question that I had was can you help us put in perspective the size of the market that you're going after? So you're now selling to more locations, more geographies, more customer segments, and gross adds went up about 8,000 sequentially, 20,000 year-over-year, and can you help us just conceptualize like that improvement in productivity relative to the size of the market that you're going after?

The final question that I had was on churn, and on the churn front, if you look at the overall churn rate, whether sequentially, year-over-year, let's just call it plus or minus flat. But you've now got half your customers on Vonage World which has lower churn than the other customers, so what's happening in the numbers? Is it that the churn from the non-World customers are going up? Is the churn for the World customers going up but just still below the other customers? Can you just help us think through those mechanics? Thanks very much.

Mike, it's Marc. Let me take your second question first in terms of size of market and then kind of move down the funnel to churn and USF. So from a size of market, as we've discussed before, the international long-distance market is sizeable. We're looking at 12% frequent users of US pops in any given month. We call frequent users those who use more than 20 minutes a month. In terms of global scale, you're talking about a market that is a US market well in excess of $17 billion a year. Globally as orders of magnitude we estimate it to be four to five times larger than that. So relative to the overall market opportunity, our growth is very small. We have a very small market share and there remains significant additional opportunity.

What we've learned in proprietary market research is despite popular belief, the vast majority of customers, more than 60%, still make their international long-distance calls directly through their mobile phone or their wireline phone, paying very high carrier rates. We believe with improved applications and reach into those devices, either by extend -- to those customers either by extending our Vonage home phone service penetration to new segments or by extending it to additional devices, mobiles specifically, and making that a more convenient experience through smart phones, we can increase share and we have virtually limitless upside opportunity on a global basis.

And, Mike, let me respond to your other two questions specifically regarding USF fees. They increased $0.40 from the fourth quarter to the first quarter from $2.07 to $2.47, which in aggregate was about a $3 million increase sequentially. And with regard to your question on churn, let me take that apart for you a little bit if I can. Yes, churn is basically flat with last year's overall level of 2.4%. There are a couple of drivers there.

One is you mentioned the impact of Vonage World now being over 40% of our base, but it's important to point out that approximately half or nearly half of the Vonage World customers use the product for domestic only. So the real split in the churn drivers has less to do with specifically the rate plan being Vonage World versus others and more to do with whether customers are meaningful Aisle D users or not. So those customers that use Aisle D reasonably extensively, we count them at more than 20 minutes per month and that represents about 25% of our base. So those customers churn at lower rates than the overall domestic user base, so that's the first point is that the Aisle D users continue to churn at lower rates than other users.

The other factor in this is that -- and we mentioned this on the last call. We introduced a no-contract offer starting in the fourth quarter of last year. As the churn had come down, we became comfortable with that. We knew going into that experience that the impact of no-contract offer is that you expect to have higher churn in the earlier life of the customers because what happens under a contract is that you'll get a modest spike in churn in the first month or two. Then it's fairly steady state churn through month 12 and then you see churn spike as people come off contract in months 13 through 15. So with that no-contract offer, the profile of churn changes so that you have and would expect to have a little higher churn in the early months relative to what you would have on a contract. So we continue to evaluate those offers in the market and we'll continue to make adjustments as appropriate going forward.

Mike, let me just add to the comments on Aisle D revenues and give you the specific numbers. I think I might have misstated the US number. The US Aisle D international long-distance revenue is $19 billion with global Aisle D revenues we estimate to be $80 billion, so obviously still a small fraction for those markets in which we've already entered.

And as we've talked on prior calls, the market for international roaming as well as for messaging services are markets where they are equally as large, $70 billion on international roaming, and about that plus a bit more on SMS, but obviously we have yet to materially enter those markets but you could expect that in coming quarters.

Thanks very much.

Next question, Operator.

Our next question comes from the line of Mike Latimore from Northland.

Great, thanks. I guess just on USF for a second, it had an impact on cost of telephony services, too. I guess do you see that repeating in the second or third quarter, or how long will that last?

We expect it basically to be flat, Mike. I mean, it tends to be a little bit lumpy, but on balance flat. Tends to be a little bit higher in the first quarter, but of course we can't predict that because it's set on a quarter-by-quarter basis. But as we look forward we wouldn't expect a dramatic shift from where things have been.

I guess it looks like your cost of telephony services were -- didn't trend up too much despite more international revenue, factoring in that USF function. So I guess are your efforts in that regard continuing? Do you see the cost of telephony services per line continuing to be flat or does it grow a little bit?

Yes, to your point, Mike, we actually saw the cost of telephony service come down from Q4 to Q1 if you take out the impact of the USF increase. So we've been very pleased with the progress we've made there. In 2010 the real progress on COTS was on lowering termination rates as you know where we were able to take termination rates down by 25% in 2010. There's still some more room to grow there, but there is also room on the domestic side as we look to implement next-generation call routing, for example. So we would expect to see in the back end of the year, assuming continued penetration of the LD segments, that's going to drive up COTS overall but it will certainly be mitigated reasonably substantially by the improvements we continue to make particularly on the US side during this year.

In terms of the gross ads, what percent of those are signing up as Vonage World, and then also I guess out of that what percent are using ILD? Because the ILD, I think it's been 25% of the base now for a few quarters.

Go ahead.

So about 80% of the gross ads are from Vonage World, and a little over half of those are Aisle D users.

Okay.

So it increase -- was about 40% of the base as of the end of the year and it's up to about 43% as of the end of the first quarter.

Okay. Got it. And I believe on the last earnings call you had discussed second half of the year expecting some more significant revenue growth let's say, I believe. Do you still expect that, and what would be the top two drivers of that?

So we do -- we have not changed our guidance around new products and services beginning to impact revenues in a meaningful way in the back half of the year. We've launched some new products recently including the Vonage World Premium that I mentioned in my call as well as imminent launches of additional mobile services that we believe can help grow the topline. In addition to that we're seeing upsell and revenue migration from our existing base where managing our existing customer base into improved ARPU is contributing to topline growth in the back half, as well.

Lastly, as we have done, as has been our practice in past years, we've been very effective at surgically implementing price increases where the value proposition we're providing is exceptional and there are not a lot of competitive alternatives. We expect to take some pricing actions that will have some impact in the back half of the year and then obviously full year 2012, as well.

So it sounds like I know you might emphasize certain metrics more than kind of others going forward, but it sounds like this would -- revenue growth would show up more in an ARPU function as opposed to a material change in kind of gross ads from over here?

Well, I think you'd expect to see a mix. I think you'd expect to see -- certainly we expect that ARPU will stable and modestly growing. We also expect to be able to grow absolute revenues as either subscriber lines or simply pay per use as might be the case in some kind of mobile applications where it's not an ongoing recurring service contribute to topline.

Thanks a lot.

Next question, Operator.

Our next question -- (Operator Instructions) And our next question does come from the line of Robert Routh from Phoenix Partners Group.

Good morning, guys. I think the quarter looked really good and I have some questions about the Spanish product that you guys recently launched. Can you give us a little bit more of an update as to how well that's doing and where you expect that to go and how big you think that opportunity could be considering that kind of redundant business platform you have established?

So let me make sure I'm clarifying for you. So our Hispanic efforts have really been increasing over the past year. We started in the spring of last year simply targeting that group, having identified them as an underserved segment both from a standpoint of international long-distance services but also to how basic telephony service has been marketed to them. During the course of the year we built out essentially an end-to-end Spanish language experience that included sales and service, sales being our inbound telemarketing environment as well as online portal, and then service both online as well as customer service and language. That combined with a shift to very specific marketing efforts not just to Spanish speakers but to Spanish speakers with varying specific countries of origin help us to grow the number of Spanish language orders in the fourth quarter to record levels.

We've continued to accelerate that business and we have with the addition of the Vonage World Premium product which just launched in the last week and a half, it's very early days but we've included some additional Spanish language countries, some additional South American countries which were not included in the original Vonage World. Beyond that there are far more mobile destinations that are included. As you may be aware, the price to call to mobile phones internationally is a tiered service for almost all carriers, mobile termination being more expensive, and we think there's enormous opportunity there to meet the needs of folks who are calling to mobile phones in other countries. The World Premium product we expect to deliver against that, but it's way too early to be able to think about the overall impact on gross ads for the year. But the early progress has been encouraging and we have seen some early response to Hispanic advertising that launched just a week ago, almost immediately after turning it on.

Okay, great. And then a few questions about the balance sheet and financial engineering. I mean, it seems as though you mentioned that you're looking at your debt and right now you're only levered pro forma at year-end at about a little over one time which doesn't seem reasonable given the cash flow characteristics of this Company and the visibility of that even if you didn't grow subscribers at all.

I'm just curious as to what the Company thinks is a reasonable debt level that you could handle because it looks like you could easily hand two to two and a half times and that possibly refinancing your debt at half the rate you're paying now because you get no tax benefit from the interest rate you're paying because of your NOLs, you could generate significant -- you'd have significant free cash flow from operations and refinancing of the debt, it seems as thought that would make a lot of sense. And then repurchasing shares could take the stock materially north of where it is and more fairly valued because the capital structure still just isn't close to optimal just from what I see. I'm just curious if you could comment a little on that.

And I know you made a little comment at the end of your presentation, but a little more clarity as to what you think an optimal leverage ratio would be, what could this Company handle, what cost to debt, and would buybacks make sense at some point given your operational free cash flow as well as potential increase in leverage.

Yes, Rob. Let me start by laying out the way we think about this sequentially, and as I mentioned in the formal remarks, during the course of this year our strategy is first to prepay the debt out of cash flow. We think that's a very good use of cash given that we are paying 9.75% interest currently. We obviously we able to cut the interest rate by approximately half due to the refinancing, so that's the first priority and that's why you see us explaining that we plan to continue those prepayments.

In addition, we do think that there will be opportunities to refinance the debt with continued and sustained financial performance. Certainly from my previous slide we'd be able to do that as the Company has successfully improved their performance. We expect that to be the case here, so we will be actively looking at the opportunities to do that and we'll certainly be taking advantage of those as they come available.

I think in terms of the priorities of the cash going forward, it would be really in this order, prepay the debt. Secondly is we do think that there are potential opportunities to continue through acquisitions to enhance the value of the Company so we would look at that. And then thirdly we would consider at the right time returning value to shareholders through more likely a stock buyback than a dividend. We have not announced any plans along those lines. I think it's early to be thinking about that currently, but that's how we think about the priorities of the cash flow.

In terms of the overall targeted leverage ratio for the Company, certainly we could sustain well more debt than we have currently. When we did the refinancing we made a decision not to leverage up the Company. I think as we go forward and go through the course of this year, we will look at what that is. But at this point we're not prepared to target what that could be, but certainly understand the impacts of that kind of financial engineering on the equity value.

Okay, great. Because it just seems like your cost of equity and your cost of debt are pretty close to parity right now. Equity is a little higher it seems, but that's a good use of your cash. If you're going to really generate $100 million in free cash flow almost this year and then going forward with some growth, it would seem you're going to start stockpiling cash, and I don't know how you're going to find acquisitions, so the question is what else would you do with it? Do you see big acquisitions on the horizon or do you just kind of stockpile the cash and then go from there?

So we think about it I think as the year unfolds, for example, so as we look at it now with the level of debt that we have at 9.75% interest, that's a very good use of our cash flow during the course of this year because you get nearly a 10% arbitrage differential there. As we go throughout the course of the year, make the planned debt paydowns, continue to evaluate other options, I think we would look at it holistically in terms of what made sense in terms of an optimal capital structure and what those other options might be. So we haven't had the ability frankly to look at acquisitions. Under our previous debt was highly restricted and essentially precluded acquisitions, so that is at least an opportunity that becomes available to us financially.

Maybe I could add a little more topspin to that. So we clearly expect as we look out over a two- to three-year time horizon that organic-only growth in a technology environment is not something that is likely to occur. We are currently in the process of evaluating acquisition prospects, and the lens through which we look at that is really can we actually acquire technology? We're not so interested in buying revenues, but technology are concepts that are beginning to get traction, potentially those that have intellectual property or strong technology engineering human resources attached to it. It's a great way to be able to scale the business and there's obviously tremendous demand for mobile application developers and engineers, so we're constantly on the lookout there.

We look at this again primarily to enhance the new product and service areas of the business and accelerate growth there, and you can think about them as relatively modest acquisitions in terms of overall size because we're not out there trying to buy huge revenue streams.

Great. And just one follow-up on that which I think makes a ton of sense, but in terms of acquisitions given where your stock is now, would you be more likely to use your stock as a currency or would you use cash?

I think we would just have to evaluate it on the facts and circumstances at the time, Rob.

Okay, fair enough. Thank you very much.

Next question, Operator.

Our next question comes from the line of William Vogel from Merlin Securities.

Good morning. I was wondering if you could just repeat the value proposition for the two new products that you're talking about today. I couldn't keep up with your -- I know they both sounded excellent, but I just was wondering if you could just repeat the value proposition.

Sure. And I'll apologize to the group in advance. For competitive reasons, until we're actually launching, I'm not going to give all the specific details, but to give you the general space so you can understand how they fit within the overall context.

So the first is a standalone mobile application for smart phones. It addresses the international long-distance market and we intend to launch that in over 75 countries simultaneously. It is one that has global reapplication and we think it solves some of the very basic problems about initially establishing service that you're paying for on a mobile phone as well as the way you use it and how fast you can be up and running. We think it will be the most convenient way to simply dial international long-distance numbers from anywhere to virtually anywhere and we'll be able to see that in the coming couple of months.

The second product is one that is an enhancement to the core Vonage home phone service offering. You can think about it as an extensions like product, the notion being people -- our consumers are telling us all the time that they want to be able to take advantage of the Vonage rate plan, the relation that they have with us directly now, and extend that benefit to other devices. And we don't care where people are sitting or which device they're on, and it would actually allow that core Vonage service to work on mobile devices or other wired phones and to register multiple devices and have that charged to the same account is an improved value proposition.

The way we're planning to structure that, we think it will give us some increased usage as there's more availability and access to Aisle D as people have it on more phones to our base so there's an ARPU enhancements that we expect over time will be delivered, and we also believe that the overall value proposition for our home phone service which has traditionally been you have to have a home phone and that's the only place you get to use it will be positioned very differently because now you become able to apply for a service plan that you can use on multiple devices -- your home, your mobile phone, your office phone -- and get the benefit of the Vonage value proposition across multiple devices no matter where you are. So that's the second of those products which will follow the first one.

And just as a follow-up, in terms of the SG&A build for the balance of the year, does this fit within that build or are we going to see a revision to that on the back of these new introductions?

I think we would be able to accommodate those within the guidance that we've given.

Okay. Thank you very much.

(Operator Instructions) And one moment for any further questions.

Next question, Operator.

And we do have a follow-up from the line of Robert Routh from Phoenix Partners.

Just one question. I know you addressed it a little bit, but given that churn kicked up a little bit because of the no-contract which makes total sense, I'm just curious as you roll out these two new products and everything else, and I'm not holding to you anything, but what are you thinking about how we should look at churn on a full-year basis and going forward? Obviously it's going to be higher when you do have no-contracts, but I'm just curious just for modeling purposes what would be a good range or number for us to look at long term?

Let me take that. We maintain our guidance that we believe it's going to be roughly flat versus 2010. You might get occasional peaks and valleys during the course of the year, but based on our current visibility and trends that's what we expect. In terms of the new products that we're launching, I should clarify that standalone mobile offering does not require Vonage home phone service. We wouldn't expect that to have any impact on churn, and since it is going to be a product that does not require an ongoing subscription, you'll see that as revenues we wouldn't report specific ongoing subscriber lines or churn associated with the product. It would be a revenue stream, Vonage extensions. We would expect that those customers that take it would certainly have a lower churn profile. It increases the utility that they see from our core service, and obviously without having launched it yet we don't know what the profile of new subscribers would be.

Okay. So just fair to keep it kind of flat is what you're expecting based on what you know now, and that's safe?

Yeah, I think as Marc pointed out, really essentially stable churn. There's some puts and takes going both directions, but in that same zip code.

And I think we did mention the -- so we had a one-time or this quarter where we had some countries that we took out of the Vonage World plan that weren't meeting financial objectives. We from time to time do that. Pricing actions can occasionally change monthly churn trajectory, so I would encourage you to keep a range up and down. It's very difficult to have visibility quarter to quarter beyond the ranges that we've experienced in the last couple of quarters.

Sure. And then one last question. You did mention how later in the year as the new product is ready you might increase prices in some markets in some areas. Can you give us some kind of a sense as to degree of magnitude of what kind of pricing increase you're thinking of or 5%, 10%, and is it across all your products or just Vonage World? Is there -- how should we look at that?

Until we announce it, I'm not going to give specifics on the price changes. Historically when we've done this, we've done it that are in ranges below 10%, so we look at this as the balance of what is opportunistic. We do it in a way that we are obviously attempting to avoid churn and resell the value proposition relative to competitive alternatives, so there's always risk when you take some level of pricing, but we have been to this movie before and have successfully implemented that. And the kind of increases we're contemplating are similar to where they were before and they're in places where consumers are getting significant value today and we think there's not a lot of alternatives for them to go to.

Okay, great.

We have time for one last question, Operator.

Our final question comes from the line of Michael Rollins from Citi.

Hi, thanks. Just to follow up, can you give us a sense in terms of service revenue what's not coming from the home replacement market or your traditional subscriber business if you look at what's coming from the mobile and the application side of the company? Thanks.

It really hasn't changed appreciably from where it has been, Mike. I think we've said in prior quarters that it was at a run rate just below about $10 million annually. So as Marc pointed out, in the process of introducing some of these new products, that will begin to take hold in the back half of the year, so that's where it is currently.

Great. Thank you very much.

Okay, Operator. This will conclude the call. Thank you.

Thank you. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.