Vonage Trims Q1 Loss, Promises Patent Workarounds

Vonage may have found a way to provide its services without using disputed technology that Verizon Communications has patented, Vonage said Thursday, offering hope that the troubled VoIP (Voice over Internet Protocol) provider can get out from under potentially crushing legal obligations to Verizon.

Jeffrey Citron, Vonage's chairman and interim CEO, referred to the so-called "workarounds" as the firm announced its first quarter earnings.

"We believe we have workable designs for the two name translation patents, and intend to begin deploying the solution to our customers shortly," he said, referring to two of the three patents that a jury found Vonage had unintentionally infringed upon. "In addition, we are continuing our development of the workaround for the wireless patent."

A 'Difficult Quarter'

The disputed patents include technologies related to voice mail retrieval and a key link in the VoIP service that connects Internet-based phone calls to traditional telephone networks. Without that technology or a workaround, Vonage faced the prospect of having its 2.4 million customers only be able to call one another -- and not reach homes with standard landline phones.

"We have battled through an extremely difficult quarter, and will continue the fight in the courtroom," Citron added. "While the patent litigation has challenged our business, it has not distracted our focus on providing consumers with the opportunity to choose a better phone service."

Vonage shares moved higher on the news, rising 4.6 percent to US$3.19.

Loss Shrinks, Growth Slows

As for its financials, Vonage managed to cut its fiscal losses to $72 million, or 47 cents per share, in the quarter, compared to a loss of $86 million in the same time the year before.

Revenue rose 64 percent to $196 million, a strong showing, considering most of the quarter took place under the dark cloud of the legal storm with Verizon -- including a stretch when Vonage was facing the prospect of an injunction that could have forced it to shut down its service or stop soliciting new customers.

The loss would have been even smaller, Vonage stated, except for money it set aside to make required royalty payments to Verizon if its fast-tracked appeal of the patent verdict does not overturn the jury's penalties -- a one-time payment of $58 million and an ongoing royalty of 5.5 percent of subscription revenues.

Vonage grew its subscriber base to 2.4 million homes, adding 166,000 new subscribers in the quarter, the company stated. The rate of growth has slowed markedly, with that figure about half the new additions Vonage added in the first three months of 2006.

An End in Sight?

Profitability has proven elusive for Vonage to date, as it continues to spend heavily to attract new customers. Vonage said last month that it would slash its 2007 marketing budget by $110 million, part of a larger plan to trim costs and push the company into the black.

Still, the possibility of a workaround was what most observers focused on in the report. Vonage has been somewhat vague in the past about whether it would be able to find ways to build workarounds to avoid the Verizon technology.

Vonage will start deploying the first two workarounds "hopefully over the next few weeks," Citron said. Customers will not have to do anything or notice any changes in service, he added, noting that the moves will not significantly eat into future earnings.

"We believe the end of this difficult period is in sight," Citron stated.

Courting Alternatives

Though it was believed to be searching for a workaround, Vonage had focused on what it saw as flaws in the way the patent case was handled in district court, saying it would press appeals as far as necessary. It also tried to use a recent Supreme Court decision clarifying the role of "obviousness" in patent reviews to win a new trial; that effort fell short, however.

Vonage's appeal has been put on a fast track, with oral arguments set to be heard next month.

That the company is now pinning its -- and investors' -- hopes on a workaround may suggest it is somewhat less confident it can win its appeal.

The granting of a stay putting injunctions against it on hold suggested that the courts feel it has a strong case, Vonage previously stated. However, winning the stay of the injunction doesn't necessarily mean its appeal will succeed, John Rabena, an intellectual property attorney with Sughrue Mion, told the E-Commerce Times.

Not Without Risks

The recent U.S. Supreme Court ruling could also impact the case, but courts are likely to grapple for some time with how to interpret that decision.

"Lawsuits and appeals are very risky because it's impossible to predict the outcome," Rabena said. Most higher courts take a largely deferential stance toward district court judges and juries, meaning Vonage faces a high hurdle in attempting to prove that the lower court ruling was tainted in some way, he noted.

When it comes to workarounds, Vonage has argued in court that solutions would be time-consuming to implement, with no guarantees they would work. "While Vonage has studied methods for designing around the patents, the removal of the allegedly infringing technology, if even feasible, could take many months to fully study and implement," the company said as part of its appeal filing.

Workarounds are not without risks, since most components of a service such as Vonage are connected to numerous other software elements that may need to be tweaked to handle a change.

"Vonage can't afford to disrupt service," telecom analyst Jeff Kagan told the E-Commerce Times. "If more customers leave for whatever reason, profitability is going to become that much more elusive, especially when cable companies and traditional telecom carriers are now standing ready with their own VoIP offerings."