Vonage 2013 Annual Report Download - page 33

27 VONAGE ANNUAL REPORT 2013
ITEM 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations
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, Wi-Fi, Cable,
or DSL broadband networks. This technology enables delivery of voice,
messaging and video services globally on a variety of devices.
Since its inception, Vonage has used IP technology to disrupt
large existing markets by offering high-value, low cost communications
services. From its start-up roots, the Company has evolved into a leader
in the VoIP services market, with 2.5 million customer lines serving
residential and small and medium business customers. Customers
using our core Vonage landline replacement service are located in the
United States (94% of lines), Canada and the UK. Our mobile
applications serve customers around the world.
Key to the Company's evolution was its strategic, operational
and financial transformation, which was largely completed in 2012. This
transformation resulted in a dramatic swing to profitability enabled by
significant cost reductions, a meaningful lowering of customer
defections, and the successful restructuring our balance sheet. This
transformation positioned the Company to pursue our current growth
strategy.
Strategically, we shifted our primary focus in our domestic
markets to serving the rapidly growing but under-served ethnic
segments in the United States with international calling needs. We
improved the customer 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 differentiated our service by providing
enhanced features, including our mobile Extensions service, 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.
Operationally, we lowered customer churn from highs of 3.6%
in July 2009 to 2.6% in 2012; we further lowered churn in 2013 to 2.5%.
Through three debt refinancings in December 2010, July 2011, and
February 2013, we lowered our interest rate from 20% to less than 4%,
saving over $40 million in annual interest expense.
Our disciplined approach to cash management was
fundamental in enabling us to establish our share repurchase program
which was first instituted in August of 2012. We currently have a
$100,000 repurchase authorization in place to be completed by
December 31, 2014. As of December 31, 2013, we have repurchased
$50,653 or 16,954 shares of Vonage common stock. Since beginning
the first repurchase program, we have repurchased $83,971 or 31,390
shares of Vonage stock.
We believe our repurchase program reflects our balanced
approach to capital allocation as we invest for growth, both organically
and inorganically through acquisitions, and deliver value to shareholders
without compromising our ongoing operational needs.
In 2013 we made important progress against each of our
growth priorities. We launched the BasicTalk brand nationally, offering
compelling value to domestic callers. In the core Vonage branded
business, we continued to allocate marketing investments from mass-
reach vehicles like television to more ethnically-targeted and cost-
efficient, in-person selling channels. These initiatives combined to offset
the existing weakening in our premium domestic service, which reflects
broad market trends. As a result, for 2013, we delivered positive net
line additions for the first time since 2008. We grew the penetration rate
of our mobile Extension service, which extends our home phone product
to mobile phones, and we improved our standalone mobile app with
quality and feature enhancements, including video calling and video
voicemail. Early in 2013 we announced a joint venture to launch service
in Brazil and we expect to enter this market with a phased launch in the
second quarter of 2014. In late 2013 we acquired Vocalocity, a leading
provider of hosted VoIP services to small and medium businesses.
Recent Developments
Acquisition of Vocalocity. Pursuant to the Agreement and
Plan of Merger (the “Merger Agreement”) dated October 9, 2013, by
and among Vocalocity Inc. ("Vocalocity"), Vista Merger Corp., a
Delaware corporation and newly formed wholly-owned subsidiary of
Vonage (“Merger Sub”), Vonage and Shareholder Representative
Services, LLC (acting solely in its capacity as the Representative, the
“Representative”). Pursuant to the Merger Agreement, on November
15, 2013, Merger Sub merged with and into Vocalocity, and Vocalocity
became a wholly-owned subsidiary of Vonage (the “ Merger ”).
Vocalocity was acquired for $130,000 adjusted for $2,869 of
excess cash as of the closing date and the increase in value of the 7,983
shares of Vonage common stock from the signing date to the closing
date of $1,298, resulting in a total acquisition cost was $134,167. We
financed the transaction through $32,981 of cash and $75,000 from our
credit facility. The acquisition of Vocalocity immediately positions
Vonage as a leader in the SMB hosted VoIP market. SMB and SOHO
services will be offered under the Vonage Business Solutions brand.
Joint Venture in Brazil. We continue to make progress
building the foundation to deliver VoIP services through our joint venture
in Brazil. The joint venture has completed network testing, finalized
plans to host its billing platform, built out its management team, is
currently performing integrated production testing, and has established
and trained customer care centers. We are also implementing a change
to the ownership structure of our joint venture. In late 2013, our partner
was unable to meet its capital call obligations resulting in the delivery
of a notice to our partner in early 2014 that we would be exercising our
dilution rights. As a result, our ownership level in the joint venture is
expected to increase to more than 90%. Our joint venture partner
continues to contribute to implementation steps and progress building
the foundation to deliver VoIP services. We do not expect these funding
issues to increase risk to our planned market entry in the second quarter
of 2014.
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
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