VOIP Bastard Vonage Jumps 10% on International Earnings

In 2006, Vonage (VG) was everyone’s favorite momo short. Vonage was a first-mover in VOIP … then every telecom and Skype got in the game.

Today, Vonage announced better than expected earnings and the stock squeezed some shorts to the tune of a 10% increase in value. Is Vonage making a comeback? Or will Apple (AAPL) apps destroy them next? Here are the highlights:

Vonage Holdings Corp. (NYSE: VG), a leading provider of high-quality voice and messaging services over broadband networks, today announced results for the first quarter ended March 31, 2010.

Vonage generated net income of $14 million or $0.07 per share. This is an improvement from $5 million or $0.03 per share in the first quarter of 2009 and $4 million or $0.02 per share, sequentially.

Vonage reported record adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”)(1) of $40 million, up from $21 million in the year ago quarter and $34 million sequentially. This is the tenth consecutive quarter of record high adjusted EBITDA. Revenue of $228 million increased from $224 million year-over-year and sequentially. Income from operations increased to $25 million, up from $5 million in the year ago quarter and $19 million sequentially.

Marc Lefar, Vonage Chief Executive Officer, said “We continue to make significant progress improving the fundamentals of our core business while laying the foundation to deliver next generation services to our customers. We achieved best-in-class customer satisfaction levels and reduced churn to its lowest rate in nearly three years.

“Our financial performance was particularly strong, as we achieved record high net income and EBITDA. We more than doubled cash from operations sequentially and generated $47 million in free cash flow in the quarter. This strong cash generation enabled us to reduce our debt by prepaying $23 million in first lien obligations. This prepayment will reduce 2010 interest expense by $2.5 million and approximately $13 million over the life of the remaining debt.

“We continue to invest in new growth opportunities, including international and mobile, where innovation, customer service and cost-effective services are expected to drive future growth.”

First Quarter Financial and Operating Highlights

Revenue for the first quarter was $228 million, an increase from $224 million in the year ago quarter and sequentially. Average revenue per user (“ARPU”) increased to $31.37 from $28.86 in the year ago quarter and $30.54 sequentially. Telephony services ARPU increased to $30.90 from $27.78 reported a year ago and $29.84 sequentially. The Company does not expect this trend of increasing ARPU to continue into the second quarter due to the greater second quarter impact of the $14.99 promotion, which will be partially offset by other rate favorability.

As expected, direct cost of telephony services (“COTS”) increased in part due to higher international call volume as more customers signed up for Vonage World. On a per line basis, the cost of telephony services increased to $8.60 from $6.67 in the prior year and $7.96 sequentially. While COTS is higher for international callers on Vonage World, the net present value of international customers is currently higher than that of domestic only customers, due to lower churn rates.

Direct cost of goods sold was $17 million, down from $21 million in the year ago and flat sequentially. Direct margins(2) declined to 65% from 68% in the year ago quarter and 66% sequentially as a result of an increase in COTS.

Selling, general and administrative (“SG&A”) expense was $61 million, down from $68 million in the year ago quarter and $63 million sequentially as the Company benefited from cost management and operating efficiencies in customer care and compensation and benefits.

Pre-marketing operating income (“PMOI”)(1), which represents cash generated from the Company’s existing customer base, increased to $102 million, up from $98 million in the year ago quarter and $99 million sequentially. PMOI per line increased to $14.07, up from $12.68 in the first quarter of 2009 and $13.50 sequentially.

Marketing expense was $49 million, down 25% from $66 million in the first quarter of 2009 and $53 million sequentially as the Company allocated marketing dollars to promotions costs. Gross line additions declined to 155,000 from 188,000 sequentially. Subscriber line acquisition cost (“SLAC”) increased to $318, up from $281 sequentially. SLAC was $290 in the year ago quarter.

Vonage generated adjusted EBITDA of $40 million, up from $21 million in the year ago quarter and $34 million sequentially. The Company continues to expect to deliver adjusted EBITDA growth in 2010.

Churn declined to 2.6% from 3.1% in the year ago quarter and 2.8% sequentially driven by improvements in customer quality and satisfaction. The decline in churn was not enough to offset lower gross line additions and the Company lost 26,000 net subscriber lines in the first quarter.

As of March 31, 2010, cash, cash equivalents and restricted cash totaled $123 million. Capital and software expenditures were $4 million. The Company continues to expect capital expenditures and software for the full year 2010 to be consistent with last year’s spending levels in the mid-$40 million range.

Excess Cash Flow

During the first quarter, the Company reached the $75 million unrestricted cash threshold provided in its credit agreements which enabled the Company to use excess cash flow to prepay at par $23 million of loans and $1 million of accrued interest under its senior secured first lien credit facility. This prepayment occurred on April 27, 2010.

The Company will save $2.5 million in interest expense in 2010 and $3.7 million annually thereafter from the reduction in first lien debt, a total of $13 million over the remaining life of the debt. The Company expects that it will generate excess cash flow from operations during the second quarter enabling it to make additional prepayment offers.

Third Lien Debt Conversions

As of March 31, 2010, approximately $3 million of the original $18 million in third lien convertible debt remained unconverted. Shares outstanding at quarter end were 211 million.

NYSE Compliance Update

On March, 12, 2010, the New York Stock Exchange (the “NYSE”) provided early approval for Vonage’s return to full compliance with NYSE listing standards for market capitalization. This approval came several months earlier than required and was a result of Vonage’s sustained, positive financial performance consistent with the business plan the Company presented to the NYSE in March of 2009.

(1) This is a non-GAAP financial measure. Refer below to Table 3 for a reconciliation to GAAP income (loss) from operations.

(2) Direct margin is defined as operating revenues less direct cost of telephony services and direct cost of goods sold as a percentage of revenues.

                              VONAGE HOLDINGS CORP.                  TABLE 1. SUMMARY CONSOLIDATED FINANCIAL DATA                (Dollars in thousands, except per share amounts)

                                                  Three Months Ended                                                       March 31,                                                       ---------                                                  2010            2009                                                  ----            ----

    Statement of Operations Data:    Operating Revenues:      Telephony services                      $224,527        $215,643      Customer equipment and shipping            3,424           8,362                                               227,951         224,005                                               -------         -------    Operating Expenses:      Direct cost of telephony services       (excluding depreciation and         amortization of  $4,902, and $4,757,          respectively)                         62,495          51,751      Direct cost of goods sold                 16,647          20,512      Selling, general and administrative       60,787          68,051      Marketing                                 49,240          65,695      Depreciation and amortization             13,768          12,896                                               202,937         218,905                                               -------         -------

    Income from operations                      25,014           5,100

    Other income (expense):      Interest income                               53             110      Interest expense                        (13,211)         (13,542)      Gain on extinguishment of notes            1,038               -      Change in fair value of embedded       conversion option and stock warrant         835          12,970      Other, net                                   103             801                                              (11,182)             339                                               -------             ---

    Income before income tax benefit     (expense)                                  13,832           5,439

    Income tax benefit (expense)                   136            (168)

    Net income                                 $13,968          $5,271                                               =======          ======

    Net income (loss) per common share:      Basic                                      $0.07           $0.03                                                 =====           =====      Diluted                                    $0.06          $(0.03)                                                 =====          ======    Weighted-average common shares     outstanding:      Basic                                    201,324         156,718                                               =======         =======      Diluted                                  221,947         218,787                                               =======         =======

                              VONAGE HOLDINGS CORP.           TABLE 1. SUMMARY CONSOLIDATED FINANCIAL DATA - (Continued)                (Dollars in thousands, except per share amounts)

                                                         Three Months Ended                                                              March 31,                                                              ---------                                                         2010            2009                                                         ----            ----

    Statement of Cash Flow Data:    Net cash provided by operating activities         $51,248          $6,563    Net cash used in investing activities            (31,098)          (6,951)    Net cash used in financing activities                (648)           (869)    Capital expenditures, intangible asset purchases     and      development of software assets                   (4,000)         (6,514)

                                                       March        December                                                        31,            31,                                                         2010            2009                                                         ----            ----

    Balance Sheet Data (at period end):    Cash and cash equivalents                         $52,055         $32,213    Restricted cash                                    70,773          43,700    Property and equipment, net                        84,979          90,548    Total assets                                      334,267         313,384    Total long-term debt, including current portion,     net of discount                                  203,927         201,771    Embedded conversion option within convertible     notes, at fair value                              10,860          25,050    Capital lease obligations                          20,596          20,948    Total liabilities                                 396,086         405,293    Total stockholders' deficit                      (61,819)         (91,909)

                              VONAGE HOLDINGS CORP.                   TABLE 2. SUMMARY CONSOLIDATED OPERATING DATA                                   (unaudited)

                                               Three Months Ended                                         March 31,   December 31, March 31,                                         ---------   ------------ ---------                                               2010          2009       2009                                               ----          ----       ----    Gross subscriber line additions         154,718       187,592    226,610    Change in net subscriber lines          (25,779)      (10,131)    (6,493)    Subscriber lines (at period end)      2,409,117     2,434,896  2,583,861    Average monthly customer churn              2.6%          2.8%       3.1%    Average monthly revenue per line         $31.37        $30.54     $28.86    Average monthly telephony services     revenue per line                        $30.90        $29.84     $27.78    Average monthly direct cost of     telephony services per line              $8.60         $7.96      $6.67    Marketing costs per gross subscriber     line addition                             $318          $281       $290    Employees (excluding temporary help)     (at period end)                          1,207         1,225      1,413    Direct margin as a % of total     revenue                                   65.3%         66.3%      67.7%

                              VONAGE HOLDINGS CORP.       TABLE 3.  RECONCILIATION OF GAAP INCOME FROM OPERATIONS TO ADJUSTED                    EBITDA AND PRE-MARKETING OPERATING INCOME                              (Dollars in thousands)                                   (unaudited)

                                             Three Months Ended                                March 31,      December 31,     March 31,                                ---------      ------------     ---------                                       2010             2009           2009                                       ----             ----           ----    Income from operations          $25,014          $18,779         $5,100      Depreciation and       amortization                  13,768           13,766         12,896      Share-based expense             1,018            1,580          2,608    Adjusted EBITDA                  39,800           34,125         20,604      Marketing                      49,240           52,758         65,695      Customer equipment and       shipping                      (3,424)          (5,131)        (8,362)      Direct cost of goods sold      16,647           17,070         20,512    Pre-marketing operating     income                        $102,263          $98,822        $98,449                                   ========          =======        =======      As a % of telephony       services revenue                45.5%            45.2%          45.7%

                                VONAGE HOLDINGS CORP.                   TABLE 4.  RECONCILIATION OF GAAP NET INCOME TO                       NET INCOME (LOSS) EXCLUDING ADJUSTMENTS                  (Dollars in thousands, except per share amounts)                                     (unaudited)

                                           Three Months Ended                                       March 31, December 31, March 31,                                       --------- ------------ ---------                                             2010          2009      2009                                             ----          ----      ----    Net income                            $13,968        $4,401    $5,271      Gain on extinguishment of notes      (1,038)         (225)        -      Change in fair value of embedded       conversion                            (835)        1,055   (12,970)          option and stock warrant    Net income (loss) excluding     adjustments                          $12,095        $5,231   $(7,699)                                          =======        ======   =======

    Net income (loss) per common     share:      Basic                                 $0.07         $0.02     $0.03                                            =====         =====     =====      Diluted                               $0.06         $0.02    $(0.03)                                            =====         =====    ======

    Weighted-average common      shares outstanding:      Basic                               201,324       199,503   156,718                                          =======       =======   =======      Diluted                             221,947       203,376   218,787                                          =======       =======   =======

    Net income (loss) per common     share, excluding      adjustments:      Basic                                 $0.06         $0.03    $(0.05)                                            =====         =====    ======      Diluted                               $0.06         $0.03    $(0.05)                                            =====         =====    ======

    Weighted-average common      shares outstanding:      Basic                               201,324       199,503   156,718                                          =======       =======   =======      Diluted                             221,947       223,358   156,718                                          =======       =======   =======