|
VONAGE HOLDINGS CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge)
You should read the following discussion together with "Selected Financial Data"
and our consolidated financial statements and the related notes included
elsewhere in this Annual Report on Form 10-K. This discussion contains
forward-looking statements, which involve risks and uncertainties. Our actual
results may differ materially from those we currently anticipate as a result of
many factors, including the factors we describe under "Item 1A-Risk Factors,"
and elsewhere in this Annual Report on Form 10-K.
OVERVIEW
We are a leading provider of communications services connecting people through
cloud-connected devices worldwide. We rely heavily on our network, which is a
flexible, scalable Session Initiation Protocol (SIP) based Voice over Internet
Protocol, or VoIP, network. This platform enables a user via a single
"identity," either a number or user name, to access and utilize services and
features regardless of how they are connected to the Internet, including over
3G, 4G, Cable, or DSL broadband networks. This technology enables us to offer
our customers attractively priced voice and messaging services and other
features around the world on a variety of devices.
Over the past five years, we have fundamentally transformed our company -
strategically, operationally and financially. Strategically, we shifted our
primary focus to serving rapidly growing but under-served ethnic segments in the
United States with international calling needs. We improved our value
proposition by being the first to deliver flat-rate, unlimited calling to over
60 countries with the launch of our Vonage World service, and we were the first
to provide easy-to-use, enhanced features, like voice-to-text translation and
mobile Extension services, at no extra cost. These strategic shifts have
resulted in new customers with a higher average lifetime value and a better
churn profile than those in the past.
Our focus on operations during this period has resulted in a significantly
improved cost structure. We have implemented operational efficiencies throughout
our business and have reduced domestic and international termination costs per
minute, and customer care costs. Importantly, we have enabled structural cost
reductions while significantly improving network call quality and customer
service performance. Improvements in the overall customer experience have
contributed to lower churn, which declined from highs of 3.6% in July 2009 to
2.5% at the end of the 2012.
Through debt refinancings in December 2010 and July 2011, we have fundamentally
improved our balance sheet, reducing annual interest expense from $49 million in
2010 to $6 million in 2012 and reducing interest rates from as high as 20% in
2009 to less than 4% today.
In part as a result of our operational and financial stability, on February 7,
2013, Vonage's Board of Directors discontinued the remainder of our existing
share repurchase program effective at the close of business on February 12, 2013
with $16,682 remaining, and authorized a new program to repurchase up to
$100,000 of the Company's outstanding shares by December 31, 2014. We believe
our repurchase program reflects our balanced approach to capital allocation as
we invest for growth through our growth initiatives and deliver value to
shareholders without compromising our ongoing operational needs.
Having achieved operational and financial stability, we are focused on driving
revenue through three major growth initiatives. The first growth initiative is
in our core North American markets, where we will continue to provide
extraordinary value in international long distance calling, while targeting
under-served ethnic segments, and expect to
enter the low-end domestic market with a secondary brand. Our second growth
initiative is international expansion outside of North America through strategic
partnerships. Our third growth initiative is mobile services which we view as a
strategic enabler of the Company's entire product offering over time.
We had approximately 2.4 million subscriber lines for broadband telephone
replacement services as of December 31, 2012. We bill customers in the United
States, Canada, and the United Kingdom. Customers in the United States
represented 93% of our subscriber lines at December 31, 2012.
Recent Developments
Amended Credit Agreement. On February 11, 2013, we entered into an amendment to
the credit facility that we entered into in July 2011 (the "2011 Credit
Facility"). The amendment (the "2013 Credit Facility") consists of a $70,000
senior secured term loan and a $75,000 revolving credit facility. The
co-borrowers under the 2013 Credit Facility are us and Vonage America Inc., our
wholly owned subsidiary. Obligations under the 2013 Credit Facility are
guaranteed, fully and unconditionally, by our other United States subsidiaries
and are secured by substantially all of the assets of each borrower and each of
the guarantors. We used $42,500 of the available proceeds of the 2013 Credit
Facility to retire all of the debt under our 2011 Credit Facility.
Share Repurchase Authorization. On February 7, 2013, Vonage's Board of Directors
discontinued the remainder of our existing share repurchase program effective at
the close of business on February 12, 2013 with $16,682 remaining, and
authorized a new share repurchase program to repurchase up to $100,000 of the
Company's outstanding shares. This new authorization expires on December 31,
2014. The specific timing and amount of repurchases will vary based on available
capital resources and other financial and operational performance, market
conditions, securities law limitations, and other factors. The repurchases will
be made using our cash resources. The repurchase program may be commenced,
suspended or discontinued at any time without prior notice. In any period, cash
used in financing activities related to common stock repurchased may differ from
the comparable change in stockholders' equity, reflecting timing differences
between the recognition of share repurchase transactions and their settlement
for cash.
Joint Venture with Datora in Brazil. On February 8, 2013, we entered into our
second international partnership, a joint venture with Datora Telecomunicacoes
Ltda. ("Datora"), to deliver communication services in Brazil. Our partner,
Datora, is a telecom operator in Brazil delivering managed business-to-business
and termination services throughout South America and other parts of the world.
Datora also has a significant physical presence in Brazilian economic centers.
We expect this partnership to accelerate our entry into the Brazilian market.
Trends in Our Industry and Key Operating Data A number of trends in our industry
have a significant effect on our results of operations and are important to an
understanding of our financial statements.
Competitive landscape. We face intense competition from traditional telephone
companies, wireless companies, cable companies, and alternative voice
communication providers. Most traditional wireline and wireless telephone
service providers and cable companies are substantially larger and better
capitalized than we are and have the advantage of a large existing customer
base. In addition, because our competitors provide other services, they often
choose to offer VoIP services or other voice services as part of a bundle that
includes other products, such as Internet access, cable television, and home
telephone service, with an implied price for telephone service that
24 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
may be significantly below ours. In addition, such competitors may in the future
require new customers or existing customers making changes to their service to
purchase voice services when purchasing high speed Internet access. Further, as
wireless providers offer more minutes at lower prices, better coverage, and
companion landline alternative services, their services have become more
attractive to households as a replacement for wireline service. We also compete
against alternative voice communication providers, such as magicJack, Skype, and
Google Voice. Some of these service providers have chosen to sacrifice telephony
revenue in order to gain market share and have offered their services at low
prices or for free. As we continue to introduce applications that integrate
different forms of voice and messaging services over multiple devices, we are
facing competition from emerging competitors focused on similar integration, as
well as from alternative voice communication providers. In addition, our
competitors have partnered and may in the future partner with other competitors
to offer products and services, leveraging their collective competitive
positions. We also are subject to the risk of future disruptive technologies. In
connection with our increasing emphasis on the international long distance
market, we face competition from low-cost international calling cards and VoIP
providers in addition to traditional telephone companies, cable companies, and
wireless companies.
Broadband adoption. The number of United States households with broadband
Internet access has grown significantly. On March 16, 2010, the Federal
Communications Commission ("FCC") released its National Broadband Plan, which
seeks, through supporting broadband deployment and programs, to encourage
broadband adoption for the approximately 100 million United States residents who
do not have broadband at home. We expect the trend of greater broadband adoption
to continue. We benefit from this trend because our service requires a broadband
Internet connection and our potential addressable market increases as broadband
adoption increases.
Regulation. Our business has developed in a relatively lightly
regulated environment. The United States and other countries, however, are
examining how VoIP services should be regulated. A November 2010 order by the
FCC that permits states to impose state universal service fund obligations on
VoIP service, discussed in Note 10 to our financial statements, is an example of
efforts by regulators to determine how VoIP service fits into the
telecommunications regulatory landscape. In addition to regulatory matters that
directly address VoIP, a number of other regulatory initiatives could impact our
business. One such regulatory initiative is net neutrality. In December 2010,
the FCC adopted a revised set of net neutrality rules for broadband Internet
service providers. These rules make it more difficult for broadband Internet
service providers to block or discriminate against Vonage service. Several
broadband Internet service providers have filed appeals of the FCC's new rules
at the D.C. Circuit Court of Appeals alleging that the FCC lacks authority to
apply its rules to broadband Internet service providers. In addition, on
February 9, 2011, the FCC released a Notice of Proposed Rulemaking on reforming
universal service and the intercarrier compensation ("ICC") system that governs
payments between telecommunications carriers primarily for terminating traffic.
The FCC's adoption of an ICC proposal will impact Vonage's costs for
telecommunications services. On October 27, 2011, the FCC adopted an order
reforming universal service and ICC. The FCC order provides that VoIP originated
calls will be subject to interstate access charges for long distance calls and
reciprocal compensation for local calls that terminate to the public switched
telephone network ("PSTN"). The termination charges for all traffic, including
VoIP originated traffic, will transition over several years to a bill and keep
arrangement (i.e., no termination charges). Numerous parties filed appeals of
the FCC's ICC order. We believe that the order, if effected, will positively
impact our costs over time. See also the discussion under "Regulation" in Note
10 to our financial statements for a discussion of regulatory issues that impact
us.
The table below includes key operating data that our management uses to measure
the growth and operating performance of our business:
For the Years Ended December 31,
2012 2011 2010
Gross subscriber line additions 652,750 672,274 640,205
Change in net subscriber lines (15,071 ) (29,996 ) (30,013 )
Subscriber lines (at period end) 2,359,816 2,374,887 2,404,883
Average monthly customer churn 2.6 % 2.6 % 2.4 %
Average monthly operating revenues per line $ 29.89 $ 30.35 $ 30.48
Average monthly direct cost of telephony
services per line $ 8.16 $ 8.23 $ 8.40
Marketing costs per gross subscriber line
addition $ 325.61 $ 303.84 $ 309.54
Employees (excluding temporary help) (at period
end) 983 1,008 1,140
Gross subscriber line additions. Gross subscriber line additions for a
particular period are calculated by taking the net subscriber line additions
during that particular period and adding to that the number of subscriber lines
that terminated during that period. This number does not include subscriber
lines both added and terminated during the period, where termination occurred
within the first 30 days after activation. The number does include, however,
subscriber lines added during the period that are terminated within 30 days of
activation but after the end of the period.
Net subscriber line additions. Net subscriber line additions for a particular
period reflect the number of subscriber lines at the end of the period, less the
number of subscriber lines at the beginning of the period.
Subscriber lines. Our subscriber lines include, as of a particular date, all
paid subscriber lines from which a customer can make an outbound telephone call
on that date. Our subscriber lines include fax lines and soft phones but do not
include our virtual phone numbers or toll free numbers, which only allow inbound
telephone calls to customers. Subscriber lines decreased by 15,071 from
2,374,887 as of December 31, 2011 to 2,359,816 as of December 31, 2012. This
decrease was partially attributable to the removal of unlimited calling to
Pakistan from our Vonage World plan in the fourth quarter of 2012 due to a
government imposed increase in termination costs.
Average monthly customer churn. Average monthly customer churn for a particular
period is calculated by dividing the number of customers that terminated during
that period by the simple average number of customers during the period, and
dividing the result by the number of months in the period. The simple average
number of customers during the period is the number of customers on the first
day of the period, plus the number of customers on the last day of the period,
divided by two. Terminations, as used in the calculation of churn statistics, do
not include customers terminated during the period if termination occurred
within the first 30 days after activation. Our average monthly customer churn
was flat at 2.6% for 2012 compared to 2011. Our average monthly customer churn
declined year over year from 2.7% for the three months ended December 31, 2011
to 2.5% for the three months ended December 31, 2012. The decline in churn was a
result of reintroduction of a service period requirement, sustained improvements
in customer satisfaction and more effective retention processes. Our average
monthly customer churn remained the same sequentially for the three months ended
December 31, 2012 from the three months ended September 30, 2012. There was an
increase in
25 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
churn due to the removal of unlimited calling to Pakistan from our Vonage World
plan as a result of significant increases in call completion costs to Pakistan
imposed by regulatory authorities in Pakistan, offset by the decrease in churn
as a result of sustained improvements in customer satisfaction and more
effective retention processes. We monitor churn on a daily basis and use it as
an indicator of the level of customer satisfaction. Other companies may
calculate churn differently, and their churn data may not be directly comparable
to ours. Customers who have been with us for a year or more tend to have a lower
churn rate than customers who have not. In addition, our customers who are
international callers generally churn at a lower rate than customers who are
domestic callers. Our churn will fluctuate over time due to economic conditions,
competitive pressures, marketplace perception of our services, and our ability
to provide high quality customer care and network quality and add future
innovative products and services.
Average monthly operating revenues per line. Average monthly revenue per line
for a particular period is calculated by dividing our total revenue for that
period by the simple average number of subscriber lines for the period, and
dividing the result by the number of months in the period. The simple average
number of subscriber lines for the period is the number of subscriber lines on
the first day of the period, plus the number of subscriber lines on the last day
of the period, divided by two. Our average monthly revenue per line decreased to
$29.89 for 2012 compared to $30.35 for 2011. This decrease was due primarily to
the expansion of lower priced plan offerings to meet customer segment needs, and
lower activation fee revenue, offset by selected pricing actions, higher priced
rate plans, and higher USF fees.
Average monthly direct cost of telephony services per line. Average monthly
direct cost of telephony services per line for a particular period is calculated
by dividing our direct cost of telephony services for that period by the simple
average number of subscriber lines for the period, and dividing the result by
the number of months in the period. We use the average monthly direct cost of
telephony services per line to evaluate how effective we are at managing our
costs of providing service. Our average monthly direct cost of telephony
services per line decreased slightly to $8.16 for 2012 compared to $8.23 for
2011, due primarily to the decrease in domestic termination costs due to a lower
customer base and more favorable rates negotiated with our service providers and
the decrease in our network costs and in our E-911 costs, offset by the increase
in international calling by our growing base of Vonage World customers and an
increase in regulatory fees.
Direct cost of telephony services both overall and on a per line basis is
expected to experience upward pressure from increased international calling by
our base of Vonage World customers offset by intelligent call routing, peering
relationships, and improved pricing from various carriers.
Marketing cost per gross subscriber line addition. Marketing cost per gross
subscriber line addition is calculated by dividing our marketing expense for a
particular period by the number of gross subscriber line additions during the
period. Marketing expense does not include the cost of certain customer
acquisition activities, such as rebates and promotions, which are accounted for
as an offset to revenues, or customer equipment subsidies, which are accounted
for as direct cost of goods sold. As a result, it does not represent the full
cost to us of obtaining a new customer. Our marketing cost per gross subscriber
line addition increased to $325.61 for 2012 from $303.84 in 2011, due primarily
to television and direct mail marketing investment efficiency, the market test
of our low-priced domestic offer, and less line additions due to the removal of
unlimited calling to Pakistan from our Vonage World plan in the fourth quarter
of 2012 due to a government imposed increase in termination costs.
Employees. Employees represent the number of personnel that are on our payroll
and exclude temporary or outsourced labor.
OPERATING REVENUES
Revenues consist of telephony services revenue and customer equipment and
shipping revenue. Substantially all of our revenues are telephony services
revenue. In the United States, we offer
domestic and international rate plans to meet the needs of our customers,
including a variety of residential plans, mobile plans, and small office and
home office calling plans. The "Vonage World" plan, now available in the United
States and Canada, offers unlimited calling across the United States and Puerto
Rico, unlimited international calling to over 60 countries including India,
Mexico, and China, subject to certain restrictions, and free voicemail to text
messages with Vonage Visual Voicemail. Each of our unlimited plans other than
Vonage World offers unlimited domestic calling as well as unlimited calling to
Puerto Rico, Canada, and selected European countries, subject to certain
restrictions. Each of our basic plans offers a limited number of domestic
calling minutes per month. We offer similar plans in Canada. Under our basic
plans, we charge on a per minute basis when the number of domestic calling
minutes included in the plan is exceeded for a particular month. International
calls (except for calls to Puerto Rico, Canada and certain European countries
under our unlimited plans and a variety of countries under international calling
plans and Vonage World) are charged on a per minute basis. These per minute fees
are not included in our monthly subscription fees.
In addition to our landline telephony business, we are leveraging our technology
to offer services and applications for mobile and other connected devices to
address large existing markets. We introduced our first mobile offering in late
2009 and in early 2012 we introduced Vonage Mobile, our all-in-one mobile
application that provides free calling and messaging between users who have the
application, as well as traditional paid international calling to any other
phone. This mobile application works over WiFi, 3G and 4G and in more than 90
countries worldwide. The application consolidates the best features of our prior
applications, while adding important functionality, value and ease of use
including direct payment through iTunes.
We derive most of our telephony services revenue from monthly subscription fees
that we charge our customers under our service plans. We also offer residential
fax service, virtual phone numbers, toll free numbers and other services, and
charge an additional monthly fee for each service. One business fax line is
included with each of our two small office and home office plans, but we charge
monthly fees for additional business fax lines. We automatically charge these
fees to our customers' credit cards, debit cards, or electronic check payments
("ECP"), monthly in advance. We also automatically charge the per minute fees
not included in our monthly subscription fees to our customers' credit cards,
debit cards or ECP monthly in arrears unless they exceed a certain dollar
threshold, in which case they are charged immediately.
By collecting monthly subscription fees in advance and certain other charges
immediately after they are incurred, we are able to reduce the amount of
accounts receivable that we have outstanding, thus allowing us to have lower
working capital requirements. Collecting in this manner also helps us mitigate
bad debt losses, which are recorded as a reduction to revenue. If a customer's
credit card, debit card or ECP is declined, we generally suspend international
calling capabilities as well as the customer's ability to incur domestic usage
charges in excess of their plan minutes. Historically, in most cases, we are
able to correct the problem with the customer within the current monthly billing
cycle. If the customer's credit card, debit card or ECP could not be
successfully processed during three billing cycles (i.e., the current and two
subsequent monthly billing cycles), we terminate the account.
In the United States, we charge regulatory, compliance, E-911, and intellectual
property-related recovery fees on a monthly basis to defray costs, and to cover
taxes that we are charged by the suppliers of telecommunications services. In
addition, we recognize revenue on a gross basis for contributions to the Federal
Universal Service Fund ("USF") and related fees. All other taxes are recorded on
a net basis.
In addition, historically, we charged a disconnect fee for customers who
terminated their service plan within the first twelve months of service.
Disconnect fees are recorded as revenue and are recognized at the time the
customer terminates service. Beginning in September 2010, we eliminated the
disconnect fee for new customers. In February of 2012 we re-introduced service
agreements as an option for new customers.
Telephony services revenue is offset by the cost of certain
26 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
customer acquisition activities, such as rebates and promotions.
Customer equipment and shipping revenue consists of revenue from sales of
customer equipment to our wholesalers or directly to customers and retailers. In
addition, customer equipment and shipping revenue includes the fees, when
collected, that we charge our customers for shipping any equipment to them.
OPERATING EXPENSES
Operating expenses consists of direct cost of telephony services, royalties,
direct cost of goods sold, selling, general and administrative expense,
marketing expense, depreciation and amortization, and loss from abandonment of
software.
Direct cost of telephony services. Direct cost of telephony services primarily
consists of fees that we pay to third parties on an ongoing basis in order to
provide our services. These fees include:
> Access charges that we pay to other telephone companies to terminate
domestic and international calls on the public switched telephone network.
These costs represented approximately 49% and 50% of our total direct cost
of telephony services for 2012 and 2011, respectively, with a portion of
these payments ultimately being made to incumbent telephone companies.
When a Vonage subscriber calls another Vonage subscriber, we do not pay an
access charge.
> The cost of leasing Internet transit services from multiple Internet
service providers. This Internet connectivity is used to carry VoIP
session initiation signaling and packetized audio media between our
subscribers and our regional data centers.
> The cost of leasing from other telephone companies the telephone numbers
that we provide to our customers. We lease these telephone numbers on a
monthly basis.
> The cost of co-locating our regional data connection point equipment in
third-party facilities owned by other telephone companies, Internet
service providers or collocation facility providers.
> The cost of providing local number portability, which allows customers to
move their existing telephone numbers from another provider to our
service. Only regulated telecommunications providers have access to the
centralized number databases that facilitate this process. Because we are
not a regulated telecommunications provider, we must pay other
telecommunications providers to process our local number portability
requests.
> The cost of complying with the FCC regulations regarding VoIP emergency
services, which require us to provide enhanced emergency dialing
capabilities to transmit 911 calls for all of our customers.
> Taxes that we pay on our purchase of telecommunications services from our
suppliers or imposed by government agencies such as Federal USF and
related fees.
> License fees for use of third party intellectual property.
Direct cost of goods sold. Direct cost of goods sold primarily consists of costs
that we incur when a customer first subscribes to our service. These costs
include:
> The cost of the equipment that we provide to customers who subscribe to
our service through our direct sales channel in excess of activation fees
when an activation fee is collected. The remaining cost of customer equipment is deferred up to the activation fee collected and amortized
over the estimated average customer life.
> The cost of the equipment that we sell directly to retailers.
> The cost of shipping and handling for customer equipment, together with
the installation manual, that we ship to customers.
> The cost of certain products or services that we give customers as promotions.
Selling, general and administrative expense. Selling, general and administrative
expense includes:
> Compensation and benefit costs for all employees, which is
the largest component of selling, general and administrative
expense and includes customer care, research and development, network
engineering and operations, sales and marketing, executive, legal, finance, and
human resources personnel.
> Share-based expense related to share-based awards to employees, directors,
and consultants.
> Outsourced labor related to customer care, kiosk and community based
events teams, and retail in-store support activities.
> Product awareness advertising.
> Transaction fees paid to credit card, debit card, and ECP companies and
other third party billers such as iTunes, which may include a per
transaction charge in addition to a percent of billings charge.
> Rent and related expenses.
> Professional fees for legal, accounting, tax, public relations, lobbying,
and development activities.
> Litigation settlements.
Marketing expense. Marketing expense consists of:
> Advertising costs, which comprise a majority of our marketing expense and
include online, television, direct mail, alternative media, promotions,
sponsorships, and inbound and outbound telemarketing.
> Creative and production costs.
> The costs to serve and track our online advertising.
> Certain amounts we pay to retailers for activation commissions.
> The cost associated with our customer referral program.
Depreciation and amortization expenses. Depreciation and amortization expenses
include:
> Depreciation of our network equipment, furniture and fixtures, and
employee computer equipment.
> Amortization of leasehold improvements and purchased and developed software.
> Amortization of intangible assets (patents and trademarks).
> Loss on disposal or impairment of property and equipment.
Loss from abandonment of software assets. Loss from abandonment of software
assets include:
> Impairment of investment in software assets.
OTHER INCOME (EXPENSE)
Other Income (Expense) consists of:
> Interest income on cash and cash equivalents.
> Interest expense on notes payable, patent litigation judgments and
settlements, and capital leases.
> Amortization of debt related costs.
> Accretion of notes.
> Realized and unrealized gains (losses) on foreign currency.
> Debt conversion expense relating to the conversion of notes payable to equity.
> Gain (loss) on extinguishment of notes.
> Change in fair value of embedded features within notes payable and stock
warrant.
27 VONAGE ANNUAL REPORT 2012-------------------------------------------------------------------------------- Table of Contents
RESULTS OF OPERATION
The following table sets forth, as a percentage of consolidated operating
revenues, our consolidated statement of operations for the periods indicated:
For the Years Ended December 31,
2012 2011 2010
Revenues 100 % 100 % 100 %
Operating Expenses:
Direct cost of telephony services (excluding
depreciation and amortization) 27 27 28
Direct cost of goods sold 5 5 6
Selling, general and administrative 28 27 27
Marketing 25 24 22
Depreciation and amortization 4 4 6
Loss from abandonment of software assets 3 - -
92 87 89
Income from operations 8 13 11
Other Income (Expense):
Interest income - - -
Interest expense (1 ) (2 ) (5 )Change in fair value of embedded features within notes
payable and stock warrant
- - (11 )
Loss on extinguishment of notes - (1 ) (4 )
Other expense, net - - -
(1 ) (3 ) (20 )
Income (loss) before income tax (expense) benefit 7 10 (9 )
Income tax (expense) benefit (3 ) 37 -
Net income (loss) 4 % 47 % (9 )%
28 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
Summary of Results for the Years Ended December 31, 2012, 2011, and 2010
Revenues, Direct Cost of Telephony
Percent
Services and Direct Cost of Good Sold Dollar Dollar Change
For the Years Ended December 31, Change 2012 Change 2011 2012 vs. Percent Change
(in thousands, except percentages)
2012 2011 2010 vs. 2011 vs. 2010 2011 2011 vs. 2010
Revenues $ 849,114 $ 870,323 $ 885,042 $ (21,209 ) $ (14,719 ) (2 )% (2 )%
Direct cost of telephony services (1) 231,877 236,149 243,794 (4,272 ) (7,645 ) (2 )% (3 )%
Direct cost of goods sold 39,133 41,756 55,965 (2,623 ) (14,209 ) (6 )% (25 )%
(1) Excludes depreciation and amortization of $15,115, $15,824, and $18,725,
respectively.
2012 compared to 2011
Revenues. The decrease in revenues of $21,209, or 2%, was primarily driven by a
decrease of $21,307 in monthly subscription fees resulting from a decreased
number of subscription lines, which reduced from 2,374,887 at December 31, 2011
to 2,359,816 at December 31, 2012, and plan mix, a decrease in activation fees
of $3,850, and a decrease in overage in plan minutes of $864. There was an
increase in rebates and credits issued to subscribers of $249 and a decrease in
additional features revenue of $1,424 due primarily to customers opting for our
Vonage World offering, which now includes directory assistance and voice mail to
text. In addition, there was a decrease of $1,663 in equipment and shipping
revenue due to lower direct customer additions and elimination of equipment
recovery fees for new customers and a decrease in other revenue of $2,578 due to
lower rates from our revenue sharing partners. These decreases were offset by a
decrease of $1,064 in bad debt expense due to improved customer credit quality
and lower non-pay churn, and an increase in our regulatory fee revenue of
$7,473, which includes an increase of $7,231 in USF fees. There was also an
increase in international minutes of use revenue of $390 and an increase in fees
that we charged for disconnecting our service of $1,798 due to reinstatement of
contracts for new customers beginning in February 2012.
Direct cost of telephony services. The decrease in direct cost of telephony
services of $4,272, or 2%, was primarily due to a decrease in domestic
termination costs of $8,538 due to improved termination rates, which are costs
that we pay other phone companies for terminating phone calls, and fewer minutes
of use and a decrease in our network costs of $7,550, which includes costs for
co-locating in other carriers' facilities, leasing phone numbers, routing calls
on the Internet, E-911 costs, and transferring calls to and from the Internet to
the public switched telephone network due to improved rates. There was also a
decrease in local number portability costs of $837 due to lower rates and a
decrease in other costs of $503. These decreases were partially offset by an
increased cost of $5,386 from higher international call volume associated with
Vonage World, an increased cost of $7,231 for USF and related fees imposed by
government agencies, and an increase in other taxes and surcharges of $540.
Direct cost of goods sold. The decrease in direct cost of goods sold of $2,623,
or 6%, was primarily due to a decrease in amortization costs on deferred
customer equipment of $2,918, a decrease in waived activation fees for new
customers of $4,711 due to lower direct customer adds, and a decrease in
shipping costs of $300. These decreases were offset by an increase in customer
equipment costs of $5,303 from additional customers from our retail expansion
started in the second quarter of 2011.
2011 compared to 2010
Revenues. The decrease in revenues of $14,719, or 2%, was primarily driven by a
decrease in activation fees of $13,193 as the historical deferred activation
fees are amortized and new activation fees are no longer charged and deferred, a
decrease in fees that we charged for disconnecting our service of $8,587 due to
fewer disconnections and elimination of this fee for new customers beginning in
September 2010, and a reduction in international minutes of use revenue of
$2,248 primarily due to customers moving, as expected, to our fixed rate Vonage
World plan. In addition, there was an increase in rebates and credits issued to
subscribers of $2,889 and a decrease in additional features revenue of $3,420
due primarily to customers opting for our Vonage World offering, which now
includes directory assistance and voice mail to text. There was also a decrease
in equipment sales, net of rebates, of $7,508 related to lower equipment
recovery fees due to fewer disconnections and elimination of equipment recovery
fees for new customers beginning in September 2010 and a decrease in customer
shipping revenue of $837 due to higher priority shipping in 2010, partially
offset by higher customer additions in 2011. These decreases were offset by an
increase in our regulatory recovery and E-911 fees of $9,000 that we collected
from subscribers due to pricing actions in 2010, which included $4,257 of USF
and related fees, a decrease of $10,455 in bad debt expense due to improved
customer credit quality and lower non-pay churn, an increase in other revenue of
$1,268, and an increase in monthly subscription fees of $3,153 due to changes in
plan mix.
Direct cost of telephony services. The decrease in direct cost of telephony
services of $7,645, or 3%, was primarily due to a decrease in domestic
termination costs of $16,828 due to improved termination rates, which are costs
that we pay other phone companies for terminating phone calls, and fewer minutes
of use and a decrease in our network costs of $7,258, which includes costs for
co-locating in other carriers' facilities, leasing phone numbers, routing calls
on the Internet, E-911 costs, and transferring calls to and from the Internet to
the public switched telephone network due to improved rates. There was also a
decrease in other cost of $920 and a decrease in local number portability costs
of $838 due to lower rates. These decreases were partially offset by an
increased cost of $14,739 from higher international call volume associated with
Vonage World and an increase of USF and related fees imposed by government
agencies of $3,460.
Direct cost of goods sold. The decrease in direct cost of goods sold of $14,209,
or 25%, was primarily due to a decrease in customer equipment costs of $5,758
resulting from a lower cost device introduced in September 2010 and lower home
installations. There was also a corresponding decrease in shipping costs of $595
and a decrease in amortization costs on deferred customer equipment of $10,572
as the historical deferred customer equipment costs are amortized and new
customer equipment costs are no longer charged and deferred. These decreases
were offset by an increase in waived activation fees for new customers of
$2,716.
29 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
Selling, General and Administrative Percent
For the Years Ended December 31, Dollar Dollar Change
Change 2012 Change 2011 2012 vs. Percent Change
(in thousands, except percentages) 2012
2011 2010 vs. 2011 vs. 2010 2011 2011 vs. 2010
Selling, general and administrative $ 242,368 $ 234,754 $ 238,986 $ 7,614 $ (4,232 )
3 % (2 )%
2012 compared to 2011
Selling, general and administrative. Selling expense increased by $9,831
including $4,286 due to the expansion of the number of community sales teams,
$2,189 due to an increase in the number of retail outlets with assisted selling,
and $3,256 related to our new mobile offering launched in February 2012 and our
Digital Calling Card launched in the fourth quarter of 2012. General and
administrative expense decreased by $2,217 due to a decrease in credit card fees
of $3,064 as a result of the Durbin Amendment, lower uncollected state and
municipal tax expense of $965, and lower share based cost of $2,304, including a
reversal of executive stock compensation expense of $1,200. These decreases were
partially offset by an increase in compensation and benefits related expense of
$3,669 driven by higher salary related expense of $6,486 offset by a decrease in
outsourced temporary labor of $2,577, of which $2,118 was related to Customer
Care.
2011 compared to 2010
Selling, general and administrative. Selling expense increased by $6,425
including $5,981 due to the expansion of the number of community sales teams and
$869 due to an increase in the number of retail outlets with assisted selling
partially offset by lower retail commissions of $425. General and administrative
expense decreased by $10,657 due to a decrease in compensation and benefits
related expense of $9,591 driven by lower salary related expense of $6,554 and
lower outsourced temporary labor of $2,714, of which $2,223 is related to
Customer Care. In addition, we had a decrease in credit card fees of $1,957 as a
result of the Durbin Amendment, lower settlement costs related to litigation and
contractual disputes of $2,506, lower uncollected state and municipal tax
expense of $1,922, and lower professional fees of $572. These decreases were
offset by an increase in share based cost of $6,024.
Marketing Percent
For the Years Ended December 31, Dollar Dollar Change
Change 2012 Change 2011 2012 vs. Percent Change
2012 2011 2010 vs. 2011 vs. 2010 2011 2011 vs. 2010
Marketing $ 212,540 $ 204,263 $ 198,170 $ 8,277 $ 6,093 4 % 3 %
2012 compared to 2011
Marketing. The increase in marketing expense of $8,277, or 4%, resulted from
increasing our marketing investment in direct mail and retail to reach targeted
ethnic segments and incremental media expenses associated with the market test
of our low-priced domestic offer partially offset by the decrease in television
advertising.
2011 compared to 2010
Marketing. The increase in marketing expense of $6,093, or 3%, resulted from
increasing our marketing investment in direct mail to targeted ethnic segments
which drove a 5% improvement in gross subscriber line additions.
Depreciation and Amortization Percent
For the Years Ended December 31, Dollar Dollar Change
Change 2012 Change 2011 2012 vs. Percent Change
(in thousands, except percentages) 2012
2011 2010 vs. 2011 vs. 2010 2011 2011 vs. 2010
Depreciation and amortization $ 33,324
$ 37,051 $ 53,073 $ (3,727 ) $ (16,022 ) (10 )% (30 )%
2012 compared to 2011
Depreciation and amortization. The decrease in depreciation and amortization of
$3,727, or 10%, was primarily due to lower depreciation of network equipment,
computer hardware, and furniture of $2,356 and lower software amortization of
$2,471 due to certain projects being fully amortized, offset by an increase in
intangible asset amortization of $1,098 from additional intangible assets
acquired during the fourth quarter of 2011.
2011 compared to 2010
Depreciation and amortization. The decrease in depreciation and amortization of
$16,022, or 30%, was primarily due to lower software amortization of $10,455 due
to our internally developed customer acquisition and customer care automation
tools projects being fully amortized, lower depreciation of network equipment,
computer hardware, and furniture of $5,284, and lower impairment charges of
$411.
Loss from abandonment of software assets Dollar Percent
For the Years Ended December 31, Dollar Change Change
Change 2012 2011 vs. 2012 vs. Percent Change
(in thousands, except percentages) 2,012 2,011 2,010 vs. 2011 2010 2011 2011 vs. 2010
Loss from abandonment of software assets $ 25,262 $ - $ - $ 25,262 $ - 100 % *
2012 compared to 2011
Loss from abandonment of software assets. The loss from abandonment of software
assets of $25,262 in 2012 was due to the write-off of our investment in the
Amdocs system, net of settlement amounts to the Company, during the second
quarter of 2012.
2011 compared to 2010
Loss from abandonment of software assets. None.
30 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
Other Income (Expense) Percent
For the Years Ended December 31, Dollar Change
(in thousands, except Dollar Change Change 2011 2012 vs. Percent Change
percentages) 2012 2011 2010 2012 vs. 2011 vs. 2010 2011 2011 vs. 2010
Interest income $ 109 $ 135 $ 519 $ (26 ) $ (384 ) (19 )% (74 )%
Interest expense (5,986 ) (17,118 ) (48,541 ) 11,132 31,423 65 % 65 %
Change in fair value of
embedded features within notes
payable and stock warrant - (950 ) (99,338 ) 950 98,388 100 % 99 %
Loss on extinguishment of
notes - (11,806 ) (31,023 ) 11,806 19,217 100 % 62 %
Other expense, net (11 ) (271 ) (18 ) 260 (253 ) 96 % *
$ (5,888 ) $ (30,010 ) $ (178,401 )
2012 compared to 2011
Interest income. Interest income decreased $26, or 19%.
Interest expense. The decrease in interest expense of $11,132, or 65%, was due
to lower principal outstanding and the reduced interest rate on the 2011 Credit
Facility.
Change in fair value of embedded features within notes payable and stock
warrant. The change in the fair value of our stock warrant fluctuated with
changes in the price of our common stock and was an expense of $950 in 2011, as
the stock warrant was exercised during the three months ended March 31, 2011. An
increase in our stock price resulted in expense while a decrease in our stock
price resulted in income.
Loss on extinguishment of notes. The loss on extinguishment of notes of $11,806
in 2011 was due to the acceleration of unamortized debt discount and debt
related costs in connection with prepayments of the credit facility we entered
into in December 2010 (the "2010 Credit Facility") and our refinancing of the
2010 Credit Facility in July 2011.
Other. Net other income and expense decreased by $260 in 2012 compared to 2011.
2011 compared to 2010
Interest income. The decrease in interest income of $384, or 74%, was due to
lower interest rates and lower average cash balances driven by prepayments on
the 2010 Credit Facility and the repayments on the 2011 Credit Facility.
Interest expense. The decrease in interest expense of $31,423, or 65%, was due
to the reduced interest rate on our 2010 Credit Facility and our 2011 Credit
Facility resulting from our refinancings
in December 2010 and July 2011 and lower principal outstanding due to the
refinancings and prepayments in 2011.
Change in fair value of embedded features within notes payable and stock
warrant. The change in fair value of the embedded conversion option within our
prior third lien convertible notes fluctuated with changes in the price of our
common stock and was $0 during 2011 compared to loss of $7,308 in 2010 as all
convertible notes had been converted as of December 31, 2010. The change in the
fair value of our stock warrant fluctuated with changes in the price of our
common stock and was an expense of $950 in 2011 compared to $344 in 2010. An
increase in our stock price resulted in expense while a decrease in our stock
price resulted in income. In addition, due to the progress of our repurchase
negotiations and other factors, the make-whole premiums in our prior senior
secured first lien credit facility and prior senior secured second lien credit
facility from our 2008 financing were ascribed a value of $91,686 at the time
the make-whole premiums were paid in December 2010.
Loss on extinguishment of notes. The loss on extinguishment of notes of $11,806
in 2011 was due to the acceleration of unamortized debt discount and debt
related costs in connection with prepayments of our 2010 Credit Facility and our
refinancing of the 2010 Credit Facility in July 2011. The loss on extinguishment
of notes of $31,023 in 2010 was due to the acceleration of unamortized debt
discount, debt related costs, and administrative agent fees associated with our
prior senior secured first lien credit facility and prior senior secured second
lien credit facility from our 2008 financing prepayments partially offset by
gains associated with conversion of our prior third lien convertible notes.
Other. Net other income and expense decreased by $253 in 2011 compared to 2010.
Income Tax Benefit (Expense) Percent
For the Years Ended December 31, Dollar Dollar Change
Change 2012 Change 2011 2012 vs. Percent Change
(in thousands, except percentages) 2012
2011 2010 vs. 2011 vs. 2010 2011 2011 vs. 2010
Income tax (expense) benefit $ (22,095 ) $ 322,704 $ (318 ) $ (344,799 ) $ 323,022 (107 )% 101,579 %
Effective tax rate 38 % (375 )% - %
We recognize income tax expense equal to our pre-tax income multiplied by our
effective income tax rate, an expense that had not been recognized prior to the
reduction of the valuation allowance in the fourth quarter of 2011. In addition,
adjustments were recorded for discrete period items related to stock
compensation and changes to our state effective tax rate.
The provision also includes the federal alternative minimum tax in 2012 and 2011
and state and local income taxes in 2012, 2011, and 2010.
We are required to record a valuation allowance which reduces net deferred tax
assets if we conclude that it is more likely than not that taxable income
generated in the future will be insufficient to utilize the future income tax
benefit from these net deferred tax assets prior to expiration. Our net deferred
tax assets primarily consist of net
operating loss carry forwards ("NOLs"). We periodically review this conclusion,
which requires significant management judgment. Until the fourth quarter of
2011, we recorded a valuation allowance which reduced our net deferred tax
assets to zero. In the fourth quarter of 2011, based upon our sustained
profitable operating performance over the past three years excluding certain
losses associated with our prior convertible notes and our December 2010 debt
refinancing and our positive outlook for taxable income in the future, our
evaluation determined that the benefit resulting from our net deferred tax
assets (namely, the NOLs) are likely to be usable prior to their expiration.
Accordingly, we released the related valuation allowance against our United
States and Canada net deferred tax assets, and a portion of the allowance
against our state net deferred tax assets as certain NOLs may expire prior to
utilization due to shorter utilization periods in certain states, resulting in a
one-time non-cash income tax benefit of $325,601 that we recorded in our
31 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
statement of operations and a corresponding net deferred tax asset of $325,601
that we recorded on our balance sheet on December 31, 2011. In the future, if
available evidence changes our conclusion that it is more likely than not that
we will utilize our net deferred tax assets prior to their expiration, we will
make an adjustment to the related valuation allowance and income tax expense at
that time.
We participated in the State of New Jersey's corporation business tax benefit
certificate transfer program, which allows certain high technology and
biotechnology companies to transfer unused New Jersey net operating loss
carryovers to other New Jersey corporation business taxpayers. During 2003 and
2004, we submitted an application to the New Jersey Economic Development
Authority, or EDA, to participate in the program and the application was
approved. The EDA then issued a certificate certifying our eligibility to
participate in the program. The program requires that a purchaser pay at least
75% of the amount of the surrendered tax benefit. In tax years 2010, 2011, and
2012, we sold approximately, $2,194, $0, and $0, respectively, of our New Jersey
State net operating loss carry forwards for a recognized benefit of
approximately $168 in 2010, $0 in 2011, and $0 in 2012. Collectively, all
transactions represent approximately 85% of the surrendered tax benefit each
year and have been recognized in the year received.
As of December 31, 2012, we had net operating loss carry forwards for United
States federal and state tax purposes of $744,139 and $290,196, respectively,
expiring at various times from years ending 2013 through 2030. In addition, we
had net operating loss carry forwards for Canadian tax purposes of $25,476
expiring through 2028. We also had net operating loss carry forwards for United
Kingdom tax purposes of $37,765 with no expiration date.
Net Income (Loss) Percent
For the Years Ended December 31, Dollar Dollar Change
Change 2012 Change 2011 2012 vs. Percent Change
(in thousands, except percentages) 2012
2011 2010 vs. 2011 vs. 2010 2011 2011 vs. 2010
Net income (loss) $ 36,627 $ 409,044 $ (83,665 ) $ (372,417 ) $ 492,709 (91 )% 589 %
2012 compared to 2011
Net Income. Based on the activity described above, our net income of $36,627 for
the year ended December 31, 2012 decreased by $372,417, or 91%, from net income
of $409,044 for the year ended December 31, 2011.
2011 compared to 2010
Net Income (Loss). Based on the activity described above, our net income of
$409,044 for the year ended December 31, 2011 increased by $492,709, or 589%,
from net loss of $83,665 for the year ended December 31, 2010.
32 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth quarterly statement of operations data. We
derived this data from our unaudited consolidated financial statements, which we
believe have been prepared on substantially the same basis as our audited
consolidated financial statements. The operating results in any quarter are not
necessarily indicative of the results that may be expected for any future
period.
For the Quarter Ended
Mar 31, Jun 30, Sep 30, Dec 31, Mar 31, Jun 30, Sep 30, Dec 31,
(dollars in thousands, except operating data) 2011 2011 2011 2011 2012 2012 2012 2012
Revenues $ 219,841 $ 218,285 $ 216,507 $ 215,690 $ 215,903 $ 211,916 $ 207,584 $ 213,711
Operating expenses:
Direct cost of telephony services (1) 60,189 57,883 59,230 58,847 61,623 58,195 55,245 56,814
Direct cost of goods sold 11,055 9,865 10,711 10,125 9,846 9,275 10,444 9,568
Selling, general and administrative 58,243 58,481 59,451 58,579 61,835 58,396 59,676 62,461
Marketing 49,404 52,211 51,044 51,604 53,422 54,956 51,361 52,801
Depreciation and amortization 11,066 8,664 8,683 8,638 8,644 8,518 8,110 8,052
Loss from abandonment of software assets - - - - - 25,262 - -
189,957 187,104 189,119 187,793 195,370 214,602 184,836 189,696
Income from operations 29,884 31,181 27,388 27,897 20,533 (2,686 ) 22,748 24,015
Other income (expense):
Interest income 42 37 33 23 20 30 30 29
Interest expense (6,602 ) (5,588 ) (2,926 ) (2,002 ) (1,751 ) (1,566 ) (1,402 ) (1,267 )
Change in fair value of embedded features
within notes payable and stock warrant (950 ) - - - - - - -
Loss on extinguishment of notes (593 ) (3,228 ) (7,985 ) - - - - -
Other, net (2 ) 44 (47 ) (266 ) 42 (65 ) 28 (16 )
(8,105 ) (8,735 ) (10,925 ) (2,245 ) (1,689 ) (1,601 ) (1,344 ) (1,254 )
Income (loss) before income tax (expense)
benefit 21,779 22,446 16,463 25,652 18,844 (4,287 ) 21,404
22,761
Income tax (expense) benefit (666 ) (698 ) (426 ) 324,494 (4,923 ) 947 (8,191 ) (9,928 )
Net income (loss) $ 21,113 $ 21,748 $ 16,037 $ 350,146 $ 13,921 $ (3,340 ) $ 13,213 $ 12,833
Net income (loss) per common share:
Basic $ 0.10 $ 0.10 $ 0.07 $ 1.55 $ 0.06 $ (0.01 ) $ 0.06 $ 0.06
Diluted $ 0.09 $ 0.09 $ 0.07 $ 1.48 $ 0.06 $ (0.01 ) $ 0.06 $ 0.06
Weighted-average common shares outstanding:
Basic 222,162 224,233 225,281 225,572 225,732 226,429 225,555 219,379
Diluted 240,340 244,590 241,189 237,342 236,036 226,429 233,708 228,107
Operating Data:
Gross subscriber line additions 175,388 158,004 170,344 168,538 165,454 163,349 171,628 152,319
Change in net subscriber line 3,345 (10,568 ) (8,939 ) (13,834 ) (18,739 ) (64 ) 9,440 (5,708 )
Subscriber lines at end of period 2,408,228 2,397,660 2,388,721 2,374,887 2,356,148 2,356,084 2,365,524 2,359,816
Average monthly customer churn
2.5 % 2.5 % 2.7 % 2.7 % 2.8 % 2.5 % 2.5 %
2.5 %
Average monthly operating revenues per line $ 30.45 $ 30.28 $ 30.16 $ 30.19 $ 30.42 $ 29.98 $ 29.31 $ 30.15
Average monthly direct costs of telephony
services per line $ 8.34 $ 8.03 $ 8.25 $ 8.24 $ 8.68 $ 8.23 $ 7.80 $ 8.02
Marketing costs per gross subscriber line
additions $ 281.68 $ 330.44 $ 299.65 $ 306.19 $ 322.88 $ 336.43 $ 299.26 $ 346.65
Employees at end of period 1,126 1,059 1,035 1,008 1,004 988 971 983
(1) Excludes depreciation and amortization of $4,124, $3,867, $3,864, and
$3,969 for the quarters ended March 31, June 30, September 30 and
December 31, 2011, respectively, and $3,930, $3,929, $3,722, and $3,534
for the quarters ended March 31, June 30, September 30 and December 31,
2012, respectively.
.
33 VONAGE ANNUAL REPORT 2012-------------------------------------------------------------------------------- Table of Contents
LIQUIDITY AND CAPITAL RESOURCES
Overview
The following table sets forth a summary of our cash flows for the periods
indicated:
For the Years Ended December 31,
(dollars in thousands) 2012 2011 2010Net cash provided by operating activities $ 119,843 $ 146,786 $ 194,212
Net cash used in investing activities (25,472 ) (37,604 )
(4,686 )
Net cash used in financing activities (56,257 ) (130,138 ) (143,762 )
For the three years ended December 31, 2012, 2011, and 2010 we generated income
from operations. We expect to continue to balance efforts to grow our customer
base while consistently achieving profitability. To grow our customer base, we
continue to make investments in marketing and application development as we seek
to launch new services, network quality and expansion, and customer care.
Although we believe we will maintain consistent profitability in the future, we
ultimately may not be successful and we may not achieve consistent
profitability. We believe that cash flow from operations and cash on hand will
fund our operations for at least the next twelve months.
December 2010 Financing
On December 14, 2010, we entered into the 2010 Credit Facility consisting of a
$200,000 senior secured term loan. The co-borrowers under the 2010 Credit
Facility were us and Vonage America Inc., our wholly owned subsidiary.
Obligations under the 2010 Credit Facility were guaranteed, fully and
unconditionally, by our other United States subsidiaries and were secured by
substantially all of the assets of each borrower and each of the guarantors. An
affiliate of the chairman of our board of directors and one of our principal
stockholders was a lender under the 2010 Credit Facility.
Use of Proceeds
We used the net proceeds of the 2010 Credit Facility of $194,000 ($200,000
principal amount less original discount of $6,000), plus $102,090 of cash on
hand, to (i) exercise our existing right to retire debt under our prior senior
secured first lien credit facility for 100% of the contractual make-whole price,
(ii) retire debt under our prior senior secured second lien credit facility at a
more than 25% discount to the contractual make-whole price, and (iii) cause the
conversion of all then outstanding third lien convertible notes into 8,276
shares of our common stock. We also incurred $11,444 of fees in connection with
the 2010 Credit Facility and repayment of the prior financing.
Repayments
In 2011, we repaid the entire $200,000 under the 2010 Credit Facility, with
$20,000 designated to cover our 2011 mandatory amortization, $50,000 designated
to cover our 2011 annual excess cash flow mandatory repayment, if any, and
$130,000 designated to cover the outstanding principal balance under the 2010
Credit Facility at the time of the 2011 Credit Facility financing.
July 2011 Financing
On July 29, 2011, we entered into the 2011 Credit Facility consisting of an
$85,000 senior secured term loan and a $35,000 revolving credit facility. The
co-borrowers under the 2011 Credit Facility were us and Vonage America Inc., our
wholly owned subsidiary. Obligations under the 2011 Credit Facility were
guaranteed, fully and unconditionally, by our other United States subsidiaries
and were secured by substantially all of the assets of each borrower and each of
the guarantors.
Use of Proceeds
We used $100,000 of the net available proceeds of the 2011 Credit Facility, plus
$31,000 of cash on hand, to retire all of the debt
under our 2010 Credit Facility, including a $1,000 prepayment fee to holders of
the 2010 Credit Facility.
Repayments
In 2012 and 2011, we made mandatory repayment of $28,333 and $14,166,
respectively, under the senior secured term loan. In addition, we repaid the
$15,000 outstanding under the revolving credit facility in 2011.
As of December 31, 2012, we were in compliance with all covenants, including
financial covenants, for the 2011 Credit Facility.
The 2011 Credit Facility contains customary events of default that may permit
acceleration of the debt. During the continuance of a payment default, interest
will accrue at a default interest rate of 2% above the interest rate which would
otherwise be applicable, in the case of loans, and at a rate equal to the rate
applicable to base rate loans plus 2%, in the case of all other amounts.
February 2013 Financing
On February 11, 2013 we entered into the 2013 Credit Facility. The 2013 Credit
Facility consists of a $70,000 senior secured term loan and a $75,000 revolving
credit facility. The co-borrowers under the 2013 Credit Facility are us and
Vonage America Inc., our wholly owned subsidiary. Obligations under the 2013
Credit Facility are guaranteed, fully and unconditionally, by our other United
States subsidiaries and are secured by substantially all of the assets of each
borrower and each of the guarantors.
Use of Proceeds
We used $42,500 of the net available proceeds of the 2013 Credit Facility to
retire all of the debt under our 2011 Credit Facility. Remaining proceeds from
the senior secured term loan and the undrawn revolving credit facility under the
2013 Credit Facility will be used for general corporate purposes.
2013 Credit Facility Terms
The following description summarizes the material terms of the 2013 Credit
Facility:
The loans under the 2013 Credit Facility mature in February 2016. Principal
amounts under the 2013 Credit Facility are repayable in quarterly installments
of $5,833 per quarter for the senior secured term loan. The unused portion of
our revolving credit facility incurs a 0.45% commitment fee.
Outstanding amounts under the 2013 Credit Facility, at our option, will bear
interest at:
> LIBOR (applicable to one-, two-, three- or six-month periods) plus an
applicable margin equal to 3.125% if our consolidated leverage ratio is
less than 0.75 to 1.00, 3.375% if our consolidated leverage ratio is
greater than or equal to 0.75 to 1.00 and less than 1.50 to 1.00, and 3.625% if our consolidated leverage ratio is greater than or equal to 1.50
to 1.00, payable on the last day of each relevant interest period or, if
the interest period is longer than three months, each day that is three
months after the first day of the interest
34 VONAGE ANNUAL REPORT 2012-------------------------------------------------------------------------------- Table of Contents
period, or
> the base rate determined by reference to the highest of (a) the federal
funds effective rate from time to time plus 0.50%, (b) the prime rate of
JPMorgan Chase Bank, N.A., and (c) the LIBOR rate applicable to one month
interest periods plus 1.00%, plus an applicable margin equal to 2.125% if
our consolidated leverage ratio is less than 0.75 to 1.00, 2.275% if our
consolidated leverage ratio is greater than or equal to 0.75 to 1.00 and less than 1.50 to 1.00, and 2.625% if our consolidated leverage ratio is
greater than or equal to 1.50 to 1.00, payable on the last business day of
each March, June, September, and December and the maturity date of the
2013 Credit Facility.
The 2013 Credit Facility provides greater flexibility to us in funding
acquisitions and restricted payments, such as stock buybacks, than the 2011
Credit Facility.
We may prepay the 2013 Credit Facility at our option at any time without premium
or penalty. The 2013 Credit Facility is subject to mandatory prepayments in
amounts equal to:
> 100% of the net cash proceeds from any non-ordinary course sale or other
disposition of our property and assets for consideration in excess of a certain amount subject to customary reinvestment provisions and certain
other exceptions and
> 100% of the net cash proceeds received in connection with other
non-ordinary course transactions, including insurance proceeds not
otherwise applied to the relevant insurance loss.
Subject to certain restrictions and exceptions, the 2013 Credit Facility permits
us to obtain one or more incremental term loans and/or revolving credit
facilities in an aggregate principal amount of up to $60,000 plus an amount
equal to repayments of the senior secured term loan upon providing documentation
reasonably satisfactory to the administrative agent, without the consent of the
existing lenders under the 2013 Credit Facility. The 2013 Credit Facility
includes customary representations and warranties and affirmative covenants of
the borrowers. In addition, the 2013 Credit Facility contains customary negative
covenants, including, among other things, restrictions on the ability of us and
our subsidiaries to consolidate or merge, create liens, incur additional
indebtedness, dispose of assets, consummate acquisitions, make investments, and
pay dividends and other distributions. We must also comply with the following
financial covenants:
> a consolidated leverage ratio of no greater than 2.00 to 1.00;
> a consolidated fixed coverage charge ratio of no less than 1.75 to 1.00
subject to adjustment to exclude up to $50,000 in specified restricted
payments;
> minimum cash of $25,000 including the unused portion of the revolving
credit facility or $35,000 in the event of certain specified corporate
actions; and
> maximum capital expenditures not to exceed $55,000 during any fiscal year, provided that the unused amount of any permitted capital expenditures in
any fiscal year may be carried forward to the next following fiscal year.
In addition, annual excess cash flow up to $8,000 increases permitted
capital expenditures.
The 2013 Credit Facility contains customary events of default that may permit
acceleration of the debt. During the continuance of a payment default, interest
will accrue at a default interest rate of 2% above the interest rate which would
otherwise be applicable, in the case of loans, and at a rate equal to the rate
applicable to base rate loans plus 2%, in the case of all other amounts.
State and Local Sales Taxes
We also have contingent liabilities for state and local sales taxes. As of
December 31, 2012, we had a reserve of $1,514. If our
ultimate liability exceeds this amount, it could affect our liquidity
unfavorably. However, we do not believe it would significantly impair our
liquidity.
Capital expenditures
For 2012, capital expenditures were primarily for the implementation of software
solutions and purchase of network equipment as we continue to expand our
network. Our capital expenditures for the year ended 2012 were $26,750, of which
$12,987 was for software acquisition and development. The majority of these
expenditures are comprised of investments in information technology and systems
infrastructure, including an electronic data warehouse, online customer service,
customer management platforms, and the Amdocs billing and order management
system. As previously disclosed, we experienced delays and incremental costs
during the course of the development and implementation of the Amdocs billing
and ordering system and the transition of customers to the system. We conducted
discussions with Amdocs to resolve the issues associated with the billing and
ordering system. Based on these discussions, and after our consideration of the
progress made improving our overall IT infrastructure, the incremental time and
costs to develop and implement the Amdocs system, as well as the expected
reduction in capital expenditures, in June 2012 we and Amdocs determined that
terminating the program was in the best interest of both parties. On July 30,
2012, we entered into a settlement agreement with Amdocs terminating the related
license agreement. As a result, we determined that a write-off of our investment
in the system of $25,262, net of settlement amounts to the Company, was required
in the second quarter of 2012. This charge is recorded as loss from abandonment
of software assets in the statement of operations. For 2013, we believe our
capital and software expenditures will be approximately $30,000 to $35,000.
Operating Activities
Cash provided by operating activities decreased to $119,843 during the year
ended December 31, 2012 compared to $146,786 for the year ended December 31,
2011, primarily due to planned investments in our growth initiatives, lower
revenues and changes in working capital.
Changes in working capital requirements include changes in accounts receivable,
inventory, prepaid and other assets, other assets, accounts payable, accrued and
other liabilities, and deferred revenue and costs. Cash used for working capital
increased by $5,704 during the year ended December 31, 2012 compared to the year
ended December 31, 2011, primarily due to the timing of payments.
Cash provided by operating activities decreased to $146,786 during the year
ended December 31, 2011 compared to $194,212 for the year ended December 31,
2010 , primarily due to changes in working capital requirements and higher
marketing expenditures partially offset by lower interest expense as a result of
our debt refinancings in December 2010 and July 2011.
Changes in working capital requirements include changes in accounts receivable,
inventory, prepaid and other assets, other assets, accounts payable, accrued and
other liabilities, and deferred revenue and costs. Cash provided by working
capital decreased by $69,137 during the year ended December 31, 2011 compared to
the year ended December 31, 2010, primarily due to the timing of payments.
Investing Activities
Cash used in investing activities for 2012 of $25,472 was attributable to
capital expenditures of $13,763 and software acquisition and development of
$12,987, offset by a decrease in restricted cash of $1,278 due primarily to the
return of part of the security deposit on our leased office property in Holmdel,
New Jersey.
Cash used in investing activities for 2011 of $37,604 was attributable to
capital expenditures of $12,636, software acquisition and development of
$22,292, and purchase of intangible assets of $3,725, offset by a decrease in
restricted cash of $1,049 due primarily to the return of part of the security
deposit on our leased office property in Holmdel, New Jersey.
35 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
Cash used in investing activities for 2010 of $4,686 was attributable to capital
expenditures of $17,674 and development of software assets of $22,712, partially
offset by a decrease in restricted cash of $35,700 due primarily to the
reduction of $32,830 of reserves held by our credit card processors as a result
of improvements in credit quality and the elimination of the concentration
account under our prior credit facilities of $3,277 as a result of our new
Credit Facility.
Financing Activities
Cash used in financing activities for 2012 of $56,257 was primarily attributable
to $28,333 in 2011 Credit Facility principal payments, $2,104 in capital lease
payments, and $27,545 in common stock repurchases, offset by $1,725 in proceeds
received from the exercise of stock options.
Cash used in financing activities for 2011 of $130,138 was primarily
attributable to $200,000 in 2010 Credit Facility and $29,166 in
2011 Credit Facility and revolving credit facility principal payments,
respectively, $1,783 in capital lease payments, and $2,697 in 2011 Credit
Facility debt related cost payments, offset by $100,000 in proceeds received
from the issuance of the 2011 Credit Facility and $4,562 in proceeds received
from the exercise of stock options and a common stock warrant.
Cash used in financing activities for 2010 of $143,762 was attributable to
$128,165 in prior senior secured first lien credit facility principal payments,
$104,349 in prior senior secured second lien credit facility principal payments,
including $32,320 representing paid-in-kind ("PIK") interest payments, payments
of $99,938 to extinguish our prior senior secured first lien credit facility,
our prior senior secured second lien credit facility and our prior third lien
convertible notes, and $1,500 in capital lease payments partially offset by
proceeds of the 2010 Credit Facility of $200,000 offset by note discount of
$6,000 and debt related costs of $5,430, and proceeds of $1,620 from stock
options exercised.
CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
The table below summarizes our contractual obligations at December 31, 2012, and
the effect such obligations are expected to have on our liquidity and cash flow
in future periods.
Payments Due by Period
Less
than 2-3 4-5 After 5(dollars in thousands) Total 1 year years years years
(unaudited)
Contractual Obligations:
2011 Credit Facility $ 42,500 $ 28,333 $ 14,167 $ - $ -
Interest related to 2011 Credit Facility 1,591 1,303 288 - -
Capital lease obligations 20,726 4,284 8,826 7,616 -
Operating lease obligations 9,987 5,455 4,532 - -
Purchase obligations 63,590 49,810 12,713 1,067 -
Other obligations 2,750 1,000 1,750 - -
Total contractual obligations $ 141,144 $ 90,185 $ 42,276 $ 8,683 $ -
Other Commercial Commitments:
Standby letters of credit $ 5,558 $ 5,558 $ - $ - $ -
Total contractual obligations and other
commercial commitments $ 146,702 $ 95,743 $ 42,276 $ 8,683 $ -
Credit Facility. On July 29, 2011, we entered into the 2011 Credit Facility
which consists of an $85,000 senior secured term loan and a $35,000 revolving
credit facility. On February 11, 2013 we entered into Amendment No. 1 to the
2011 Credit Agreement (the "2013 Credit Facility"). The 2013 Credit Facility
consists of a $70,000 senior secured term loan and a $75,000 revolving credit
facility. See Note 6 in the notes to the consolidated financial statements.
Capital lease obligations. At December 31, 2012, we had capital lease
obligations of $20,726 related to our corporate headquarters in Holmdel, New
Jersey.
Operating lease obligations. At December 31, 2012, we had future commitments for
operating leases for co-location facilities mainly in the United States that
accommodate a portion of our network equipment, for kiosks leased in various
locations throughout the United States, for office space leased for our London,
United Kingdom office, for office space leased in Atlanta, Georgia for product
development, for office space leased in Tel Aviv, Israel for application
development, and for apartment space leased in New Jersey for certain
executives.
Purchase obligations. The purchase obligations reflected above are primarily
commitments to vendors who will provide voice termination services, provide
voicemail to text transcription services, provide local inbound services,
process our credit card billings, provide E-911 services to our customers,
assist us with local number portability, license patents to us, sell us
communication devices, sell us data center equipment, lease us collocation
facilities, and provide carrier operation services and provide in-store assisted
sales labor. In certain cases, we may terminate these arrangements early upon
payment of specified fees. These amounts do not represent our entire anticipated
purchases in the future, but represent only those items for which we are
contractually committed. We also purchase products and services as needed with
no firm commitment. For this reason, the amounts presented do not provide a
reliable indicator of our expected future cash outflows or changes in our
expected cash position. See also Note 10 to our consolidated financial
statements.
36 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our significant accounting policies are summarized in Note 1 to our consolidated
financial statements. The following describes our critical accounting policies
and estimates:
Use of Estimates
Our consolidated financial statements are prepared in conformity with accounting
principles generally accepted in the United States, which require management to
make estimates and assumptions that affect the amounts reported and disclosed in
the consolidated financial statements and the accompanying notes. Actual results
could differ materially from these estimates.
On an ongoing basis, we evaluate our estimates, including the following:
> the useful lives of property and equipment, software costs, and
intangible assets;
> assumptions used for the purpose of determining share-based
compensation and the fair value of our prior stock warrant using the
Black-Scholes option pricing model ("Model"), and various other
assumptions that we believed to be reasonable; the key inputs for this
Model are our stock price at valuation date, exercise price, the
dividend yield, risk-free interest rate, life in years, andhistorical
volatility of our common stock;
> assumptions used in determining the need for, and amount of, a
valuation allowance on net deferred tax assets;
> assumptions used to determine the fair value of the embedded
conversion option within our prior third lien convertible notes using
the Monte Carlo simulation model; the key inputs are maturity date,
risk-free interest rate, our stock price at valuation date, and
historical volatility of our common stock; and
> assumptions used to determine the fair value of the embedded
make-whole premium feature within our prior senior secured first lien
credit facility and our prior senior secured second lien credit
facility.
We base our estimates on historical experience, available market information,
appropriate valuation methodologies, and on various other assumptions that we
believed to be reasonable, the results of which form the basis for making
judgments about the carrying values of assets and liabilities.
Revenue Recognition
The point in time at which revenues are recognized is determined in accordance
with Staff Accounting Bulletin No. 104, Revenue Recognition, and Financial
Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC")
605, Revenue Recognition.
At the time a customer signs up for our telephony services, there are the
following deliverables:
> Providing equipment, if any, to the customer that enables our
telephony services and
> Providing telephony services.
The equipment is provided free of charge to our customers and in most instances
there are no fees collected at sign-up. We record the fees collected for
shipping the equipment to the customer, if any, as shipping and handling revenue
at the time of shipment.
A further description of our revenues is as follows:
Substantially all of our operating revenues are telephony services revenues,
which are derived primarily from monthly
subscription fees that customers are charged under our service plans. We also
derive telephony services revenues from per minute fees for international calls
if not covered under a plan, including applications for mobile devices and other
stand-alone products, and for any calling minutes in excess of a customer's
monthly plan limits. Monthly subscription fees are automatically charged to
customers' credit cards, debit cards or electronic check payments, or ECP, in
advance and are recognized over the following month when services are provided.
Revenues generated from international calls and from customers exceeding
allocated call minutes under limited minute plans are recognized as services are
provided, that is, as minutes are used, and are billed to a customer's credit
cards, debit cards or ECP in arrears. As a result of our multiple billing cycles
each month, we estimate the amount of revenues earned from international calls
and from customers exceeding allocated call minutes under limited minute plans
but not billed from the end of each billing cycle to the end of each reporting
period. These estimates are based primarily upon historical minutes and have
been consistent with our actual results.
We also provide rebates to customers who purchase their customer equipment from
retailers and satisfy minimum service period requirements. These rebates in
excess of activation fees are recorded as a reduction of revenues over the
service period based upon the estimated number of customers that will ultimately
earn and claim the rebates.
Customer equipment and shipping revenues include sales to our retailers, who
subsequently resell this customer equipment to customers. Revenues were reduced
for payments to retailers and rebates to customers, who purchased their customer
equipment through these retailers, to the extent of customer equipment and
shipping revenues.
Inventory
Inventory consists of the cost of customer equipment and is stated at the lower
of cost or market, with cost determined using the average cost method. We
provide an inventory allowance for customer equipment that has been returned by
customers but may not be able to be reissued to new customers or returned to the
manufacturer for credit.
Income Taxes
We recognize deferred tax assets and liabilities at enacted income tax rates for
the temporary differences between the financial reporting bases and the tax
bases of our assets and liabilities. Any effects of changes in income tax rates
or tax laws are included in the provision for income taxes in the period of
enactment. Our net deferred tax assets primarily consist of net operating loss
carry forwards ("NOLs"). We are required to record a valuation allowance against
our net deferred tax assets if we conclude that it is more likely than not that
taxable income generated in the future will be insufficient to utilize the
future income tax benefit from our net deferred tax assets (namely, the NOLs)
prior to expiration. We periodically review this conclusion, which requires
significant management judgment. If we are able to conclude in a future period
that a future income tax benefit from our net deferred tax assets has a greater
than 50 percent likelihood of being realized, we are required in that period to
reduce the related valuation allowance with a corresponding decrease in income
tax expense. This will result in a non-cash benefit to our net income in the
period of the determination. In the future, if available evidence changes our
conclusion that it is more likely than not that we will utilize our net deferred
tax assets prior to their expiration, we will make an adjustment to the related
valuation allowance and income tax expense at that time. In the fourth quarter
of 2011, we released $325,601 of valuation allowance (see Note 5. Income Taxes).
In subsequent periods, we would expect to recognize income tax expense equal to
our pre-tax income multiplied by our effective income tax rate, an expense that
was not recognized prior to the reduction of the valuation allowance.
37 VONAGE ANNUAL REPORT 2012
-------------------------------------------------------------------------------- Table of Contents
Net Operating Loss Carryforwards
As of December 31, 2012, we had NOLs for United States federal and state tax
purposes of $744,139 and $290,196, respectively, expiring at various times from
years ending 2013 through 2030. In addition, we had NOLs for Canadian tax
purposes of $25,476 expiring through 2028. We also had NOLs for United Kingdom
tax purposes of $37,765 with no expiration date.
Under Section 382 of the Internal Revenue Code, if we undergo an "ownership
change" (generally defined as a greater than 50% change (by value) in our equity
ownership over a three-year period), our ability to use our pre-change of
control NOLs and other pre-change tax attributes against our post-change income
may be limited. The Section 382 limitation is applied annually so as to limit
the use of our
pre-change NOLs to an amount that generally equals the value of our stock
immediately before the ownership change multiplied by a designated federal
long-term tax-exempt rate. At December 31, 2012, there were no limitations on
the use of our NOLs.
Share-Based Compensation
We account for share-based compensation in accordance with FASB ASC 718,
"Compensation-Stock Compensation". Under the fair value recognition provisions
of this pronouncement, share-based compensation cost is measured at the grant
date based on the fair value of the award, reduced as appropriate based on
estimated forfeitures, and is recognized as expense over the applicable vesting
period of the stock award using the accelerated method.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements.
[ Back To asia.tmcnet.com's Homepage 's Homepage ]
|
Internet Telephony Magazine
Click here to read latest issue
CUSTOMER 
Cloud Computing Magazine
Click here to read latest issue
M2M Evolution Magazine
Call Center/CRM
Info Tech 
IP Communications 
Mobile 
Green 
Satellite 
Robotics 
