Vonage, AOL, Packet8: Howzit Going?

Vonage may just be tweaking its business model. AOL has blown its model up. And 8x8 made a course correction years ago. So how are the tweaks and disruptions playing out?

“Not bad” to “pretty well,” depending on one’s perspective. If one thinks Vonage should keep growing subscribers, one won’t be impressed by slower net additions. If one thinks Vonage has to move smartly to profitability, one might like the recent results.

If one thinks AOL erred in abandoning its paid Internet access business, one could point to declining revenues. If one thinks AOL had no choice, one might be encouraged by the relatively stable earnings picture.

Perhaps the least controversial performance was turned in by 8x8, which retooled its model a couple years ago to focus on the small business segment and showed net income after five years of losses. Not to mention healthy results from its hosted PBX business.

Vonage perhaps has been under the most scrutiny. And perhaps it wins simply by not losing, at least in the short term. By deliberately cutting back on its marketing spend Vonage shaved its second quarter loss to $33.6 million, compared to a loss of $74.1 million for the same quarter last year.

At the same time, Vonage posted sales growth of 40 percent, or $205.9 million for the quarter.

Of course, the tradeoff came in terms of slower net customer additions. Vonage added 57,000 net subscriber lines during the quarter and finished with 2.45 million lines in service. And the company says it is optimistic net additions will grow at a faster rate once it reignites its marketing this quarter.

The most significant non-financial achievement was the development of work-arounds for the three patents it is alleged to have infringed. “We have substantially completed the deployment of workarounds for the two name translation patents and have completed the development of the wireless patent workaround,” says Jeffrey Citron, Vonage chairman.

Vonage’s adjusted loss from operations also narrowed dramatically to $18 million in the quarter, a 70 percent improvement from a loss of $60 million in the year-ago quarter.

Vonage’s average monthly revenue per line in the second quarter 2007 was $28.38, up $0.49 from $27.89 in the year-ago quarter and up from $28.31 reported in the first quarter 2007.

Vonage’s direct cost of telephony services was $52 million, up from $40 million a year ago, but down from $56 million in the first quarter 2007. As a percent of revenue, cost of telephony services fell to 26 percent from 29 percent of revenue last year.

On a per line basis, Vonage’s average cost of telephony services fell to $7.21, down from $7.72 in the second quarter 2006 and $8.03 sequentially as a result of one-time quarterly benefits associated with Universal Service Fund refunds of $2 million.

Marketing expenditures in the second quarter 2007 were reduced to $68 million, or 33 percent of revenue, from $90 million, or 62 percent a year ago. Sequentially, marketing declined from $91 million, or 46% of revenue.

Marketing cost for each gross addition was $287 in the second quarter 2007, an increase of $14 from $273 last quarter, and up $48 from $239 a year ago.

8x8 arguably can claim the most satisfaction over the quarterly results. For the first time since the Company launched its Packet8 VoIP service in November 2002, 8x8 posted net income of $508,000 (using the generally accepted accounting principles), compared to a net loss of $2.9 million for the previous quarter.

In addition, the Company posted a $284,000 increase in cash and investments for the first fiscal quarter compared to a $492,000 reduction in cash and investments during the previous quarter, improving its balance sheet to approximately $12.2 million in cash and investments with no debt.

Indeed, 8x8 VP Huw Rees says he is more proud of the cash flow improvement than of the profit performance.

Total revenues for the first quarter of fiscal 2008 increased to $14.7 million compared to $14.4 million for the previous quarter, and $12.3 million for the same period of fiscal 2007, an increase of 20 percent.

Packet8 Virtual Office revenue grew sequentially by 23 percent over the previous quarter, while residential revenue declined five percent. Gross margins grew to 64 percent, up from 54 percent in the previous quarter, and Packet8 service margins grew to 70 percent from 62 percent in the previous quarter.

As of June 30, 2007, over 8,000 U.S. based businesses subscribed to the company’s Packet8 Virtual Office hosted PBX service. Packet8 Virtual Office revenues represented 44 percent of the Company’s total revenues in the June quarter, up from 37 percent in the March quarter.

But it is AOL that has taken the biggest gamble with its business model, opting out of the Internet access business and moving to become an advertising-supported portal.

AOL has sacrificed some near-term cash flow, but not much, really, considering that it has given up or lost a billion dollars of top-line revenue over the last two years by abandoning its access business.

Over the past year, AOL has shed seven million subscribers, approximately three million more than it would have lost if it had maintained the status quo. Still, the attrition rate has now returned to almost the pre-free rate (one million a quarter), and the subscriber base is still a considerable 11 million.

AOL managed to nearly preserve its pre-free subscriber cash flow, despite all that. And subscription revenue should continue to throw off at least $200 million a quarter for several more quarters, some analysts estimate.

Unique users have been relatively stable at about 110 million to 115 million for the past year, despite the loss of seven million subs. That basically validates AOL’s contention that “eyeballs” wouldn’t suffer once the shift out of the access business accelerated.

Taking stock, it wasn’t a bad quarter for Vonage, which radically scaled back the spending and customer growth sides of its business and developed some patent protection.

8x8 broke new ground in both the cash flow and profit areas after a couple of years with a new approach to the market. Packet8 also has very strong hosted PBX revenues.

And AOL, which gambled on doing better by abandoning a business throwing off $1.8 billion in revenue, so far has managed to produce results on its bottom line despite massive reductions on its top line.

Overall, we’d say it wasn’t a bad quarter for three companies that are battling in tough markets. The broadest impact undoubtedly comes as AOL moves from the subscription-based access (“pipe”) business into the ad-supported portal business. In some ways, it parallels what the broader service provider market will have to do in replacing recurring voice revenues. IP