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Vonage Fraught With Troubles Amid Patent Case Loss

Vonage Holdings Corp.s stock hit its lowest point ever this week and CEO Michael Snyder resigned as the company dealt with the fallout from losing a VoIP patent dispute to Verizon Communications Inc.

At press time, Vonage was likely to pay millions more in bond money than originally expected and it faced the prospect of being barred from signing new subscribers. On April 9, the companys shares plummeted to a 52-week low of $2.88. Two days later, Snyder stepped down in a move founder Jeffrey Citron would only say was in the best interest of the company.

Most of the troubles stemmed from the patent suit Vonage lost, a case that holds implications beyond determining Vonages future. On the positive side, it is focusing more attention on VoIP and highlighting that the technology has come of age. On the skeptical side, it has caused the industry to question Verizons timing in pursuing its largest competitor. And on the practical side, the suit looks to unleash a torrent of copycat patent infringement accusations.

In March, a jury found Vonage guilty of infringing although not willfully on three Verizon patents. The patents cover connecting VoIP calls to the PSTN; Vonage contests Verizons assertion that the three patents are specific and valid the patents protect processes. Nonetheless, Vonage was ordered to pay Verizon $58 million plus 5.5 percent royalty fees on all of its future revenue. District Judge Claude Hilton then barred Vonage from using the Verizon technology and adding new customers. However, an appeals court overturned that decision and will hear arguments on April 24. If the judge accepts the case, the appeals process could take at least one year.

In the meantime, Hilton ordered Vonage to fork over $66 million in bond money to cover lost profits to Verizon. Vonage likely will have to pay another $189 million, which would pay Verizon back for future lost revenue while Vonage uses the patents during the appeals process. Hilton was scheduled to make that decision on April 12.

Thats a lot of money for a company that has yet to turn a profit. In its latest earnings report from the third quarter of 2006 Vonage was $62.2 million in the hole. In spite of that, its board in mid-March approved millions in raises, bonuses and stock option grants for its executives, including Citron and now-former CEO Snyder. Then, earlier this month, Vonage told the Securities and Exchange Commission it wont be able to file its annual report for 2006 until it knows how much it owes Verizon. However, Vonage does expect to release updated quarterly earnings in May.

If one theme resonates among VoIP experts, it is that the Vonage-Verizon case while very bad for Vonage is good for IP telephony adoption. In the long term, says Dave Lemelin, a senior analyst for In-Stat, the dispute can benefit overall take rates because its making VoIP more visible. In fact, 1.6 million more households started using VoIP in the past six months thanks in part to Vonage and cable VoIP, the firm says.

Still, Vonage and its rivals stand to lose subscribers to cable operators. They are the biggest threat for Vonage, Lemelin says. Much of that is because cable VoIP has not been embroiled in patent disputes, says Scott Sleek, director of Pike & Fischers broadband advisory services unit. These lawsuits will prompt more and more consumers to migrate to cable digital phone services, he says.

If Vonage loses its appeal, its the end of a company thats certainly done a lot to increase the profile of the voice-over-IP market, and that would be tragic, says Lynda Starr, a senior analyst for Frost & Sullivan.

Some media have taken those thoughts a step further, reporting that a doomed Vonage would translate into a doomed VoIP industry. One article, for instance, says venture capitalists will stop funding VoIP companies. But analysts and investors approached by PHONE+ say that was a drastic interpretation and overreaction.

For its part, Vonage continues putting a positive spin on its situation. The company could not give PHONE+ an interview by press time, but in a prepared statement, said it will continue providing service and adding subscribers. It even accused Verizon of simply using the court room to do what Verizon could not succeed in doing in the marketplace which is to put Vonage out of business.

While Verizon has insisted its just protecting its intellectual property, some people question the timing. They speculate that the company didnt pursue litigation earlier because competition wasnt intense enough. Verizon probably waited until the market created a target worth going after because patent litigation is pretty expensive, says Ed Pennington, a patent lawyer and partner at Bingham McCutchen LLP in Washington, D.C.

To be sure, the timing of Verizons lawsuit filed last June strikes onlookers as interesting. Vonage was founded in 2001 and started providing service the following year. Verizon secured its patent in 2000, but did not roll out its VoIP product, VoiceWing, until 2004. That offering whose success Pike & Fischer calls tepid has gained little traction in the marketplace.

Regardless, Verizon is ready to play, Starr says. I think the next step is to watch and see what Verizon does in this space. I think that theyre going to step up and theyre just clearing the way.

Indeed, the case illustrates just how far a company like Verizon is willing to go, says Pennington. To that end, he is advising other VoIP providers to doublecheck their technologies before Verizon comes after them, too.

And Verizons not the only company on the warpath. Were seeing new lawsuits popping up every day involving various patents, Pennington says.

For example, on March 14, Web Telephony LLC filed a patent infringement suit against Verizon, AT&T, EarthLink Inc., SunRocket Corp. and Vonage. Web Telephony, based in Illinois, holds and licenses patents governing Web control of telephony services. The company claims the defendants are infringing on two of its patents, issued in 2002 and 2004, respectively.

All of this is coming together like the perfect storm, Pennington says. The VoIP industry is catching on. At first it was a novelty and now its mainstream.

Bingham McCutchen LLP www.bingham.com  

Frost & Sullivan www.frost.com  

In-Stat www.in-stat.com  

Pike & Fischer www.pf.com  

Verizon Communications Inc. www.verizon.com  

Vonage Holdings Corp. www.vonage.com


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