News Column

VONAGE HOLDINGS CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 13, 2014

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 27 VONAGE ANNUAL REPORT 2013 --------------------------------------------------------------------------------



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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 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 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. In connection with our Vonage Business Solutions SMB and SOHO markets, we face competition from the traditional telephone and cable companies discussed above, as well as from SMB communications providers such as 8x8, Ring Central, and other 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 made it more difficult for broadband Internet service providers to block or discriminate against Vonage service. On January 14, 2014, the D.C. Circuit Court of Appeals vacated the anti-blocking and the unreasonable discrimination provisions of the rules. The D.C. Circuit decision did not foreclose the FCC from adopting anti-blocking or non-discrimination rules and the FCC may revisit these issues or appeal the ruling. 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,

2013 2012 2011 Gross subscriber line additions 652,852 652,750 672,274 Change in net subscriber lines 9,392 (15,071 ) (29,996 ) Subscriber lines (at period end) 2,542,926 2,359,816 2,374,887 Average monthly customer churn 2.5 % 2.6 % 2.6 % Average monthly operating revenues per line $ 28.18$ 29.89$ 30.35 Average monthly direct cost of telephony services per line $ 7.27$ 8.16$ 8.23 Marketing costs per gross subscriber line addition $ 347.78$ 325.61$ 303.84 Employees (excluding temporary help) (at period end) 1,243 983 1,008 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. Change in net subscriber lines. Change in net subscriber lines for a particular period reflects 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 increased by 9,392, excluding subscriber lines from Vocalocity prior to acquisition, from 2,359,816 as of December 31, 2012 to 2,542,926, as of December 31, 2013. 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 decreased to 2.5% for 2013 compared to 2.6% for 2012. The decline in churn was a result of reintroduction of a service 28 VONAGE ANNUAL REPORT 2013 --------------------------------------------------------------------------------



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period requirement in certain instances, sustained improvements in customer satisfaction and more effective retention processes. Our average monthly customer churn also decreased sequentially from 2.6% for the three months ended September 30, 2013 to 2.5% for the three months ended December 31, 2013 and was flat compared to the three months ended December 31, 2012. 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 residential international callers generally churn at a lower rate than residential customers who are domestic callers. Customers with service period requirements tend to have a lower churn rate than customers without service period requirements. Similar trends are seen between customers obtained through retail sales, which generally do not include service period requirements, and those obtained through non-retail channels, which generally do include such service period requirements. In addition, business customers generally churn at a lower rate than residential customers. 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 $28.18 for 2013 compared to $29.89 for 2012. This decrease was due primarily to rate plan mix and lower USF fees. The continued expansion of lower priced plan offerings including BasicTalk to meet customer segment needs may cause downward pressure on average monthly revenues per line, offset by any selected pricing actions. 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 to $7.27 for 2013 compared to $8.16 for 2012, due primarily to the decrease in termination costs driven by more favorable rates negotiated with our service providers, the decrease in our network costs and in our E-911 costs, and the decrease in regulatory fees. 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 $347.78 for 2013 from $325.61 in 2012, due primarily to our investment in BasicTalk including a portion of costs that were fixed and not variable with subscriber line additions. 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 and mobile plans. The "Vonage World" plan, 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. Through our recent acquisition of Vocalocity, we offer SMB and SOHO customers several service plans with different pricing structures under the Vonage Business Solutions brand. The service plans include an array of basic and enhanced features applicable to the needs of SMB and SOHO customers. Customers also have the opportunity to purchase premium features for additional fees. We have begun to integrate the combined operations of Vocalocity, now under the Vonage Business Solutions brand, with Vonage, eliminating overlapping processes and integrating products and sales efforts. We have also begun to optimize lead flow generated by the Vonage brand, directing prospective business customers from Vonage inbound telemarketing or websites to the Vonage Business Solutions website and inbound telesales channels. We expect these efforts to shift certain core gross subscriber line additions and revenue from the Vonage brand to Vonage Business Solutions, leading to subscriber additions with higher total lines and average monthly revenue per line. 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. 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 29 VONAGE ANNUAL REPORT 2013 --------------------------------------------------------------------------------



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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 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 revenues include revenues from the sale of VoIP telephones in order to access our small and medium business services on a net basis rather than a gross basis as we act as an agent, rather than a principal. Customer equipment and shipping revenue also 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 52% and 49% of our total direct cost

of telephony services for 2013 and 2012, 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.

> Acquisition related transaction and integration costs.

> 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 (developed technology, customer relationships, non-compete agreements, patents, trademarks and trade names).



> 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.

30 VONAGE ANNUAL REPORT 2013

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Table of Contents 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.

> Gain (loss) on extinguishment of notes.

> Change in fair value of stock warrant.

RESULTS OF OPERATION



The following table sets forth, as a percentage of consolidated operating revenues, our consolidated statement of income for the periods indicated:

For the Years Ended December 31, 2013 2012 2011 Revenues 100 % 100 % 100 % Operating Expenses: Direct cost of telephony services (excluding depreciation and amortization) 26 27 27 Direct cost of goods sold 5 5 5 Selling, general and administrative 32 28 27 Marketing 27 25 24 Depreciation and amortization 4 4 4 Loss from abandonment of software assets - 3 - 94 92 87 Income from operations 6 8 13 Other Income (Expense): Interest income - - - Interest expense (1 ) (1 ) (2 ) Change in fair value of stock warrant - - - Loss on extinguishment of notes - - (1 ) Other expense, net - - - (1 ) (1 ) (3 ) Income before income tax expense 5 7 10 Income tax expense (2 ) (3 ) 37 Net income 3 % 4 % 47 %



Plus: Net loss attributable to noncontrolling interest - %

- % - % Net income attributable to Vonage 3 % 4 % 47 % 31 VONAGE ANNUAL REPORT 2013 --------------------------------------------------------------------------------



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Summary of Results for the Years Ended December 31, 2013, 2012, and 2011 Revenues, Direct Cost of Telephony

Percent Services and Direct Cost of Good Dollar Dollar Change Sold For the years ended



December 31, Change 2013 Change 2012 2013 vs. Percent Change (in thousands, except percentages)

2013 2012



2011 vs. 2012 vs. 2011 2012 2012 vs. 2011 Revenues

$ 829,067$ 849,114$ 870,323$ (20,047 )$ (21,209 ) (2 )% (2



)%

Direct cost of telephony services (1) 213,712 231,877 236,149 (18,165 ) (4,272 ) (8 )% (2 )% Direct cost of goods sold 37,586 39,133 41,756 (1,547 ) (2,623 ) (4 )% (6 )%



(1) Excludes depreciation and amortization of $14,892, $15,115, and $15,824, respectively.

2013 compared to 2012 Revenues. The decrease in revenues of $20,047, or 2%, was primarily driven by a decrease of $17,573 in monthly subscription fees resulting from rate plan mix, lower customer acquisitions on premium plans, prior year line losses, and retention activities partially offset by revenue from Vocalocity since the acquisition that closed on November 15, 2013. There was also a decrease in activation fees of $1,077 and a decrease in other revenue of $996 due to lower rates from our revenue sharing partners. There was an increase in credits issued to subscribers of $2,449, a decrease in additional features revenue of $1,090, and a decrease in international minutes of use revenue of $1,234. These decreases were offset by an increase in fees that we charged for disconnecting our service of $1,024 due to reinstatement of contracts for new customers beginning in February 2012, and an increase in our regulatory fee revenue of $3,784, which includes a decrease of $7,771 in USF fees offset by an increase in regulatory recovery fees and E-911 fees of $11,555. Direct cost of telephony services. The decrease in direct cost of telephony services of $18,165, or 8%, was primarily driven by a decrease in domestic termination costs of $1,290 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 $5,962, 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. There was also a decrease in other costs of $678, a decrease in international usage of $2,413 driven by improved termination rates, and a decrease of USF and related fees imposed by government agencies of $7,775. Direct cost of goods sold. The decrease in direct cost of goods sold of $1,547, or 4%, was primarily due to a decrease in waived activation fees for new customers of $5,566 due to lower direct customer adds, a decrease in shipping costs of $1,598, and a decrease in amortization costs on deferred customer equipment of $585, offset by an increase in customer equipment costs of $6,204 from additional customers from our retail expansion. 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. 32 VONAGE ANNUAL REPORT 2013 --------------------------------------------------------------------------------

Table of Contents Selling, General and Administrative Percent For the years ended December 31, Dollar Dollar Change (in thousands, except



Change 2013 Change 2012 2013 vs. Percent Change percentages)

2013 2012 2011 vs. 2012 vs. 2011 2012 2012 vs. 2011 Selling, general and administrative $ 262,302$ 242,368$ 234,754$ 19,934$ 7,614 8 % 3 % 2013 compared to 2012 Selling, general and administrative. For the year ended 2013 compared to the year ended 2012, selling expense increased by $12,641 including $3,701 due to the expansion of the number of community sales teams, and $10,749 due to an increase in the number of retail stores with assisted selling and the nationwide BasicTalk launch, offset by a decrease of $2,158 related to product awareness advertising of our mobile offering launched in February 2012. For the year ended 2013 compared to the year ended 2012, general and administrative expense increased by $7,293 due mainly to higher share based cost of $5,868, an increase in compensation and employee related expense of $7,703 including expense from Vocalocity since the acquisition that closed on November 15, 2013, and an increase in professional fees of $1,798. There was also an increase in taxes of $2,082 and an increase in acquisition related costs of $2,768 related to the acquisition of Vocalocity, primarily related to professional fees. These increases were offset by a resolution of an insurance claim for prior period legal fees and settlement expenses of $2,300, lower customer care costs of $7,145, and a decrease in telecommunications expenses of $1,100. There was also a decrease in settlement cost of $972 and a decrease in other expense of $1,122. 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. Marketing Percent For the years ended December 31, Dollar Dollar Change (in thousands, except

Change 2013 Change 2012 2013 vs. Percent Change percentages) 2013 2012 2011 vs. 2012 vs. 2011 2012 2012 vs. 2011 Marketing $ 227,052$ 212,540$ 204,263$ 14,512$ 8,277 7 % 4 % 2013 compared to 2012 Marketing. The increase in marketing expense of $14,512, or 7%, as a result of our investment for the nationwide launch of BasicTalk including a portion of costs that were fixed and not variable with subscriber line additions. 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. Depreciation and Amortization Percent For the years ended December 31, Dollar Dollar Change (in thousands, except Change 2013 Change 2012 2013 vs. Percent Change percentages) 2013 2012 2011 vs. 2012 vs. 2011 2012 2012 vs. 2011 Depreciation and amortization $ 36,066$ 33,324$ 37,051$ 2,742$ (3,727 ) 8 % (10 )% 2013 compared to 2012 Depreciation and amortization. The increase in depreciation and amortization of $2,742, or 8%, was primarily due to the amortization of acquisition-related intangibles of $2,483 and an increase in software amortization of $1,553 partially offset by lower depreciation of network equipment, computer hardware, and furniture of $1,295. 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. 33 VONAGE ANNUAL REPORT 2013

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Table of Contents Loss from abandonment of software assets Percent For the years ended December 31, Dollar Dollar Change (in thousands, except Change 2013 Change 2012 2013 vs. Percent Change percentages) 2,013 2,012 2,011 vs. 2012 vs. 2011 2012 2012 vs. 2011 Loss from abandonment of software assets $ - $ 25,262 $ - $ (25.262 )$ 25.262 (100 )% 100 % 2013 compared to 2012 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. 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. Other Income (Expense) Percent For the years ended December 31, Change (in thousands, except

Dollar Change Dollar Change 2013 vs. Percent Change percentages) 2013 2012 2011 2013 vs. 2012 2012 vs. 2011 2012 2012 vs. 2011 Interest income $ 307$ 109$ 135 $ 198 $ (26 ) 182 % (19 )% Interest expense (6,557 ) (5,986 ) (17,118 ) (571 ) 11,132 (10 )% 65 % Change in fair value of stock warrant - - (950 ) - 950 - % 100 % Loss on extinguishment of notes - - (11,806 ) - 11,806 - % 100 % Other expense, net (104 ) (11 ) (271 ) (93 ) 260 (845 )% 96 % $ (6,354 )$ (5,888 )$ (30,010 ) 2013 compared to 2012 Interest income. Interest income increased $198, or 182%. Interest expense. The increase in interest expense of $571, or 10%, was due mainly to a higher principal balance on our credit facility entered into in connection with our refinancing in February 2013 than the remaining principal balance on our credit facility entered into in connection with our refinancing in July 2011 and the funds we borrowed from the 2013 revolving credit facility in November 2013 in connection with the acquisition of Vocalocity. Other expense, net. Other expense, net increased by $93 in 2013 compared to 2012. 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 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. Income Tax (Expense) Benefit Percent For the years ended December 31, Dollar Dollar Change



Change 2013 Change 2012 2013 vs. Percent Change (in thousands, except percentages) 2013

2012



2011 vs. 2012 vs. 2011 2012 2012 vs. 2011 Income tax (expense) benefit $ (18,194 )$ (22,095 )$ 322,704$ 3,901$ (344,799 ) 18 %

(107 )% Effective tax rate 39 % 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 and state and local income taxes in 2013, 2012, and 2011. 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 34 VONAGE ANNUAL REPORT 2013 --------------------------------------------------------------------------------



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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 statement of income 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. As of December 31, 2013, we had net operating loss carry forwards for United States federal and state tax purposes, including the NOLs of Vocalocity as of the date of acquisition, of $715,524 and $251,627, respectively, expiring at various times from years ending 2013 through 2033. In addition, we had net operating loss carry forwards for Canadian tax purposes of $14,171 expiring through 2027. We also had net operating loss carry forwards for United Kingdom tax purposes of $41,423 with no expiration date. Net Income Percent For the years ended December 31, Dollar Dollar Change (in thousands, except Change 2013 Change 2012 2013 vs. Percent Change percentages) 2013 2012 2011 vs. 2012 vs. 2011 2012 2012 vs. 2011 Net income $ 27,801$ 36,627$ 409,044$ (8,826 )$ (372,417 ) (24 )% (91 )% 2013 compared to 2012 Net Income. Based on the activity described above, our net income of $27,801 for the year ended December 31, 2013 decreased by $8,826, or 24%, from net income of $36,627 for the year ended December 31, 2012. 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. Net loss attributable to Dollar Percent noncontrolling interest Change Change For the years ended December 31, Dollar Change 2012 vs. 2013 vs. Percent Change 2013 2012 2011 2013 vs. 2012 2011 2012 2012 vs. 2011 Net loss attributable to noncontrolling interest $ 488 $ - $ - $ 488 $ - 100 % - % 2013 compared to 2012 Net loss attributable to noncontrolling interest. The net loss attributable to noncontrolling interest of $488 for the year ended December 31, 2013 represented 30% of the net loss of a consolidated subsidiary in Brazil. 2012 compared to 2011 Net loss attributable to noncontrolling interest. None. Net income attributable to Vonage Percent For the years ended December 31, Dollar Dollar Change Change 2013 Change 2012 2013 vs. Percent Change 2013 2012 2011



vs. 2012 vs. 2011 2012 2012 vs. 2011 Net income attributable to Vonage$ 28,289$ 36,627$ 409,044

$ (8,338 )$ (372,417 ) (23 )% (91 )% 2013 compared to 2012 Net Income attributable to Vonage. Based on the activity described above, our net income attributable to Vonage of $28,289 for the year ended December 31, 2013 decreased by $8,338, or 23%, from net income of $36,627 for the year ended December 31, 2012. 2012 compared to 2011 Net Income attributable to Vonage. Based on the activity described above, our net income attributable to Vonage 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. 35 VONAGE ANNUAL REPORT 2013 --------------------------------------------------------------------------------



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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) 2012 2012 2012 2012 2013 2013 2013 2013 Revenues $ 215,903$ 211,916$ 207,584$ 213,711$ 209,087$ 204,776$ 203,984$ 211,220 Operating expenses: Direct cost of telephony services (1) 61,623 58,195 55,245 56,814 55,181 53,527 52,882 52,122 Direct cost of goods sold 9,846 9,275 10,444 9,568 8,878 9,217 9,535 9,956 Selling, general and administrative 61,835 58,396 59,676 62,461 62,910 61,481 64,752 73,159 Marketing 53,422 54,956 51,361 52,801 51,669 58,330 59,133 57,920 Depreciation and amortization 8,644 8,518 8,110 8,052 7,975 8,205 8,459 11,427 Loss from abandonment of software assets - 25,262 - - - - - - 195,370 214,602 184,836 189,696 186,613 190,760 194,761 204,584 Income from operations 20,533 (2,686 ) 22,748 24,015 22,474 14,016 9,223 6,636 Other income (expense): Interest income 20 30 30 29 37 74 97 99 Interest expense (1,751 ) (1,566 ) (1,402 ) (1,267 ) (1,457 ) (1,732 ) (1,509 ) (1,859 ) Other, net 42 (65 ) 28 (16 ) (39 ) (17 ) (15 ) (33 ) (1,689 ) (1,601 ) (1,344 ) (1,254 ) (1,459 ) (1,675 ) (1,427 ) (1,793 ) Income (loss) before income tax (expense) benefit 18,844 (4,287 ) 21,404 22,761 21,015 12,341 7,796 4,843 Income tax (expense) benefit (4,923 ) 947 (8,191 ) (9,928 ) (7,968 ) (4,894 ) (3,811 ) (1,521 ) Net income (loss) 13,921 (3,340 ) 13,213 12,833 13,047 7,447 3,985 3,322 Plus: Net loss attributable to noncontrolling interest - - - - - - 222



266

Net income (loss) attributable to Vonage $ 13,921$ (3,340 )$ 13,213$ 12,833$ 13,047$ 7,447$ 4,207$ 3,588 Net income (loss) attributable to Vonage per common share: Basic $ 0.06$ (0.01 )$ 0.06$ 0.06$ 0.06$ 0.04$ 0.02$ 0.02 Diluted $ 0.06$ (0.01 )$ 0.06$ 0.06$ 0.06$ 0.03$ 0.02$ 0.02 Weighted-average common shares outstanding: Basic 225,732 226,429 225,555 219,379 214,639 212,169 209,589 209,928 Diluted 236,036 226,429 233,708 228,107 223,202 219,837 217,059 219,600 Operating Data: Gross subscriber line additions 165,454 163,349 171,628 152,319 148,003 155,412 174,670 174,767 Change in net subscriber line (18,739 ) (64 ) 9,440 (5,708 ) (12,400 ) 2,541 10,738 8,513 Subscriber lines at end of period 2,356,148 2,356,084



2,365,524 2,359,816 2,347,416 2,349,957 2,360,695 2,542,926 Average monthly customer churn

2.8 % 2.5 %



2.5 % 2.5 % 2.5 % 2.4 % 2.6 %

2.5 % Average monthly operating revenues per line $ 30.42$ 29.98$ 29.31$ 30.15$ 29.61$ 29.06$ 28.87$ 28.72 Average monthly direct costs of telephony services per line $ 8.68$ 8.23$ 7.80$ 8.02$ 7.82$ 7.60$ 7.48$ 7.09 Marketing costs per gross subscriber line additions $ 322.88$ 336.43$ 299.26$ 346.65$ 349.11$ 375.32$ 338.54$ 331.41 Employees at end of period 1,004 988 971 983 966 946 933 1,243 (1) Excludes depreciation and amortization of $3,930, $3,929, $3,722, and $3,534 for the quarters ended March 31, June 30, September 30 and



December 31, 2012, respectively, and $3,452, $3,510, $3,522, and $4,408

for the quarters ended March 31, June 30, September 30 and December 31, 2013, respectively. 36 VONAGE ANNUAL REPORT 2013

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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) 2013 2012 2011 Net cash provided by operating activities $ 88,243$ 119,843$ 146,786 Net cash used in investing activities (120,985 )



(25,472 ) (37,604 ) Net cash provided by (used in) financing activities 21,891 (56,257 ) (130,138 )

For the three years ended December 31, 2013, 2012, and 2011 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. Acquisition of VocalocityVocalocity 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. February 2013 Financing On February 11, 2013 we entered into Amendment No. 1 to the 2011 Credit Agreement (as further amended by Amendment No. 2 to our 2011 Credit Facility, 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. On July 26, 2013 we entered into Amendment No. 2 to our 2011 Credit Agreement, which amends our financial covenant related to our consolidated fixed charge coverage ratio by increasing the amount of restricted payments excluded from such calculation from $50,000 to $80,000. 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 net proceeds of $27,500 from the senior secured term loan and the undrawn revolving credit facility under the 2013 Credit Facility will be used for general corporate purposes. We used $75,000 from the 2013 revolving credit facility in connection with the acquisition of Vocalocity on November 15, 2013. We also incurred $2,009 of fees in connection with the 2013 Credit Facility, which is amortized, along with the unamortized fees of $670 in connection with the 2011 Credit Facility, to interest expense over the life of the debt using the effective interest method. 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 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 37 VONAGE ANNUAL REPORT 2013 --------------------------------------------------------------------------------



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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, 2013, we had a reserve of $4,630. 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 2013, 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 2013 were $22,180, of which $12,291 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, and customer management platforms. For 2014, we believe our capital and software expenditures will be approximately $30,000. Operating Activities Cash provided by operating activities decreased to $88,243 during the year ended December 31, 2013 compared to $119,843 for the year ended December 31, 2012, 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 $2,663 during the year ended December 31, 2013 compared to the year ended December 31, 2012, primarily due to the timing of payments. 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. Investing Activities Cash used in investing activities for 2013 of $120,985 was attributable to the acquisition of Vocalocity of $100,057, capital expenditures of $9,889, and software acquisition and development of $12,291, offset by a decrease in restricted cash of $1,252 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 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. Financing Activities Cash provided by financing activities for 2013 of $21,891 was primarily attributable to $75,000 borrowed under the 2013 revolving credit facility and $27,500 in proceeds from our 2013 Credit Facility, and $4,091 in net proceeds received from the exercise and cancellation of stock options partially offset by $23,334 in 2013 Credit Facility principal payments, $3,471 in capital lease and other liability payments, $56,294 in common stock repurchases, and $2,056 in 2013 Credit Facility debt related costs. 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. 38 VONAGE ANNUAL REPORT 2013

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CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS

The table below summarizes our contractual obligations at December 31, 2013, 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: 2013 Credit Facility $ 46,666$ 23,333$ 23,333 $ - $ - 2013 Revolving Credit Facility $ 75,000 -



75,000

Interest related to 2013 Credit Facility 1,760 1,272 488

- - Interest related to 2013 Revolving Credit Facility 5,328 2,519 2,809 Capital lease obligations 16,442 4,369 9,002 3,071 - Operating lease obligations 7,548 5,854 1,694 - - Purchase obligations 228,667 95,129 133,271 267 - Other obligations 1,628 - 1,628 - - Total contractual obligations $ 383,039$ 132,476$ 247,225$ 3,338 $ - Other Commercial Commitments: Standby letters of credit $ 4,306$ 4,306 $ - $ - $ - Total contractual obligations and other commercial commitments $ 387,345$ 136,782$ 247,225$ 3,338 $ - 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. On July 26, 2013, we entered into Amendment No. 2 to our 2011 Credit Agreement, which amends our financial covenant related to our consolidated fixed charge coverage ratio by increasing the amount of restricted payments excluded from such calculation from $50,000 to $80,000. Capital lease obligations. At December 31, 2013, we had capital lease obligations of $16,442 related to our corporate headquarters in Holmdel, New Jersey. Operating lease obligations. At December 31, 2013, 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 our Vocalocity office, 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 local inbound services, process our credit card billings, license patents to us, sell us communication devices, provide carrier operation and telephone related services, provide marketing services, and provide energy supply. 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. 39 VONAGE ANNUAL REPORT 2013

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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, and



historical

volatility of our common stock; > assumptions used in determining the need for, and amount of, a valuation allowance on net deferred tax assets; 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. In addition, customer equipment and shipping revenues include revenues from the sale of VoIP telephones in order to access our small and medium business services on a net basis rather than a gross basis as we act as an agent, rather than a principal. 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. Goodwill and Purchased-Intangible Assets Goodwill acquired in the acquisition of a business is accounted for based upon the excess fair value of consideration transferred over the fair value of net assets acquired in the business combination. Goodwill is tested for impairment on an annual basis on October 1st and, when specific circumstances dictate, between annual tests. When impaired, the carrying value of goodwill is written down to fair value. The goodwill impairment test involves a two-step process. The first step, identifying a potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying value of the reporting unit exceeds its fair value, the second step would need to be conducted; otherwise, no further steps are necessary as no potential impairment exists. The second step, measuring the impairment loss, compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. Any excess of the reporting unit goodwill carrying value over the respective implied fair value is recognized as an impairment loss. Purchased-intangible assets are accounted for based upon the fair value of assets received. Purchased-intangible assets are amortized on a straight-line or accelerated basis over the periods of benefit, ranging from two to ten years. We perform a review of purchased-intangible assets whenever events or changes in circumstances indicate that the useful life is shorter than we had originally estimated or that the carrying amount of assets may not be recoverable. If such facts and circumstances exist, we assess the recoverability of purchased-intangible assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairments, if any, are based on the excess of the carrying amount over the fair value of those assets. If the useful life of the asset is shorter than originally estimated, we accelerate the rate of amortization and amortize the remaining carrying value over the new shorter useful life. There was no impairment of purchased-intangible assets identified for the years ended December 31, 2013, 2012, or 2011. Income Taxes We recognize deferred tax assets and liabilities at enacted income tax rates for the temporary differences between the financial 40 VONAGE ANNUAL REPORT 2013 --------------------------------------------------------------------------------



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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.



Net Operating Loss Carryforwards

As of December 31, 2013, we had NOLs for United States federal and state tax purposes, including the NOLs of Vocalocity as of the date of acquisition, of $715,524 and $251,627, respectively, expiring at various times from years ending 2013 through 2033. In addition, we had NOLs for Canadian tax purposes of $14,171 expiring through 2027. We also had NOLs for United Kingdom tax purposes of $41,423 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, 2013, there were no limitations on the use of our NOLs except for the NOLs of Vocalocity as of the date of acquisition. 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.


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