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Venture Global, Inc. (VG)

Q3 2013 Earnings Call· Thu, Nov 7, 2013

$13.15

-0.19%

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Transcript

Operator

Operator

Good day, everyone, and welcome to the Vonage Holdings Corporation third quarter 2013 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.

Leslie Arena

President

Thank you. Good morning and welcome to our third quarter 2013 earnings conference call. Speaking on our call this morning will be Marc Lefar, Chief Executive Officer; and Dave Pearson, CFO. Marc will discuss the company's strategy and progress and Dave will review our financial results. Slides that accompany Dave's discussion are available on the IR website. At the conclusion of our prepared remarks, we will be happy to take your question. As referenced on Slide 2, I would like to remind everyone that statements made during this call 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 expectations and depend on assumptions that maybe 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 slide and contained in our SEC filings. We caution listeners not to rely unduly on these 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 GAAP is available on the IR website. And now, I will turn the call over to Marc.

Marc Lefar

Chief Executive Officer

Thank you, Leslie, and good morning, everyone. Today we reported a solid third quarter. Gross line additions of $175,000 were up 12% sequentially and up 2% versus the prior year. This was our best quarter of GLAs since the first quarter of 2011, as we benefited from a stable volume of international callers and a first full quarter of national BasicTalk sales. As expected, churn increased modestly to 2.6%, due to targeted price increases executed during the quarter, and the early life churn associated with higher levels of new gross line additions. Low seasonal churn during the second quarter also affected the sequential comparison. Total net lines grew by 11,000, a sequential increase of 8,000, the highest level of net additions since the first quarter of 2008. Revenue of $204 million was roughly flat sequentially and down 1.7% versus prior year due to prior period line losses in our premium domestic customer base, a modest ARPU compression. BasicTalk sales and targeted pricing actions help to offset these factors. Adjusted EBITDA of $23 million was down sequentially from $27 million, primarily due to the full quarter impact of national launch investments in support of BasicTalk. This investment will begin to ramp down towards the end of the year, as we move to more normalized levels of acquisition cost. Our steadfast focus on improving efficiency have led to further cost reductions in customer care and telephony services, which are down 14% and 4%, respectively compared to the prior year. We will continue to emphasize structural cost reductions in our 2014 plans, to help offset the cost of investments in growth and domestic pricing pressure. Free cash flow was $20 million, $9 million higher sequentially due to positive changes in working capital and lower capital expenditures. We are now at the halfway point…

David Pearson

Management

Thanks, Marc, and good morning everyone. I am pleased to review our financial results and provide you with an update on our outlook. Beginning on Slide 3, adjusted EBITDA was $23 million, down from $27 million sequentially reflecting our planned investments to build BasicTalk brand awareness. It's also reflects lower ARPU, which I will discuss in a moment, and $1 million lower net settlements to the company in the period, as we have benefited from the substantial one-time insurance settlement in the second quarter. Adjusted EBITDA was down from $34 million in the year ago quarter, consistent with our previously discussed plans to increase investments in strategic priorities. I'd like to highlight, two new financial disclosures for this quarter, as we discuss EBITDA, the first relating to the acquisition of Vocalocity. In the third quarter, we incurred one-time cost of $680,000 associated with the Vocalocity acquisition, mostly relating to professional fees. These costs are included in SG&A, but have been excluded from the calculation of adjusted EBITDA in order to maintain period-to-period comparability. We anticipated additional transaction related costs in the fourth quarter, related to the closing of this acquisition. The second disclosure relates to our joint venture in Brazil, in which Vonage has a controlling interest, and therefore reports on a consolidated basis. Beginning in the third quarter we're reporting on our income statement and add-back of net loss attributable to non-controlling interest, reflecting the interest in this venture owned by our JV partner. For the third quarter this item was $222,000. For the same comparability reasons this item is also excluded from adjusted EBITDA. Looking to Slide 4. GAAP net income was $4 million or $0.02 per share, down from $7 million or $0.04 per share sequentially. GAAP net income was down from $13 million or $0.06 per…

Leslie Arena

Operator

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

Operator

Operator

(Operator Instructions) Our first question comes from the line of Greg Burns from Sidoti & Company.

Greg Burns

Analyst · Sidoti & Company

Just a couple of questions around BasicTalk. Could you kind of talk to the linearity that you saw in terms of subscriber growth throughout the quarter? And then also if you've seen any competitive response since you brought that service to market?

Marc Lefar

Chief Executive Officer

So as you know, we actually launched BasicTalk in a direct mail format to those customers that had left Vonage historically or folks who have broken out of the purchase process as part of our trial markets going back as much as a year. We launched nationally with advertising and distribution in mid-May of this past year. We have seen continuing growth quarter-over-quarter, as you'd expect, and it's accelerated week-over-week. In the most recent weeks, we've seen that flattened a bit as we've got full distribution through Wal-Mart and/or through the initial phase of heavy merchandizing. We do expect some additional merchandizing behind BasicTalk and Wal-Mart coming into the holidays, and the holidays for our retail stores, we expect to get some uplift. In addition, we have been testing a number of other vehicles to optimize BasicTalk sales that includes a number of different ways to get into direct households from [ph] FSIs as well as other formations. Some of those tests that worked quite well for us. We're in the process of aggressively expanding those nationally in the fourth quarter. So we're bullish on the long-term prospects for BasicTalk. And as you might expect, one of the key drivers on this business is to evaluate what the right distribution mix is and Wal-Mart has been a great partner for us. We are also looking at how we might expand distribution and improve our self-service capabilities online. So as we look through 2014, we feel very good about the overall contribution of BasicTalk and the efficiency of the BasicTalk business. Keep in mind we only have aided awareness in the mid-20s of percentages compared to awareness of Vonage in the 80s. We still believe that launching it as a separate brand was critical to avoid cannibalization and that has been the case. We've not seen that. So we're effectively competing at the low end. We did see initially some competitive response for magicJack and other players at the low end, who changed and rollback some pricing on devices. But we feel like that is largely stabilized at this point in time, we haven't seen additional aggressive activity. So we feel like we're progressing well in the current pricing environment.

Greg Burns

Analyst · Sidoti & Company

And then in terms of mobile, can you speak to the adoption rates? Are they still kind of below what you have been looking for? And what you need to do to kind of get that viral adoption of the platform?

David Pearson

Management

It's a good question. Relative to the overall expectations, we first launched for the free mobile clients, our downloads are less than we would have expected. We are still in the mid-to-high-single digit millions of downloads. We are seeing solid international usage on those downloads, but obviously scale matters. So we would have like to seen larger numbers at this point in time. Now keep in mind, mobile lens through which we look at all of our initiatives, the Vonage mobile extensions product has been ragingly successful and a lot of people have actually shifted their usage from their homes and business phones on to the mobile platform. When we think about our allocations of revenues to mobile, we don't allocate the number of minutes being used on those services. And we are getting incremental revenue on second line extensions that are being sold into the base. As we look at churn levels on customers that are using extensions, we see that to be quite a bit lower and it's also allowed us to take targeted price increases with very modest impacts on churns. So while mobile's investment spends probably a little bit more transparent, some of the benefits hit our business in many different areas. It's also a core element to our expansion internationally. And we think it will be leverageable in the SMB market with Vocalocity. We've got some plans for mobile client enhancement for Vocalocity shortly after our day one launch. So I guess in short, relative to the original ongoing assumption, we would have liked to seeing larger viral spread to the point of what will it take to do more. I think it comes to the point of being first and differentiating on a meaningful consumer attribute. We think that the world is quickly moving to some mobile carrier displacement, it goes beyond SMS. It goes to this notion of a Wi-Fi or Wi-Phone based service with a wide area network as a compliment for certain sub-segments. We think about it as a software virtual network operator, a form of an MBNL, if you will. And we think that for anything from university students to first phones, for youth and integrating this with iPads and any other kind of existing device, an iPod or dead phone that exists and integrating the home service to business service with any number of broadband connected devices is where the market is going and we've got some exciting things for 2014 in that area. I think that combined with some of the features I mentioned during my comments, has the potential to get a significant stimulation.

Greg Burns

Analyst · Sidoti & Company

I understand, having the features saying the lot, the roadmap you have, they are seemingly pretty exciting, stuff on the horizon to be rolled out, but if no one knows about it, it doesn't do much good. So if you feel like you need to increase marketing around the mobile platform in the future or is it just not the developmental stage yet where it justifies that incremental investment?

David Pearson

Management

As you look at those folks who have gotten viral scale, much of it is referral based. We very much believe in -- can we take a look at the folks who are driving the largest level of downloads and subscription. Many of them are still unprofitable underwater. We're not in the business to drive something, it's going to be patently unprofitable. We expect that our investment and we've done this thinking about the whole lens is our mobile teams and the development expense we spend must drive benefit for our core businesses, our international business and have a revenue option even in the free downloadable marketplace. So we look at this potentially a little bit differently then some of the venture-funded businesses that we believe are largely trying to build the community regardless, if with there profit outlook is and try to get acquired for that network effect. We're in the business of really building functionality that people will use that has an opportunity to drive revenues going forward. As we see that revenue opportunity we will invest behind it, but my personal believe and I know that of our marketing and mobile teams, is that the client itself needs to very much be the sales force. So as you build unique functionality and as you improve, and we do have opportunities for improvement, the referral nature and the ability to recommended and invite friends and the social aspects of the client itself, that's was required in order to really drive rapid spread and downloaded the application. So we are working that as well.

Greg Burns

Analyst · Sidoti & Company

Just lastly, I saw Straight Path file a lawsuit. Is there any color or commentary you could give us around that?

David Pearson

Management

So what I'll tell you is we have not actually seen the actual complaint that Straight Path has filed. We are aware of Straight Path. We know the suits that they have filed against some other companies that are in the VoIP space. Straight Path is what is called a non-practicing entity, often called the troll. We have had, this is kind of a routine portion of our business, and we have successfully fought many of these kinds of suits over the last several years. As soon as we get more information about the specifics of the infringement complaint, then we can comment more specifically. But we successfully defended ourselves against many of these and we're going to vigorously defend ourselves in this case. We also have a host of patterns of our own that will need to be evaluated in terms of their utility as well. Unfortunately, lawsuits like this from non-practicing entities have become pretty common place, which is why they are so much focus on patent reform in Washington.

Operator

Operator

Our next question comes from the line of Michael Rollins from Citi Investment Research.

Michael Rollins

Analyst · Michael Rollins from Citi Investment Research

Just a clarification and then a broader question. On the clarification, Marc, I think you were describing earlier the idea of getting the lack down for the BasicTalk to below $200, if I heard you right. Does that include subsidy on the device or is that a separate number that you have to add to that?

Marc Lefar

Chief Executive Officer

We think about that in total acquisition cost, but keep in mind, we've re-engineered our device. So it is a very inexpensive in the $12 to $14 range.

Michael Rollins

Analyst · Michael Rollins from Citi Investment Research

So that would be within that $200?

Marc Lefar

Chief Executive Officer

Correct. We're targeting below $200, but at the $200 level we include the device as well.

Michael Rollins

Analyst · Michael Rollins from Citi Investment Research

And then just more broadly. So as you're thinking about the growth opportunities in the SMB segment, either before or since announcing the Vocalocity acquisition. Has the board thought a little bit more about the allocation of capital? And whether there could be a greater return earned for shareholders by maybe slowing the buyback and putting more money into, whether it's more scale or someone before was asking about the marketing? Have there been elements of consideration, just in terms of capital allocation, around this expanded strategy in the SMB segment?

Marc Lefar

Chief Executive Officer

Obviously, every time we have a major new initiative consistent with the original growth priorities, we have to make choices about how we allocate resources. It was actually at your conference, year and a half ago, when I spoke to you and you ask me about small-medium business. At that point, we were still deciding, whether we were going to build on our own or consider acquiring and I kept it pretty open-ended. We have evaluated number of different acquisitions over the past year. We concluded that was the best message to marketplace and we're really excited about the potential of Vocalocity. At our board meeting, the week before last, we actually did have significant conversation about how big do we think that business could be and it is one that obviously has relatively low awareness, but has a service set or feature set that is ready now, that continues to grow. And so when you look at the risk profile of investing in that business versus some of the other businesses, you have to look hard and trying to accelerate that business as fast as possible. I think we're, to not to be crass, but a little bit in a land grab phase in that business. And we bought this to grow it and have a long-term aspiration to be a number one provider of business solutions in this SMB marketplace. We do not have any intention of changing our share repurchase program. We fully intend to retire that as expected in the timeframe we've outlined. However with the cash that we do have available, and the flexibility, which is substantial in our own operating business, we will evaluate once we put the teams together and review the plans with Wain and his team and decide what kind of fuel, we think we can put on that fire and if we believe that we can drive revenues with the better return their versus other alternatives we would do that. The company's goal is to be the provider of cloud-based connected devices for consumers and businesses. So connecting people across multiple device is squarely inside of our strategy, and management's job is to dynamically reallocate resources. So you can expect to see that in 2014.

Michael Rollins

Analyst · Michael Rollins from Citi Investment Research

Last question. Looking at this SMB segment, how do you look at the broadband component of this? The offer that you have or say what Vocalocity has, I guess you could summarize it's like a BYOB, bring your own broadband kind of model it seems. Do you think that's still the best way to go? Do you think that there is ways of trying to partner or being an agent for broadband to make sure that the customer gets the right experience with the products that you're providing, just any thoughts on to that?

Marc Lefar

Chief Executive Officer

You're right, it is primarily you bring your own broadband solution to date. Most of the companies do have broadband, but the quality that broadband varies, so we certainly get at Vocalocity, as I understand it from the team, request for that kind of service. The question becomes one of, can you actually do it in a way that is of quality, that gets you the right kind of financial return and is that really required, given the upside in the marketplace for the core services that exists today. I don't have an opinion one way or another at this point in time. Post-closing, I'll engage with the Vocalocity team and get their perspective on the subject. There are a lot of people who wholesale broadband, so I think that's a fairly competitive marketplace. I'm not sure there is tremendous margin. I think the real question becomes one of, does that really facilitate increased penetration and is that across to doing business to accelerate revenues on the core services for which Vocalocity is differentiated. So ask me that question again in February, and I'll give you a more specific personal point of view.

Operator

Operator

Our next question comes from the line of Bill Dezellem from Tieton Capital.

Bill Dezellem

Analyst · Bill Dezellem from Tieton Capital

I have a group of questions. First of all, with the investments that you're making to build business, clearly that is having a negative impact on profitability right now which, as you've made very clear it's not your long-term intention. When are you anticipating that we hit that inflection point when the benefits from these investments are no longer are a drag, and in fact, benefit to the business?

Marc Lefar

Chief Executive Officer

First, I want to make sure that as folks are, where the people confuse some of the items. We've certainly seen some ARPU pressure in our business, so that's touch revenue to some extent. We've more than offset that ARPU impact with reduction in cost, primarily in cost. So we are engineering our business to deal with the pricing compression we see and some of the old premium domestic services, which we considered it will ongoing be a drag, that's the nature of the business that we've got as part of our legacy. And we are building new revenue stream on top of that as we speak. As we speak to the investments that we're making quarterly this year, as we've talked before, we fully expect that those investments will generate revenues, and certain investments are largely marketing and staff to build out new products and services in 2015. So 2014, you should think about as kind of stable ongoing investment. The real question becomes one of, as we see additional opportunities for growth in 2015, do we continue to invest? And our philosophy is, we're building this company for long-term profitable revenue growth. And if we can fund that revenue growth at a good return on our customer acquisition investment, we'll continue to do that. So I don't want to set an expectation. You're going to see some turning off of investment, as we turn the page to calendar 2015, and magically increase EBITDA by $15 million or $20 million a quarter. That could happen, we certainly have the capacity for that, because we spent so much in sales and marketing expense. But we'll be evaluating our approach, largely based on are we getting a reasonable return. We use to expect to see all things being equal improvements in 2015, as the investments for which we're paying today, get a small material revenues.

Bill Dezellem

Analyst · Bill Dezellem from Tieton Capital

And then two additional questions. First of all, net line addition. You talked that you are expecting those to continue to be favorable. What are you looking for in terms of level relative to where we're at now? Meaning, are you expecting an increase or it to hold steady at the current net line addition rate?

Marc Lefar

Chief Executive Officer

No, we're only five weeks into the quarter, just too early for us to know that with the holiday season, given that we're 11,000 net. That can be made or broken around those numbers with too much of the quarter to go. So it's difficult for me to give you any additional guidance versus what I've already shared.

Bill Dezellem

Analyst · Bill Dezellem from Tieton Capital

Let me do a follow-up, it might be more difficult to answer than that one even. And over the course of the next year, where would you like to see that number move to?

Marc Lefar

Chief Executive Officer

Well, I'd like to see that number move to dramatic net adds and I have great confidence that with Vocalocity's addition, even beyond their run rate and our ability to accelerate their growth by some of the things, we think we can do under the Vonage brand. I think you should expect that 2015 with the combined companies will be material net adds for the year 2014.

Bill Dezellem

Analyst · Bill Dezellem from Tieton Capital

And then, income statement question. I don't think this was addressed that the tax rate moved up approximately 10 percentage points to nearly 49%. Would you discuss the dynamics there, please?

David Pearson

Management

It was mainly due to losses in U.K. and Brazil. And so these are one-time items related to our foreign entities.

Operator

Operator

Our next question comes from the line of Greg Burns from Sidoti & Company.

Greg Burns

Analyst · Greg Burns from Sidoti & Company

Just wanted to follow up on, how the model going forward? In terms of how you're going to be reporting your subscriber statistics? Will you be breaking out Vocalocity from your kind of core business, as you've been reporting historically or is it going to all be reported in one consolidated number?

David Pearson

Management

Greg, we would expect to report it on a consolidated basis. As we do today, we give certain KPIs, which give specifics around our business and we would expect to do that, but generally we expect to report it on a consolidated basis. And I would just note as we said in our script that Vonage Business Solutions will actually have what Vocalocity is doing today, but also what Vonage is doing today in business. So there is going to be -- and then growth initiatives within the SMB business on top of that. So it's going to be some pretty significant mixing there and blending of lines, which is why we're choosing to report it that way.

Marc Lefar

Chief Executive Officer

And we'll provide key KPIs, so you'll be able to compare general performance with competitors, who also quite frankly has a different range of KPIs and information they are sharing even though they are considered peer player. So we'll try you give transparency around how we're performing relative to peers. But because of the numbers of moving parts internally and even some of the support infrastructure, it will be difficult to report that as an individual business in total P&L.

Leslie Arena

Operator

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

Operator

Operator

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