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Vonage flounders amid slowed subscriber growth

Vonage's legal troubles have cost it dearly and things just seem to keep getting worse.

Internet Protocol telephony player Vonage is still hanging on, but the company, which has been mired in a nasty patent battle with Verizon Communications, is teetering on disaster as it struggles to sign up new customers.

Vonage said Thursday during its second-quarter conference call that it has completed the necessary work-arounds for the Verizon patents that a court found it infringes, but the legal drama has cost the company dearly in terms of recruiting new customers.

Jeffrey Citron, the company's interim CEO, told investors and analysts the company had substantially completed deployments of work-arounds for two of the three patents that a court in March said it had infringed. And it's completed development for a work-around of the third patent.

"This is a significant step toward moving ahead with our business in the wake of the Verizon litigation," Citron said in a statement.

Vonage's legal troubles have no doubt scared off customers. What's more, Vonage, which had aggressively marketed its service by splashing banner ads all over the Internet and flooding television airwaves with commercials, has pared back its advertising budget to reduce costs. For the second quarter the company spent just $68 million on marketing, down from $91 million in the first quarter.

The pullback helped the company reduce its losses by about 50 percent for the quarter, but it also slowed the company's subscriber growth.

During the quarter, Vonage added only 57,000 new customers. This is down dramatically from the 166,000 new customers it added in the first quarter. In total, Vonage now has about 2.45 million subscribers. Meanwhile, cable operator Comcast reported about 3 million digital phone subscribers at the end of the second quarter, making it the largest Internet telephony player. Citron said the company plans to be more targeted with its advertising to attract new customers.

But Vonage didn't just have trouble acquiring new customers. It also had trouble keeping them. During the second quarter its churn rate or the rate at which customers cancel service rose to 2.5 percent from 2.4 percent in the previous quarter.

Citron said he had surveyed customers at Vonage and discovered that as many as seven out of 10 customers who left the service did so because of spotty customer service. Citron vowed to change this.

"It doesn't take a lot of bad experiences to cause a few thousand customers to leave, and that reduces net adds," he said. "We expect to make modest improvement in the next quarter dealing with these issues of churn and improving the customer experience."

Vonage is competing in a tough market and it will likely get tougher. Now defunct, SunRocket is just one example of how quickly things can go from bad to extreme disaster. Even Citron admitted he was surprised by how quickly the company sank.

"I was shocked to see the company go from having capital troubles to not signing up new customers and closing its doors," he said. "We tried to get as many of those customers as we could, but the demise was far too fast for any of the competitors out there to get to those customers."

Vonage still has $191 million in working capital that should keep it afloat for a little while. But if it can't stem the tide of defections and boost subscriber growth, the company's days could be numbered.

UPDATE: Vonage executives said during the conference call that the company has $191 million in working capital, which is the cash the company has on hand to run its day-to-day business. The company's total cash equivalents and marketable securities as of June 30, 2007 totaled $344 million, which includes $66 million of restricted cash used as collateral for the Verizon bond. Last quarter, Vonage had $410 million in cash and securities.