Vonage Backs Away From the Edge

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Most tech stocks were reeling yesterday, as spooked investors feared further deterioration in the economy. But Internet telephony provider Vonage (NYSE: VG) is up nearly 6% from Wednesday's close, even though its third-quarter earnings report still showed the company bleeding cash.

Vonage's results came with with a slew of adjustments -- financial hits related to stock-option grants and numerous litigation settlements. On the top line, the Internet phone service provider logged $211 million in revenue, 30% more than last year. However, the bottom line is still swimming in red ink -- to the tune of $16 million, if you factor out more than $140 million paid out for lawsuits and royalties.

The big, one-time financial payments Vonage made to Verizon (NYSE: VZ) and Sprint Nextel (NYSE: S) to settle their respective lawsuits will keep them out of Vonage's way as the company attempts to turn a profit from low-cost, Web-based phone service. Investors were relieved that the settlements also freed Vonage from crippling royalties, which would have been a big drag on already poor margins.

One positive aspect of the earnings release: Even on a drastically reduced marketing spend of $62 million for the quarter, Vonage was able to grow its base of subscriber lines by 78,000. While not a huge number, it's far better than the customer losses that Sprint Nextel recently experienced. Churn took a huge jump, however, up to 3% -- well above the 2.5% reported last quarter. Another negative -- the average monthly revenue per line dipped slightly to $28.24.

Vonage also announced that a recent patent infringement lawsuit from AT&T (NYSE: T) is close to settlement for a proposed $39 million, though a definitive agreement remains outstanding. Should Vonage put this suit behind it, all the major lawsuits that have threatened Vonage's status as an "ongoing concern" will be put in the rearview mirror (though the company still faces several more minor litigation suits). But there's always a chance that another telecom or cable operator such as Comcast (Nasdaq: CMCSA) or Time Warner Cable (NYSE: TWC) will try to derail Vonage through court action.

For the time being, however, Vonage and chairman Jeffrey Citron will be focusing on business fundamentals again, particularly the dramatic level of churn. Reducing churn is often costly, though, and it will be some time before investors see how effective the company is at managing its subscriber base going forward.

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