Venture Global, Inc. (VG) Q4 2011 Earnings Report, Transcript and Summary

Good day, everyone. And welcome to the Vonage Holdings Corp. Fourth 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 fourth quarter and full year 2011 earnings conference call. Speaking on our call this morning will be Marc Lefar, Chief Executive Officer; and Barry Rowan, CFO. Marc will discuss the company’s progress and strategy and Barry will review 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 two, 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 our 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 IR website. And now, I will turn the call over to Marc.

Thank you, Leslie. Before I review our results and provide our outlook for 2012. I’d like to provide an update on the response we’ve seen to our new Vonage Mobile app, which we launched last week. Vonage Mobile, the most exciting product we’ve offered since the launch of our initial VoIP service and continues our heritage of offering innovative products to deliver great value and convenience to customers. If you have not yet downloaded the app or seen last week’s press release, let me take a moment to describe it for you. Vonage Mobile is a free downloadable application for iPhone and Android that lets users make free high-definition calls and send free texts to all users of the app worldwide. It works over Wi-Fi, 3G and 4G wireless data networks. When calling people who don’t have the app, users get ultra low-cost calling worldwide with pay per-minute rates that are on average 70% less than major mobile carriers and 30% less than Skype. Vonage Mobile consolidates the best features of our prior applications, while adding important functionality, better value and improved ease-of-use. Early interest has been extremely positive. There have already been over 500 stories published globally and we’ve substantially exceeded our pre-launch expectations of 100,000 downloads in the first week. Most user reviews have been very favorable. We plan to release improvements in new features every few weeks. Vonage Mobile combines the best of free voice and messaging services with exceptional high-definition audio and incredible value for traditional international calling all while using the existing mobile number and address book. If you haven’t downloaded the app, I encourage you to do so and let us know what you think. The successful development and launch of Vonage Mobile is an emblematic of the strategic and operational progress we’ve made…

Thanks, Marc, and good morning, everyone. I’m pleased to review our financial and operating performance this year. In 2011, we delivered record high financial results and continue to build on the earnings and cash flow momentum established over the past several years. For the fourth consecutive year, we generated positive and growing EBITDA, and for the third consecutive year, we reported a positive and increasing net income excluding adjustments, which more than doubled from 2010. We have improved our balance sheet dramatically through the two transformative refinancing we completed over the past 14 months. Our strong operating performance and lower interest expense combined to generate $108 million or $0.48 per share in free cash flow. This was our second year of positive free cash flow and each year generated over a $100 million. With our core business now stabilized and highly profitable and with a fresh balance sheet, we are well-positioned to execute on the next phase of Vonage’s transformation through accelerating our investment and the strategic growth initiative Marc outlined. Let me now move to review our financial performance in getting on slide three. Our results in fourth quarter were generally comparable to those reported in the third quarter of 2011. In the fourth quarter, we generated EBITDA of $40 million, our fifth consecutive quarter of EBITDA at or above $40 million. For the full year, we grew EBITDA to a record high, a $168 million achieving our guidance of at least $165 million provided on our first quarter earnings call last year, which represents a 7% increase over the prior year as we delivered operational improvements across most segments of our business. Through an aggressive focus on driving operating efficiency we reduced the unit cost of devices by approximately 10%, lower cost of telephony services by 3% and…

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

Thank you. (Operator Instructions) Our first question comes from Michael Rollins of Citi. Please go ahead with your question.

Hi. Good morning. Thanks for taking the questions. I think, three if I could please. The first one is, Marc you mentioned the success of the new application in terms of, I think you mentioned over 100,000 downloads in the first week. Can you share with us how that compares to the last couple of mobile product launches that you’ve done and how we should think about the way they should ramp? The second question I had was you also described an expectation for incremental revenue, I think you said within the next few years of $100 million. Can you talk about what the margin potential for that is and how to think about the cash contribution from that type of revenue growth? And then finally, if you could just talk about the churn and what’s keeping the churn elevated from where it was earlier in the year and yeah, maybe where initially you’re hoping to get that number down too? Thanks.

Sure, Mike. And thanks for the questions. Let me take them in order. On Vonage Mobile, just to clarify we had some in going expectations that we will be pleased if we were able to generate 100,000 downloads with basically virtually zero marketing spending in the first week. We’re blown by that number by several fold and are pleased with the traction. It’s very difficult and something is only a week old to look at the viral nature and how it’s spreading. But the expectation for us at this point based upon how it compares to other application, in day five for example, we were seeing that, that acceleration was doubled what the kind of downloads were from day one. That’s a very different dynamic than what we saw, which is more straight line, continuous motion from prior applications. That combined with increasing positive rating exposed in the Android market and in the iTunes store, as well we’re seeing in terms of number of invited friends that people now have, they can talk on net gives us some optimism that we think this could grow pretty quickly and it would not be unrealistic for us to hit ballpark of 1 million downloads by end of quarter, certainly at current courses speed. Again, I want to warn folks that it’s only a weekend to it, very difficult to forecast a trend based on when we -- we are encouraged with the early signs and it’s growing much more quickly than our previous experience. Let me hit the churn comment and I’m going to ask Barry to talk about the margin potential on the $100 million of new revenues. From a churn standpoint, as you know, one of the drivers that causes an uptick in churn over the past year was the…

That’s very helpful. Thanks. And then on the margin potential for the $100 million?

Yeah. Let me speak to that, Mike. So let me start with, I mean, the revenues, we do see as having that kind of potential through a combination of the strategic growth initiatives between both the mobile services business, as well as expansion outside of the U. S. So since we’ve just introduced Vonage Mobile products, let me talk about that margin potential and how we think about it. And first is, we have very low termination rates as you know, which enabled us to be able to price at the kind of levels that we described and we have priced this for penetration. The real objective here is to build a community, because that’s really when you get the revenue potential to start to grow once you get that community build, people start making those off-net calls, which is the primary source of revenue in the early stages. So with our low cost and termination, we have been able to price this in a way that gives a good incremental contribution margins in the range of our current core business. So and overtime, what we’ll have to monitor is how the market evolves. So, as I mentioned, it’s priced to be able to drive downloads. We will continue to evolve the business model over time as we look, for example, at various alternatives or payments and the like. So, but the strategy is to be able to price it now, to drive penetration to make acceptable and attractive contribution margins and then, we will evolve that over time as we see the overall user base grow.

Great. Thanks, just a follow-up for one more moment, I apologize for asking so many questions. But just in terms of, you guys obviously get a lot of valuation of the incremental investment relative to the incremental returns. And it seems like the story for Vonage over the last couple of years has been about looking to develop this optionality that you have to move into new markets, while harvesting the cash out of the home replacement business, if I have that right? And it seems like now you are willing to take some of that home replacement cash and really get more aggressive for these new sources of growth. So, as we’re trying to evaluate returns for that, I mean is there a way to think about maybe the rate of return you should get that over a five-year period or just the ability to generate long-term margins where you are today or better. Any further thoughts on that will be just incredibly helpful? Thanks.

So, Mike, let me take the front end of that in terms of the framing, I had to think about what we’ve been doing, where we’re going. You’re largely correct in stating that we have over the last couple of years had to get to a point where we had the stable -- the stability and the cash flow that gave us this optionality to begin to invest and we saw, well, the time is right, we had the organizational capacity, the product and understood the markets. It was not long ago when we didn’t have even the flexibility of indebt covenants to be able to ride very far away from a very specific set of financial metrics that had very high pain thresholds, if we were to miss any kind of numbers. We’ve now been able to generate tremendous cash. We’ve been able to stabilize the business. Mike, Barry, talked about the pristine balance sheet. And now we’ve also, while doing that we’ve been able to understand better these markets, build some of the products and services as you see in Vonage Mobile which from that capabilities we had 18 months ago. And now that we are much closer to the ability to start really selling and marketing these and managing with the interfaces for partners, whether it be distribution partners or it be partnerships internationally, or whether it be to accelerate the speed with which we actually bring new products and services in mobile to market, we now have the ability to invest as prudently to drive these revenues. In terms of overall return, I’ll let Barry comment in terms of our internal targets kind of over a five-year, what kind of IRR we are targeting, but that’s exactly the way we’re thinking about the business, which get it to this point, generate the cash, know that we can continue to generate cash and be able to afford investment in those things that we think have strong returns and leverage our technology and organizational skills.

Yeah. Let me just drill on that a minute, Mike. You used the word harvesting, I’m not sure, I would not use that word, I think when we have got the core business to the point where it’s driving stable cash flows, we view this as an appropriate use of a portion of that cash to really drive the growth. And now as Marc described, we developed with the conviction and the plans around these growth initiatives. So, as you know this is not a change in direction at all that was really a continuation of the direction, but a deepening and an increase of -- deepening of the conviction and an increase of the investment, now that we have that conviction. So, as we have laid plans during the course of this year and now we’ve put the business models in place, we certainly are going to bring a prudent, measured financially disciplined approach to the way we evaluate these opportunities. So, we would look, for example at around 20% kind of in our threshold to both projects. That’s been the case as we look at these opportunities. We talked a lot about mobile and we also say that on the international expansion alternative, that is going to be done as we’ve described on a more case-by-case, partner-by-partner type basis. So we will look at each of those projects and opportunities as we develop a very detailed cash flow model and take projection around that, that are designed to meet those internal thresholds.

That’s very helpful. Thank you.

Let me add one more point on the guidance. Again, we are pretty straight shooters and try to give the transparency that we can and also where you don’t have it, we won’t. I think on the guidance, we wanted to communicate to folks at the start of this year that we believe the time for investment and accelerating that investment really is now. We have enough visibility to products and servicing and opportunities that we don’t want to surprise somebody later in the year. It’s not a guarantee that it will be five or 10 or that it is consistent through the quarters during the course of the year. We are providing a range of estimates because we need the flexibility, we think about our total marketing spend and total size of our business, $5 million to $10 million a quarter is not a lot, when you think about starting businesses of this magnitude. So we want to share with you the range, lay them on the table and trust that we are going to execute each one of those projects and each one of those investments and evaluate them individually. It’s not a right of communication that the money will be spent. It’s -- us trying to share with you the range of investments that we think will be required and we are going to do that very opportunistically and if something catches fire, we are going to cede it and if something isn’t working particularly well, we’re going to cut it back. That’s the way we’ve operated for the last three years, but now we are going to do that with a broader range against driving revenues.

That’s very helpful. Thank you guys very much.

Okay. Next question, Operator.

Our next question comes from Mike Latimore with Northland Capital. Please go ahead with your question.

Great. Thanks a lot. In terms of the $100 million kind of view, how would you divide that among the three kind of growth initiatives that you have here. Would you say that kind of get $33 million from roughly each of those three growth areas or is one going to be the predominant key for that $100 million? And then which of the three kind of growth areas you think will be most impactful this year?

Mike, I think it’s too early to divide those. We wanted to give a sense of guidance for what we thought the overall opportunity could result in. The way I -- we would describe them I think are generally in order of priority and sequencing as we laid out. So it’s really the mobile services opportunity, as you know, a very large market. We have a product that is out of the gate now and I’m very pleased with those initial results. So clearly that has a platform and extensions of that platform are going -- is going to be a very important for us as where we go and are probably certainly the highest priority at this point in terms of time. The second priority is, on the international geographic expansion, we’re active in discussions about that. As we’ve talked about, that will depend on the nature of the relationships that we develop because we do see that it’s primarily coming through business partnerships, so but those markets are very large and some of those potential opportunities are large. So, I think that is going to be -- characteristics of that growth are going to be different, because they are going to be based more on a project-by-project kind of a basis versus the mobile opportunity that is really driven by the overall market opportunity and the position we’re in to be able to compress the pricing in the industry historically and with our -- leveraging our technologies platform. And the third area is continuing to drive the penetration into ILD callers in the U. S. So we do see that as an opportunity, that’s a more mature market and we continue to tune up that marketing spend to drive that, that’s the order of priority and I think we put them in internally as they unfold.

Great. On the mobile -- the new mobile apps, sounds like downloads are going well. Do you have a sense or a goal as to what percent of the download will be paying users versus free users?

We didn’t -- we have a robust model on that and we’ve looked at what are general industry norms along these lines. So you have downloads obviously that translates into number of active users and in our case that then translates into the number of people that are actually monetizing it based on off-net calling. So, as typical in the industry, well, it’s a relatively small percentage of it ultimately go all the way from download to monetize calls. But the early results are positive actually. The active users are ahead of expectations. It’s too early to see how the monetization results are going to unfold. But we’re very pleased with how that is unfolding at this point relative with the model we have in mind.

Yeah. I mean over the next few months, Mike, the goal in this kind of model is you’ve got to build large community. You’ve got to get folks who are active users, using the free services that are then pulling through those additional revenue streams. And by the way, there is additional revenue streams, we talked about them as the international calling and texting, but there is also opportunities if you get the right kind of size of base particularly they’re heavily using chat and SMS to use develop advertising models, as well as there is wealth of information created based upon a large-scale community that can be monetized potentially as well. So, I think the key metrics we’re focused on right now, our downloads and folks who are actually engaging with the product and inviting others to join and having those contacts, that is where we got to go first and foremost. If you do that well then the revenues will follow.

Okay. And then on the reintroduction of annual contracts, is there going to be some sort of ARPU trade out there? How should we think about ARPU versus move back to annual?

No. There won’t be an ARPU trade-off with return to service agreements. The way we’re structuring this is, previously everybody got our promotion [dossier] and now the way we’re going to structure this is, much like the wireless industry in terms of device subsidies. If you want to get the promotional pricing, you get -- it will take us a 12 month service agreement and if you simply want to pay the full both $26 per month, then you don’t have to take that contract. Net-net, with holding any other potential ARPU compressors or competitive stuff, that will technically give you something more of an ARPU increase because you wouldn’t spend more that promotion, we are not forecasting that, but mathematically that’s what you conclude. It’s just a function of taking existing promotions and those who would require service agreement, it really returns to what we were before, but looking at people choice, so that, those who simply don’t want to be locked into a contract do have an alternative with us.

Okay. Thank you.

Okay. NEXT question, Operator.

(Operator Instructions) Our next question comes from Robert Routh with Phoenix Partners Group. Please go ahead with your question.

Hi. Good morning, guys. Thanks for taking my questions. Just two quick ones. First, I noticed, I mean, clearly, you guys reverse the NOL, which you didn’t think you’d ever be able to use and that tells me that you obviously see sustained profitability from a pre-tax point of view for GAAP in the foreseeable future. I’m just wondering if I’m reading into that right and if you can tell us kind of, obviously, how much clarity priority did you have in order to take the step of reversing that NOL and then actually putting it back on the books and being able to utilize it? And then second question is, obviously you spoke about your return on capital, you look for 20% IRR and looking to your stock down today 15% and giving your balancing sheet with solid as a rock, the free cash flow expectations, the growth and even though you had de minimis loss of subscribers for the year given your sub-base, we would see the best use of your cash now would clearly be on stock because your cost of equity has got to be over 50%. And yet, with your debts so low for the company that could be leveraged two times at almost a zero interest rate environment. I’m just wondering whether management would consider at some point instituting some kind of a share buyback because it would see as though in additions rather initiatives that would be a really good use of your cash, as well as the good signal to your major shareholders that you believe your -- stock is cheaper at current levels.

Well, let me take your first question first, relative to the NOL’s, you’ve got that exactly right, it does -- it requires a very significant analysis both by management, the Board, internal audit, sorry, external auditing firm, as well as other experts to determine what is the probability that you’ll be able to use those before expiration and the measure is degree of confident that you in fact do that so it does reflect as you rightly pointed out confidence to sustain profitability. So, that is a very bullish action to take that and put that as a differed tax asset on the balance sheet. Barry, do you want to take that?

Yeah. And so that is absolutely the case and can’t do that and make that’s kind of adjustment that is in accounting and prove without taking of course a very careful look at that that is along with scrutiny. So, we really did that and it is certainly an indication of our confidence there. With regarding the use of the cash and would we considered about buyback and the answer is yeah. As we think about per use of cash and we talk about this in the past and clearly, as we build even with the investments that we are planning and making to drive growth. We do plan to continue to build cash during the course of 2012 albeit more modestly then if we had not been making these kind of investments. So paying -- we’re paying for growth out of the operating earnings of the company. We will also continue to evaluate opportunities for inorganic growth that would make sense. But at the right time we would also consider returning capital to shareholders at an appropriate time in the future. So, as we talked about in the past, being in this position of having reasonably sizable cash positions of $59 million at the end of the this quarter, for example, it’s new to Vonage but as things unfold that is certainly something that we will and we actively discuss with our Board and in something that we would considered doing at the right time.

Great. And just a follow-up to the first answer, is there any, if you are as on our side of fence, are you looking at the company. How would you quantify the cash value of taking those NOLs and now you have the benefit of them as you wouldn’t before. What do you think is our fare kind of tax rate to apply to that number to get to the incremental equity value you’ve created by being able to do that?

Well, I think the best way to look at that is that, you look at the entry that was put on the balance sheets for the deferred tax assets are in $326 million. So, that is in fact the NOL that we have in place, that we believe are more likely than which is the pick of the tax to be used before they expire you take those NOLs and apply the effective tax rate. So that is the expected cash savings from those NOLs at prevailing tax rate at $326 million. And then you to get a present value of that, you’d have to discount it back obviously based on the expected usage over time.

Sure. Great. Thank you very much.

Okay. Operator, we have time for one more question please.

Our final question comes from [Brian Hurray] with (inaudible) and Management. Please go ahead with your question.

Hi. Thanks for taking my question. I actually have three. Just to follow-up on the last question. Do you have a target leverage ratio in mind for the business because it looks likes you’ll be either completely debt free or in a net cash position before the end of the year? Do you have any thoughts about philosophically what the right level of leverage is?

Our strategy on that Brian is to pay down the debt according to the current schedule, as you know historically, we had prepaid debt when we had interest rates up in the 9%, 10% range. At these current interest levels, it does not make sense in our view to prepay that. So the plan would be to pay debt down according to schedule and that debt gets paid off in the middle of 2014. And the strategy there is to be able to maintain debt capacity. It’s not using it for things that would make sense in the future. So the strategy is to maintain that level of debt for the foreseeable future but have that capacity available as appropriate for future uses.

Okay. And then on the Mobile app that has just been introduced, do you have a kind of a range of ARPU number there that you think is realistic to achieve once you get the community built?

Yeah. We do have expectation for that, I mean, when you look at where the market is, I mean it’s in the kind of sub $10 range, but that’s what you see is typical, for example, not to give you when you go to the Skype, that’s one for example, you see that, but what we look at is, is something in that kind of a zipcode.

Okay. That’s fair.

... high single-digit.

Okay. And then lastly with the three growth initiatives that you’ve discussed during the call, can you give us any sense as to what kind of transparency or visibility you are going to offer on the -- be it the growth or profitability or both of those, those three efforts over the course of the year?

We recognize the need for visibility into that. So we will describe those in ways that make sense as they unfold, for example, numbers of download that Marc described for the Mobile app is the best early indication of how that’s taking fold -- taking hold. In terms of profitability and we’ll have to just let this unfold, it’s obviously, it’s going to take some time for this to be material, we’ve described the in response to the previous question. Our approach to that which is to make sure that the -- make sure that the businesses indicate that mobile and the new specific opportunity achieved a targeted internal threshold, so as -- that certainly what we are achieving and we will give additional information on those revenues as they materialize over time, but it will take time.

Let me just to clarify, so we will provide tactical indicators of progress, but we do not plan to do segments specific reporting until it becomes material to the business. You should not expect that in the next couple of quarters. So we will keep you posted on progress. So you can assess how we are performing, but the level of detail as individual line item metrics and segment traditional reporting that you might expect and something that was 30% or 40% of our business. We don’t foresee that in the next couple of quarters and now we want to set certain expectation that you will see that.

Okay. Understand. Thank you.

With that, we’ll conclude the call. Thank you for joining us today.

Thank you. Ladies and gentleman, thank you for your participation in today’s conference. This thus concludes the conference. You may now disconnect. Good day.