Internet telephony provider and commercial airtime glutton Vonage (NYSE:VG) will be reporting first-quarter earnings tomorrow. While the company already announced estimated results for the quarter, let's look a little closer at where it stands.

What analysts say:

  • Buy, sell, or waffle? Of the 12 analysts that weigh in with an opinion on Vonage, only one of them rates the stock a buy, while eight maintain a hold rating and three say to sell shares. In our Motley Fool CAPS investor database, more than 875 of our 50,000 users have rated the stock, giving it a one-star rating overall.
  • Revenue. Based on the company's own estimate of $195 million less than one month ago, the average analyst expects Vonage to report $195.4 million this quarter.
  • Earnings. Analysts on average are expecting a $0.42-per-share loss.

What management says:
Ongoing litigation with competitor Verizon (NYSE:VZ) and market competition have collectively taken their toll on Vonage, and the company is taking some dramatic steps to alter course. You'll see fewer commercials and Web ads from Vonage, since the company committed to lowering marketing expenses by $110 million this year. CEO Michael Snyder also stepped down (or was pushed), and founder Jeffrey Citron will fill in and lead the company until a replacement is designated.

Mr. Citron states, "In order to strengthen Vonage's financial position, we are taking a number of measures to reduce our costs and operating expenses." Prior to the recent shift in strategy, management had been claiming progress toward its oft-repeated goal of "positive adjusted operating profits as early as the first quarter 2008." Results to date don't suggest that the company will meet this goal.

What management does:
You'll find few fans of Vonage here at the Motley Fool. Several Fools think it burns too much cash, has no defensible moat, and will go down as one of the biggest investor swindles in history. But to understand why Fools hold these opinions, take a look at the nitty-gritty details of Vonage's operations.

While Vonage is improving its average revenue per user, its churn looks rough. The worst part, though -- as it relates to "scaling" a business -- is that subscriber growth is not accelerating. This is partly because of rising churn, but it speaks volumes as to why I and others pooh-pooh Vonage's business model. To me, this shows that Vonage's business is not well grounded to fully capture benefits of scale.

Metric

9/05

12/05

03/06

06/06

09/06

12/06

Subscriber Base (in thousands)

1,062 

1,269

1,597

1,853    

2,058

2,224

Churn

2.3%

1.9%

2.1%

2.3%

2.6%

2.3%

Average Revenue Per Line

$25.79    

$27.22

$27.65

$27.70     

$27.40    

$28.25

As for margins, let's just say they're less horrendous:

Margin

9/05

12/05

3/06

6/06

9/06

12/06

Gross

51.2%

53.8%

55.1%

57.3%

60.0%

52.9%

Operating

(108.7%)

(91.4%)

(80.3%)

(64.8%)

(52.2%)

(51.6%)

Net

(106.6%)

(97.1%)

(82.5%)

(68.9%)

(56.6%)

(55.7%)
Data for both charts courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
For Vonage to eventually reach profitability, the growing size of its business must be matched by improving margins -- the same way larger telcos such as AT&T (NYSE:T), Alltel (NYSE:AT), and Qwest (NYSE:Q) did in their infancy. Margins and growth both appear to be flattening out well ahead of profitability, though the company's efforts to reduce marketing costs and expenses should improve margins going forward. But this is just pushing the pain to another part of the business -- subscriber additions. Unless Vonage can find some competitive advantage (not likely) to economically protect and grow its subscriber base (even less likely), investors should expect more pain (very likely) in the future.

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Fool contributor Dave Mock has never swam in a pool of wet noodles. He owns no shares of companies mentioned here. Dave is the author of The Qualcomm Equation. The Fool's disclosure policy is too sexy for this article.