Vonage to pay $58 million in Verizon patent case

Vonage, which provides a service that turns broadband connections into phone lines, was found by a Virginia jury to have infringed patents that cover the technology used to connect these voice-over-Internet-Protocol (VoIP) calls to the regular phone network, as well as some features for implementing call-waiting and voice-mail services.

The monetary damages and the ongoing royalties awarded Verizon could have a significant impact on Vonage, if it doesn't come up with a solution that doesn't infringe the patents. The Internet phone service provider has yet to turn a profit.

"Vonage is already losing money," said Clayton Moran, an equities analyst with Stanford Group. "If you add the expenses of the damages, royalties and the ongoing legal battles, it just throws their future profitability into question."

But the biggest risk for Vonage is that the company could also be forced to shut down its service. In addition to the damages, Verizon is asking the court for an injunction. On March 23, U.S. Judge Claude Hilton will hear arguments to decide whether Vonage's service should stop offering service until an acceptable licensing agreement can be worked out. Vonage said in a press release that it doesn't expect any interruption in service.

"We don't believe there is any basis to support Verizon's request for an injunction," it said. "If the trial court does impose an injunction, we will seek an immediate stay from the Federal Court of Appeals. Vonage's customers should see no change to any aspect of their phone service."

The threat of an injunction and a long legal battle could adversely impact the company's sales, as new customers may be reluctant to sign up for a service that could be shut down. That's what happened to Research in Motion, the maker of the Blackberry email devices and service.

In 2002, a jury found that RIM had infringed on patents held by the patent holding company NTP. A judge then imposed an injunction, which was stayed pending RIM's appeals. The situation came to a head some three and a half years later when the judge in the case was about to impose the injunction. In the eleventh hour, RIM and NTP settled the case. But the ongoing threat of a shutdown spooked potential customers, causing RIM's sales to dip during the quarter preceding the settlement, RIM said after the case was settled.

Verizon filed a lawsuit against Vonage in June 2006 in the U.S. District Court for the Virginia Eastern District accusing the IP telephony service provider of infringing several patents.

When Verizon first filed its lawsuit, it said that Vonage was infringing on seven of its patents. It later revised its complaint, and the jury ultimately considered five patents. The jury was asked not only to decide whether Vonage had infringed on its patents, but also whether the patents themselves were valid. The jury found that all five patents were valid, but it only decided that Vonage violated three of them.

The jury also found Vonage infringed on a patent involving VoIP calls using Wi-Fi handsets. Vonage was cleared of infringing two patents related to billing systems designed to prevent fraud.

The eight jurors rejected Verizon's argument that the infringement was willful. If the jury had found that the infringement was willful, it could have tripled the damages it awarded to Verizon.

Still, Verizon was delighted with the outcome.

"Patents encourage and protect innovations that benefit consumers, create jobs, and keep the economy growing," John Thorne, Verizon senior vice president and deputy general counsel, said in a statement. "We are proud of our inventors and pleased the jury stood up for the legal protections they deserve."

Verizon had sought $197 million in damages. But an expert testifying for Vonage during the trial had said that the most the company should be expected to pay would be $69 million in damages. Ultimately, the jury awarded $58 million in damages using a formula that calculated Vonage pay a royalty fee of 5.5 percent on the revenue it makes for each Vonage customer line per month. Vonage has said it has about 2.2 million subscriber lines. The same formula could be used for the ongoing royalty fee, a Verizon representative said.

Throughout the entire lawsuit Vonage has denied that it has violated any patents. It claims that most of the technology it uses is standards-based and widely available throughout the industry. The company said it plans to appeal the verdict.

The verdict comes at a time when Vonage is struggling to become profitable. Last month it reported during its fourth-quarter earnings call for 2006 that it had lost $286 million for the year, on revenue of $607 million.

Vonage's heavy losses are due in large part to the company's massive marketing budget. In 2006, it spent $365 million on marketing, a 50 percent increase in marketing spent from the previous year. But even though Vonage is spending more on marketing to acquire new customers, it has started to lose momentum in signing up new customers. In the fourth quarter, Vonage added only 166,000 new subscribers for its VoIP service. That was down from 204,591 subscribers in the third quarter 2006, and from 256,000 in the second quarter 2006.

Despite its losses, Vonage has a strong cash position. The company ended the quarter with almost $500 million in cash, which means that the $58 million in cash damages it was ordered to pay to Verizon accounts for only about 12 percent of its total cash. But still financial analysts say it's a serious enough blow to set the company back.

"Even though the damages could have been worse, the royalty fees and ongoing legal battle, will add more expenses," Moran said. "And that could impact the future profitability of the company."

Shares in Vonage ended the day down $0.19 or 3.76 percent to $4.86.