All Things Digital

Vonage’s slow death is … well, it’s slowing.The financially struggling Internet-phone company reported today a smaller first-quarter loss thanks largely to prudent cost cuts.

Great news for Vonage (VG), which has been tormented by a barrage of costly legal battles and set upon by new and powerful rivals. The company’s net loss shrank to $8.96 million, or 6 cents a share, from a loss of $72.3 million, or 47 cents, in the year-earlier quarter.

Sadly for Vonage, the company’s Q1 loss isn’t the only thing that shrank. Subscriber growth did as well. The company signed up just 30,000 new subscribers in the quarter, a big decline from a year earlier when it added nearly 166,000 subscribers. Worse, turnover rate increased to 3.3% from 3% in the fourth quarter.

Still, Vonage is a bit healthier than it’s been for some time now. So while it may not exactly be on the road to recovery, it’s at least crawling in its general direction. To that end, the company’s inked a deal to resell Covad’s DSL service under the Vonage Broadband name. An interesting idea, in that it will allow Vonage to bundle a broadband offering with its Internet telephony services like most other phone and cable companies on the planet. But DSL? Really? At a time when Verizon (VZ) is expanding its FiOS fiber-optic service and Comcast (CMCSA) is boosting the speed of its high-tier cable broadband?

About the best thing to be said about Vonage’s third quarter was that it was an improvement over the second. Which isn’t saying much–especially since the $161.8 million loss the company reported was more than double that of a year ago, weighed down by the legal costs of a pair of major patent disputes.

Still, quarterly revenue did grow to $211 million from $162 million, a bit ahead of the Street’s estimate of $210 million. And Vonage signed up some 78,000 new customers, though customer loyalty remains a problem. Churn–the percentage of subscribers who cancel service–rose to 3% from 2.5% in the prior quarter.

Best of all, Vonage has settled another of the patent-infringement lawsuits against it–this one with AT&T. Under the terms of the agreement, Vonage will pay the telecom $39 million over five years. Not exactly a pittance, but certainly less than the $80 million Vonage paid to settle its dispute with Sprint Nextel and a hell of a lot less than the $120 million it may end up forking over to Verizon.

Vonage’s long-suffering investors reacted well to the settlement, sending shares in the company up 16% to $2.38.

Unlimited local and long-distance calls aren’t the only things Vonage is selling at a steep discount these days–check out its stock. Shares of the Internet phone company, which went public in May 2006 at $17, are this morning trading at $1.32, down 14.29% on news that AT&T has filed a patent-infringement lawsuit against it.

In a filing with the U.S. District Court for the Western District of Wisconsin, the telecom accuses Vonage of willfully infringing upon a single AT&T patent: No. 6,487,200, which describes, broadly, a system for routing telephone calls over data networks. From the abstract:

A packet telephone system which employs a packet network that provides virtual circuits. The packet telephone system employs short packets containing compressed speech. The use of the short packets makes possible compression and decompression times and bounded delays in the virtual circuits, which are together short enough to permit toll-quality telephone service. The packet telephone system employs an intelligent network interface unit to interface between the packet network and standard telephone devices. The network interface unit does the speech compression and decompression and also responds to control packets from the packet network. Consequently, many telephone system features can be implemented in the network interface unit instead of in the switches. The network interface unit may also be used to provide data connections to devices attached to it. The combination of virtual circuits, with bounded delays, short packets, rapid compression and decompression, and intelligent network interface units makes it possible to build a telephone system with fewer and cheaper switches and fewer links for a given volume of traffic than heretofore possible and also permits substantial savings in provisioning and maintaining the system.”

Seems a bit broad, but now that Sprint Nextel and Verizon have proved you can win a jury verdict on such claims, AT&T would have been foolish not to sue. And, to be fair, the company claims it sued only after it failed to negotiate a “reasonable licensing arrangement” with Vonage. “We were forced to file a lawsuit,” said an AT&T spokesman.

In a statement, Vonage vowed to continue negotiations. “It’s our preference to settle disputes through negotiation rather than litigation,” said Vonage chief legal officer Sharon O’Leary. “We will continue to work toward an amicable solution.”

These patents are invalid. We don’t owe them a dime.”
– Vonage lawyer Louis Jameson, Sept. 21

Vonage lawyer Louis Jameson was right. Vonage doesn’t owe Sprint Nextel a dime. It owes the company 800 million of them. Vonage settled its patent dispute with Sprint Nextel this morning for $80 million–$35 million for past use of Sprint’s patented technology and $40 million for future licensing, along with a $5 million prepayment.

Sprint, in turn, has agreed to license Vonage its VOIP portfolio, which includes more than 100 patents covering methods and components to connect voice calls between a traditional telephone network and an IP network. The settlement comes two weeks after a federal jury ruled that Vonage illegally used Sprint patents and awarded Sprint $69.5 million in damages.

In a statement today, Vonage General Counsel Sharon O’Leary said, “We believe this deal is good news for Vonage, our customers and our shareholders. It allows us to put this litigation behind us and continue to focus on our core business by removing the uncertainty of legal reviews and long-term court action.”

Presumably with the “uncertainty of legal reviews” removed, Vonage will have that much more time to focus on other uncertainties, like its financial viability. As of June 30, Vonage only had $344 million in cash. Of that, $66 million is restricted cash used as collateral for the Verizon bond. (Verizon also won its patent-infringement case against Vonage.) And it’s carrying $248.2 million in debt, with a put option that may mean it is due as soon as December 2008.

But why dwell on matters so bleak. There is, after all, good cause for celebration: Vonage stock soared as much as 80% this morning–if soaring is what you call reaching for $2 per share from a baseline of $1.56–on the news, giving the company its biggest single-day advance since going public last year.

These patents are invalid. We don’t owe them a dime.”

–Some famous last words from Vonage lawyer Louis Jameson, Sept. 21

If things truly are destined to get worse before they get better, then Vonage may have something to look forward to. Yesterday afternoon the Internet telephony company suffered another costly legal defeat when a federal jury ordered it to pay $69.5 million in damages and a 5% royalty on future revenues to Sprint Nextel for using its patents.

It’s an ugly turn of events for the long-suffering Vonage, which has been beaten mercilessly into submission by legal setbacks since it went public in May 2006. Back in March, the company lost a similar patent-infringement case to Verizon and was ordered to pay more than $58 million in damages and a 5.5% royalty on future revenue.

Vonage was, obviously, dismayed by yesterday’s ruling and plans to appeal. “We are disappointed that the jury did not recognize that our technology differs from that of Sprint’s patents,” Sharon O’Leary, chief legal officer for Vonage, said in a statement. “Our top priority is to provide high-quality, reliable digital phone service to our customers. Vonage has already demonstrated that it can keep its focus on customers and on its core business while managing ongoing litigation.”

Question is, does Vonage have enough money to maintain that focus? As of June 30, it only had $344 million in cash. Of that, $66 million is restricted cash used as collateral for the Verizon bond. Now it may be down another $69.5 million. And who knows what sort of financial damage it might suffer from the 14 purported class-action cases against it over its initial public offering. No matter how you spin it, things are looking pretty bleak.

“Poor Vonage, they can’t get a break,” TeleGeography analyst Stephan Beckert told Bloomberg. “I don’t think it’s any secret that they’re not a well company.”

SunRocket may be dead and buried, but like the corpses in Sam Raimi’s “Evil Dead,” there’s a bit of life left in it yet. Sherwood Partners, the company presiding over the dissolution of SunRocket’s assets, sued Vonage last week, accusing the Internet telephony outfit of wrongfully using the SunRocket subscriber list to solicit new customers.

The suit claims Vonage acquired the list during confidential acquisition talks between the two companies and has done SunRocket “irreparable harm and injury” by using it without permission. Vonage, for its part, acknowledges its confidentiality agreement with SunRocket but claims it legitimately purchased the list from a third-party broker. “We believe the suit lacks merit,” Vonage spokesman Charles Sahner told the Register. “We obtained a VOIP subscriber list through an established marketing list broker. We were assured that the data was legally obtained and could be used without violating anyone’s proprietary rights.”

If that’s truly the case, the deal worked out quite nicely for Vonage, which likes to fancy itself the belle of the VOIP ball despite its lousy financials and semi-dire legal straits. In the two days after SunRocket went belly-up, Vonage signed up 11,000 new subscribers–many of them old SunRocket customers. “We were the leader from the very beginning and we have that critical mass and the scale,” Sahner said back in July. “We helped put (SunRocket) out of business. They had a cheap product and they couldn’t compete.”

SunRocket, the “No Gotchas” Internet phone company, is apparently the “No Employees” phone company as well. It has ceased operations and is transitioning its 200,000 or so customers to rival telephony ventures after reportedly failing to negotiate a sale. “We have just been informed that any and all last-ditch efforts to keep operations running as well as a potential sale of the company have not gone through and that SunRocket will cease operations at COB today,” Sonya Jefferson, SunRocket’s Director of Routing and Carrier Services wrote in a message to employees yesterday. “As such, today is my last day and everyone else you may have worked with at SunRocket.”

You can almost hear the chorus of cheers over at Vonage, can’t you? Whoo, hoo, hoo- hoo- hoo … Though really, the company has little cause to celebrate. Since its ill-starred IPO, its fortunes, too, have floundered. Today its shares were trading for a while at $2.93–down, despite the sudden departure of one of its rivals.

We are now five months into 2007 and, needless to say, it’s been a very challenging year.”

–Vonage CEO Jeffrey Citron

Looks like Vonage may have found itself a new paddle with which to navigate a certain creek it’s been traveling up lately. During a dismal quarterly earnings call yesterday, Vonage chief executive Jeffrey Citron said the Internet telephone company has developed technical workarounds for two of the three Verizon patents it’s been found to infringe. “We believe we have workable designs for the two name-translation patents and intend to begin deploying the solution to our customers shortly,” said Citron. “In addition, we are continuing our development of the workaround for the wireless patent.”

Citron said the workarounds will be relatively inexpensive to implement and require minimal effort from customers. “We will begin rolling these workarounds out shortly, hopefully in the next few weeks, and we believe they will work,” he added. I imagine Citron crossed his fingers when he said that last bit, because if they don’t, and the infringement ruling stands, Vonage must pay Verizon more than $58 million in damages and 5.5% of future subscriptions from lines that use the disputed patents. That’s an ugly future for a company whose shares have lost about 80% of their value–even without increasing competition from cable companies.