Ooma, Inc. (OOMA) Q4 2018 Earnings Report, Transcript and Summary

Good afternoon. My name is Chantelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Ooma Fourth Quarter and Fiscal Year 2018 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Presenters, you may begin your conference.

Good day, everyone, and welcome to the fourth quarter and fiscal 2018 earnings call of Ooma, Inc. My name is Matt Robison, Ooma's Director of IR and Corporate Development. With me here today are Ooma's CEO, Eric Stang and CFO, Ravi Narula. After the market closed today, Ooma issued a press release through NASDAQ Globe Newswire. The release is also available on the Company's website at ooma.com. This call is being webcast live on the Investor Relations' page of the Ooma website, and will be available for a period of one-year. During the course of today's presentation, our executives will make forward-looking statements within the meaning of the Federal Securities Laws. Forward-looking statements generally relate to future events or future financial or operating performance. Our expectations and beliefs regarding these matters may not materialize and actual results in financial periods are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks include those set forth in the press release we issued earlier today, as well as those more fully described in our filings with the Securities and Exchange Commission. The forward-looking statements in this presentation are based on information available to us as of the date hereof, and we disclaim any obligation to update any forward-looking statements, except as required by law. Please note that other than revenue or as otherwise stated the financial measures to be disclosed on this call will be on a non-GAAP basis. The non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. A discussion of why we present non-GAAP financial measures and a reconciliation of the non-GAAP financial measures discussed in this call to the mostly directly comparable GAAP financial measures are included in our earnings press release that is available on our website. On this call, we'll give guidance for the first quarter and full-year fiscal 2019 on a non-GAAP basis. Also, in addition to our press release and 8-K filings, there is an events and presentations page in the Investors Section of our website ooma.com that includes a link to cost and expenses not included in our non-GAAP values and key metrics of our core subscription businesses. Additionally, our Investor Presentation slides include GAAP to non-GAAP reconciliation that also provides resolution of GAAP expenses that are excluded from non-GAAP metrics. Our February 8, press release announced our participation in several conferences during the next few months; the first of which is next Monday, March 12, The 30th Annual ROTH Conference in Orange County, California. Okay, Eric.

Thank you, Matt. Hello and welcome to Ooma's FY2018 Q4 earnings call. I am pleased to talk with you today about our continued strong performance and our exciting plans as we look forward to the new fiscal year. We entered FY2019 with increased momentum from the many product and feature enhancements we announced at CES. We also enter FY2019 having made two very strategic acquisitions. Voxter Communications which positions us to serve larger sized businesses with a full featured UCaaS solution using unique strategic approach, and Butterfleye which gives us a leading solution in the cloud security camera space. Before expanding on our strategic priorities though, I first like to recap our Q4 progress. Once again in Q4, I believe Ooma outperformed our industry by growing our business subscription services revenues approximately 55% year-over-year and by growing our residential subscription services revenues by approximately 13% year-over-year. In both cases, I don't know of another competitor who is achieving these levels of growth. Overall, our subscription services revenue growth was a solid 22% year-over-year. Total revenue exceeded our revenue guidance and was $30.2 million and we generated positive cash flow from operations for the seventh straight quarter in a row. I am extremely proud of our Q4 and FY2018 accomplishments. More importantly, I feel our strategy is working and we have an exciting outlook ahead. Our strategy can be summarized as bringing uniquely competitive cloud communications solutions to the marketplace. It cuts across both business and residential markets; in fact, we believe serving both markets gives us competitive advantage through enhanced scale, brand awareness, and channel strength. Our strategy also encompasses new related services such as home security which add its essence to simply another communication service writing on our core platform. Even though strategically home security and other such services afford meaningful sales and marketing synergies and the ability to increase customer subscription services revenues and customer retention. The core of our strategy is to bring unique differentiated solutions to the marketplace. You can see this today with Ooma Office which we believe is the only solution in the market focused specifically on meeting the special needs of small businesses. With our acquisition of Voxter Communications, which I will describe later in more detail, we’ll also pursue unique strategy to serve the custom needs of larger businesses. And with Ooma Telo, now combined with home security and Butterfleye cameras, we are again charting our own course to provide unique customer value and set ourselves even farther apart in the marketplace. Our FY2019 plan is of course focused on executing this strategy, but before I go into that detail, I’d like to provide more background on our two recent acquisitions. First, Voxter Communications, which we announced just yesterday, Voxter provides custom UCaaS solutions for mid-market and enterprise businesses. This platform is feature rich and highly customizable. In fact, the Company’s strategy has first and foremost been to meet the special needs of its customers and along the way it developed a platform capable of easy customization and enhancement. Of the company is not big in revenues today, it has been in business for over 10 years and serves many marquee customers such as Slack, Optimizely, Whistler Blackcomb, Hyperwallet and Grafana. It also has established significant international reach for its size, serving customers in the U.S., Canada, Australia, Japan and several countries in Europe. Perhaps most important of all, Voxter’s customers love it solution and the team at Voxter is outstanding. We're excited about Voxter’s strategic positioning and believe we can serve an underserved segment of the market, namely companies that want their UCaaS to fit their individual custom needs extremely well. We also believe this acquisition will enhance Ooma’s international reach, large channel development and scale and help us expand the functionality on the office platform as well. With Voxter, we believe we can now serve businesses of any size and maximize in sales and marketing investments growth. Our second acquisition is Butterfleye, an AI-powered video camera and security platform for book home and business. The Butterfleye team has developed a leading solution that includes many advanced features, the most notable of which is facial recognition, which can tell the user who the camera is seen. It's really a very cool feature. Other leading features include, instant video capture, in other words no time delay or missed shots, automatic arm/disarm for when a user leaves and returns, continued operation through Internet and power outages, thanks to onboard storage and battery backup. No added requirement for a base station and use of temperature and audio sensors in addition to motion sensors to limit false alarms. As you can see the Butterfleye cameras technology and feature rich in a leading solution in the market today. Beyond Butterfleye’s inherent in damages over others, we are excited based on what we see in the marketplace. We believe with Butterfleye we can serve a large and fast growing market and we know that with Butterfleye we can drive additional monthly subscription services revenue for things such as increased video storage and access to advanced features. We’re also encouraged by the fact that our Ooma Home Security customers tell us their number one requested feature is a video camera solution. We intend to sell Butterfleye cameras and subscription services both standalone and in combination with Ooma’s total home security solution. In FY2019, we have work to do to capitalize on these two important acquisitions. For Voxter, we need to expand the go-to-market side of the organization and add more reseller channel partners to accelerate growth. For Butterfleye, we need to build a scalable supply chain as Butterfleye had run out of inventory before we acquired them and we also need to integrate the Butterfleye solution into our overall home security solution, so it's integrated with our Remote 911 and other special features. One focus of our FY2019 plan is to accomplish these tasks in the first half of our fiscal year, so we can gain more momentum from these acquisitions in the second half of the year. Another focus of our FY2019 plan is to continue the fast growth of Ooma Office and our small business customer base. Our goal here remains to grow faster than the industry. In FY2019, we will continue to invest in sales and marketing to drive this growth. We also intend to launch a handful of additional features for the Ooma Office platform in order to expand the addressable market, the main one of which is support for businesses with more than one location. As we discussed on our last conference call, we plan to complete most of these feature enhancements on the first half of the year begin momentum in the second half of the year. Finally, as regards Ooma Office, I'm pleased to announce that we recently launched Ooma Office for WeWork in Spain. In addition to the five other countries where we already provide this service, and we plan to launch in more countries in FY2019. The final major element of our plan for FY2019 is to bring our baseline home security strategy to fruition. This includes launching all the new features and sensors we announced at the CES, especially the siren, smoke detector, and geofencing, integrating the Butterfleye camera into Ooma Home Security as mentioned earlier, making it possible for users to unable home security on the Telo platform with or without phone service to gives us more ways to sell the solution, and finally, increasing distribution through retail channels. Our plan is to accomplish these tasks over the next six months or so, so we are well positioned to invest in greater sales and marketing awareness for Ooma Home Security in the back half of the year. We are excited about our potential in the large fast growing home security market, but we are mindful it will take us time to capture the full opportunity. Finally, I'd like to mention two things. One is that after reviewing our options, we are adjusting our strategy for Talkatone by shifting resources away from it to other parts of our business. We believe with this approach, Talkatone will continue to generate positive EBITDA even with declining ad pricing and revenue. The other is I'm thrilled to report that just today, we learned that the readers of PC Magazine have once again voted Ooma Office, the number one choice for business VoIP services beating out all competition. The article also states that Ooma received one of the highest net promoter scores, the author has seen at 89%. Now let me turn the call over to Ravi to discuss our results and outlook in more detail. I will then return with the final comment, and we will take your questions.

Thank you, Eric, and good afternoon, everyone. Today, I am going to review the financial results of our fourth quarter and fiscal year 2018 and then provide outlook for the first quarter and fiscal 2019. Additionally, I would also provide details of our recent acquisitions as it has the impact of the new revenue accounting standards to our business. All income statement items, except revenue, are on a non-GAAP basis and exclude expenses, such as stock-based compensation and acquisition related charges. The reconciliation of GAAP to non-GAAP financial data can be found in the press release issued earlier today on our Investor Relations page of our website. Now Q4 2018 and full-year fiscal 2018 results. Total revenue for the fourth quarter of fiscal 2018 was $30.2 million, an increase of $2.7 million on a year-over-year basis, and exceeded our previously issued guidance range of $29.3 million to $29.8 million. This increase in revenue was driven by strong performance of our core subscription services revenue, particularly Ooma Office. Net loss for the fourth quarter of fiscal 2018 was $508,000 compared to the previously issued loss guidance range of $500,000 to $1 million, and compares to a $203,000 loss for the same quarter last year. Total revenue for fiscal year 2018 was $114.5 million, an increase of $10 million or 10% on a year-over-year basis. Net loss for fiscal year 2018 was $1.6 million compared to $2.7 million loss for fiscal 2017. For the fourth quarter of fiscal 2018, subscription and services revenue for Ooma Office grew 55% year-over-year and Ooma Residential grew 13% year-over-year. Combined our overall Ooma Office and residential subscription services revenue grew 22%. This growth was primarily driven by user growth, growth in ARPU, and to a lesser extent by residential price change made in the third quarter of fiscal 2018. Consistent with our expectations, Talkatone declined 20% year-over-year to $1.6 million and was up 11% on a sequential basis. Product revenue for the fourth quarter of fiscal 2018 was $3.1 million, a 13% decline year-over-year and was up 2% on a sequential basis. I will now provide some details about our customer metrics. Our core user base increased 8% from 858,000 core users at the end of fiscal 2017 to approximately 929,000 users at the end of fiscal 2018. Our Ooma Office core users grew to 13% of total core users at the end of fiscal 2018 compared to 10% at the end of fiscal 2017. Ooma Office contributed approximately 23% to total revenue in the fourth quarter compared to 18% in the prior year quarter. Our large residential and office user base continues to generate significant amount of cash, which enables us to invest back in the business as we pursue our growth initiatives. Our average monthly subscription and services revenue or ARPU from Ooma Office and Ooma Residential users was $9.24 for the fourth quarter of fiscal 2018 compared to $8.28 for the prior year period. This ARPU growth was driven by higher mix of Ooma Office users as well as changes made to our residential customer pricing structure. Annualized exit recurring revenue surpassed a major milestone of $100 million and was $103 million for the fourth quarter of fiscal 2018. This was a 21% year-over-year increase from $85 million for the fourth quarter of fiscal 2017. Our net dollar subscription retention rate for the fourth quarter was 101% compared to 96% for the fourth quarter of fiscal 2017. Now moving onto gross margins; overall gross margins increased to 61% in the fourth quarter of fiscal 2018, up from 58% in the same period of fiscal 2017. This 300 basis point increase was primarily driven by continued growth of Ooma Office as well as the benefits of scale. Subscription and services revenue gross margin for the fourth quarter of fiscal 2018 was 70%, a 72 basis point increase from the same period last year. Additionally, subscription and services revenue was 90% of our total revenue compared to 87% in the year-ago period. Product and other gross margins was negative 19% for the fourth quarter flat from the prior year quarter. Fourth quarter operating expenses were $19.3 million, an increase of $2.9 million or 17% on a year-over-year basis. This increase in operating expenses were driven by investments made in developing new products as well as growing our sales channels. Sales and marketing expenses increased by approximately $1 million to $9.4 million at 12% year-over-year increase primarily to drive the growth of our small business solutions. Research and development expenses were $7.2 million, an increase of $1.7 million or 31% on a year-over-year basis to support the continued enhancements to our Office functionalities, launching WeWork service in Spain, and adding new features and product offerings to our home security solution. G&A expenses were $2.7 million, an increase of 7% from the prior year period to support the growth of our Office. Our net loss in the fourth quarter of fiscal 2018 was $508,000 or $0.03 loss per share compared to a loss of $203,000 or $0.01 loss per share in the fourth quarter of fiscal 2017. We are pleased to be getting leverage from the business, particularly G&A and continuous improvements in gross margins which allows us to invest in R&D and sales and marketing. Adjusted EBITDA loss was $176,000 in the fourth quarter of fiscal 2018 versus a gain of $171,000 for the same period last year. Now turning to the balance sheet. We have cash and investments of $51.8 million with no debt at the end of the fourth quarter. For the fourth quarter of fiscal 2018, we generated approximately $800,000 in cash from operations compared to approximately $560,000 in the prior year quarter. For full-year fiscal 2018, we generated $3.2 million in cash from operations compared to $385,000 of cash from operations in fiscal 2017. We ended the fourth quarter with 619 full time employees and contractors up from 548 in the prior year quarter. This growth in headcount was driven by sales and R&D. Before I provide details about our fiscal 2019 outlook, let me provide insights about some of our recent initiatives, including the two acquisitions. As part of developing our comprehensive home security solution, we acquired Butterfleye in December 2017. We are developing new and exciting features for the AI-enabled Butterfleye camera along with building the camera inventory. We expect to start shipping these cameras sometime in the middle of this year. It is important to note that Butterfleye will require investment in developing the technology and in the sales and marketing channels before generating meaningful revenues. It also very excited about the latest acquisition Voxter. As Eric mentioned earlier, Voxter provides businesses with a complete and highly customizable UCaaS solution, allowing us to meet the needs of organizations of all sizes. Voxter has a number of marquee customers and we believe combining the sales and marketing engine of Ooma with Voxter’s technology will yield positive results. We expect sales, marketing and operations integration for both of these acquisitions to be completed in the next six months. In summary, I expect fiscal 2019 revenues from these two acquisitions to be between $2 million to $3 million and combined R&D sales and marketing investment of approximately $5 million during the same period. Moving on to the Talkatone business for fiscal 2019, we expect approximately $4 million of revenue from Talkatone in fiscal 2019. This is a $2 million reduction from fiscal 2018 revenues. We have recently taken steps to reduced spend for this business and expect Talkatone to generate positive EBITDA. Last, but not the least, I will now provide you with some details about the adoption of the new revenue accounting rules under ASC 606. We're implementing these rules in the first quarter of fiscal 2019 using the modified retrospective approach. There are two major items to highlight under these rules. First, revenue from product sales made to our channel partners will be recognized on a sell-in basis versus the existing methodology of sell-through accounting. As of the end of fiscal 2108, we had approximately $1.4 million of deferred product revenue, reflecting inventory held by channel partners and not yet sold through to end customers. Under the old rules, the deferred product revenue would generally have become revenue in fiscal 2019. Due to the adoption of these new rules, we will lose a majority of this product revenue, which is reflected in our Q1 and fiscal 2019 guidance. Secondly, we required to capitalize sales commission charges and amortize them over the expected customer life. Previously, we were expensing these sales commission charges as incurred. This accounting change is expected to result in lower sales and marketing expense of approximately $4 million for fiscal 2019. The impact of these two accounting adjustments is reflected in our guidance. With this background, let me now provide details about our outlook. Again, the following guidance excludes stock-based compensation expense and acquisition related charges. Our first quarter of fiscal 2019 total revenue is expected to be in the range of $29.5 million to $30 million. This guidance assumes approximately $1 million of Talkatone revenue. Non-GAAP net loss for the first quarter of fiscal 2019 is expected to be in the range of $700,000 to $1.2 million driven by additional expenses of Butterfleye and Voxter. Non-GAAP net loss per share is expected to be in the range of $0.04 to $0.06. We have assumed approximately $19.3 million weighted-average shares outstanding for Q1. For full-year fiscal 2019, total revenue is expected to be in the range of $123 million to $127 million. We expect non-GAAP net loss to be in the range of $2.5 million to $4.5 million. Non-GAAP net loss per share is expected to be in the range of $0.13 to $0.23. We have assumed approximately $19.9 million, weighted-average shares outstanding of fiscal 2019. In summary, we made good progress in fiscal 2018 by executing towards growth of Ooma Office, expansion of WeWork in six countries, as well as launching our products and features at our home security solution. This momentum gives us confidence about the long-term prospects of our growth initiatives. With that, I'll pass it back to Eric for some closing remarks. Eric?

Thanks Ravi. I’m excited that we’re entering FY2019 with strong moment. We are serving large markets with unique differentiated solutions. We know our customers love our products and refer us to their friends which to us is the asset test building a great business. And now with the addition of Voxter and Butterfleye, I believe we are even better positioned to drive long-term growth. Thank you, everyone. We will take your questions now. Operator?

[Operator Instructions] Your first question comes from Michael Nemeroff with Credit Suisse. Your line is open.

Hey, guys. This is Alex Hu on for Michael. Thanks for taking our questions. So one actually that really stood out to me was the Office represent 24% of subscription and services revenue exiting the quarter while growing 55% year-over-year. And I guess my question is given the recent acquisition of Voxter along with some of the VARs you've been working with? And the WeWork partnership ramping is there any reason why we shouldn't continue to see strong growth from Office in FY 2019 and beyond? And more specifically as Office continues to be a larger piece of your overall business? Is it reasonable to assume that we should see sort of an acceleration in core subscription revenue growth?

Hi, Alex. This is Eric. Well you're right, we are first and foremost powering ahead hard on the business office market place and we are quite excited about expanding to larger businesses with Voxter, which could take a long time to build to go to market organization at Voxter. The company is focused a lot up to now on developing fantastic technology and solutions. But the team there is small from a go-to-market perspective. But yes, we're intending to now both grow office for small business and Voxter for midsize and larger businesses quite aggressively this year.

Okay. Great. And then as it relates to their home security strategy in your prepared remarks, I guess one of the larger peers has made a significant sort of acquisition recently, and I guess how do you think you might compete with some of the larger peers in this space and what do you think differences your products on the security side?

Yes. I think you're probably referring to Amazon's acquisition of Ring. We actually think that could actually be a bit of a benefit in a way because I think Amazon's focused on package delivery as much it is anything else from a home security perspective. And in any case, we work with all retailers and they're obviously now focused versus other retailers with what they're doing. We're differencing on ourselves in a couple of ways, one is our core features such as Remote 911 where you can get instant help to your home even if you're not at home. And so unlike other services which alarm and then what do you do with Ooma you have a clear path to take action? It makes self monitoring much more I think useful to the user. We also have put a lot of work in developing a very elegant app solution and a very cost effective approach to the service. And so we think we can offer more for less than what others are doing as well. And finally with our strong retail position, I think we're very well positioned to put our message out there effectively and get momentum without having to build things that some others will need to make an effort to build. The final component is the acquisition of Butterfleye. This is truly an amazing camera solution and as we build it into the home security platform, I think we're going to be just about the only guy out there who can bring you camera security, home monitoring and security and also added features that bridge over into the world of telephony. So I think users are going to realize they get quite a bit from Ooma, but certainly in the back half of the year, we're going to have to invest in awareness marketing to drive this opportunity and until then we are cautious.

Great. That's actually very helpful. And then my last question for Ravi. Can you comment or quantify the financial impact from the two recent acquisitions on your FY2019 guide namely on the expense side? How much of the increase in the implied investments is driven from those acquisitions namely? So if we could guess a sense of the core leverage with Ooma?

Yes. Alex, this is Ravi. So this year it will be a year of investment as we bring in and do the integration and we invest into the technology and the sales and marketing engines for both Voxter and Butterfleye. In the prepared remarks, I had mentioned roughly $5 million plus of investments between the two, on the R&D and sales and marketing side of it. And what I have said is we expect revenues to start coming in as we get the Butterfleye inventory and cameras and other things happening, so $2 million to $3 million of revenue in fiscal 2019. So what that really means as we are going to invest into these two businesses, one to take out the cost of service and cost of product, we will probably lose $4 million, $5 million in fiscal 2019 because of these two investments. And as we grow, the investments we will start – we expect to start seeing leverage from these two businesses in fiscal 2020 onwards. So I do believe within 12 to 24 months these businesses to become accretive.

Great. Thanks for taking our questions. Congrats.

Thank you.

Thank you.

Your next question comes from the line of Pat Walravens with JMP Securities. Your line is open.

This is Matthew Spencer on for Pat. Thank you for taking our question. What is long-term vision for Ooma in the UCaaS market given the Voxter acquisition and specifically who do you expect to compete with?

Yes. Our long-term vision is to carve out a position with unique solutions meeting individual businesses needs where they really want their UCaaS to fit into what they're trying to do as a business. Our vision of the UCaaS market is not one size fits all. I think we're seeing that today as companies try to accomplish the special needs they have in a variety of different ways. As we work with a customer and meet their needs effectively, I think we can then expand that into more of a vertical market opportunity for other businesses with similar needs. I give you one example that I think Voxter has already done a very nice job of. They have a solution that they've provided to customers who have lots of independent stores. And that solution has very good analytics built in with it as well as some other capabilities that help our central organization, monitor and manage a lot of independent store fronts. That development is something that can now be built upon in a vertical market way for others who might have similar business situation. We're excited because this Voxter platform is really very strong and being able to do these unique things and is very full featured in the general sense. So we look forward with the business to being a little bit more bespoke than our competitors would be and we think that will be our niche to succeed in the market.

Thank you. And then obviously you guys have been pretty active in terms of M&A recently with the two acquisitions. What's driven the activity and should we expect it to continue in calendar 2018? Thank you.

Well, what's driven, it is opportunity. It is a natural fit to bring video camera technology into the home security platform and we particularly like it because we can charge separately subscription services for what we do on these video cameras. So it's also a clear distinct revenue opportunity. So we're excited to do that. Similar with Voxter, we are building channels, we get asked all the time by customers for features set that Ooma Office is not designed to serve, and so with Voxter, we have the ability to leverage the Ooma channel strength and position in the market to go after midsize and larger businesses with really now some very unique solutions. So these are been very logical extensions for us. And if other things such as these come along, we will jump at them. But as we’ve said in the past, we do not have to do M&A to succeed with our strategy. And so as we stand today, we plan to execute with what we've talked about with you here.

That's very helpful. Thanks again and congratulations.

Thank you.

Your next question comes from the line of Mike Latimore with Northland Capital Markets. Your line is open.

Great. Thanks. Great quarter there. On the Voxter acquisition, I guess you mentioned Slack was a customer. Does Slack use that internally for its own places? Or does Slack sell that to its own customers as part of a collaboration?

Yes. That's a good question. This is the corporate phone system within Slack. For Slack’s employees to receive UCaaS services, so that's how Slack uses it. Now not surprisingly the company has also developed some unique capabilities of its UCaaS solution interfacing with Slack and it's a good example of working with the customers they have to develop customized and added features and those on capabilities gives the Company a potential now with other users to Slack to bring something extra to what they're trying to do. So – but no it is – Slack is one of the Company's larger customers today.

And then this is – Voxter has its own proprietary technology. Is that right? It's not like reselling like BroadSoft for something like that?

It is not reselling BroadSoft. That’s correct. Yes, they've been developing for over 10 years and as we put in our press release, nice range of solutions for the UCaaS base.

Okay. And then just last on Voxter. The gross margins on them longer-term that sort of in line with company gross margin?

And Mike, this is Ravi. Yes, in the longer-term, we do expect the margins to be generally speaking within our long-term target model, which is 75% to 80% on subscription services. So we expect that similar margin range.

Okay. Thank you.

Thank you.

Your next question comes from Bhavan Suri with William Blair. Your line is open.

Hey, guys. Thanks for taking my question. Congrats on the growth there, especially on the SMB side. I’ve had a follow-up on Voxter question, a little more sort of strategic on the product side here. Eric, as you think about the product mix you sort – there is offline today that start sort of a Linux box if you sort of deploy in a customer 10/20 sort of lines around it for the for the small business and nice sort of Voxter, just trying to understand, you think these days two separate products segments or to these sort of at some point converge over time as you sort of do the RD integration within pieces. So this sort of a natural blend from small to sort of middle large enterprise?

Hi, Bhavan, yes, it's a little more nuanced. So give me a moment here. At the core, I believe the two segments stay very different. We have curated the experience for small businesses. So that they can get what they need easily, simply, install it themselves, that we put a lot of work into the user interface and portals, so it's very clear how to operate the system as the administrator in the business. And if we tried to add all the complexity of UCaaS into the office solution, we would harm our ability to serve small businesses very well with it. Similarly with Voxter and UCaaS solution, they have lots of flexibility, lots of dimensionality that the small business doesn't need, it takes a little bit more of a solutions expert to help set it up or maybe an IT department. But that's okay, because the business can really get a more powerful solution that it doing so. So in the marketplace we see them is to different markets go after with different types of solutions. But that said, there are a couple things we've been trying to add into the office platform that Voxter does do well and that may help us with bringing some of those capabilities on to the office platform. It's not a long list because there's not a lot more we want to do with the office platform, but there are a couple things. And similarly in the background if you will, away from the customer experience, but at the core of how the cloud network and system operates, we do see opportunities for blending the two solutions over the longer-term and that – it's not an essential for our strategy. It's not something that we're going to power hard on fast, but I think over the longer-term, we are going to achieve that. This is going to make us stronger as the platforms come closer together at the at the core level.

Got it. In terms of sort of the sales approach a little bit, I know you’re going to make the investments in sales, but – and I have a quick follow-up on little bit. Enterprise sales tend to be sort of heavy expense, quarter caring guys, large target account seems like that. How we thinking because that’s not the model today for Ooma? How are you thinking about sort of that approaching that sort of an appraisal mid to large business sort of sales opportunity, obviously Voxter has a handful of people, but sort of expanded understanding sort of how do we drive growth here, sort of how you guys think about sort of that approach and strategy there in terms of the sales investments? What types of people? How many – something that would be helpful?

Yes. You're right to make that distinction, selling to a mid-sized or larger businesses is a more complicated sale over a longer time period with a number of other factors involved in it. Voxter sells two ways today. They sell direct and they sell through channel partners. They actually have very good solutions for channel partners. They're able to white label through channel partners very effectively not just billing, but the way the IP phones display information, the way the web portals look, the way the mobile apps look. They've enabled channel partners to be very effective when those channel partners want to take a very active role in the sales process. Many of our competitors are trying to basically destroy that channel and turn it into just a sell and go channel. I think Voxter on the channel side has some very unique positioning as well. Now we will have to hire sales personnel that are more senior the way you describe them and we will not jump at that with a big amount of people right out of the gate, but we're going to be hiring – we're hiring now and we're going to build up that team at a measured pace. So that's the best answer I can give you. I think it depends a little bit on how best things develop and how fast we can find the right people.

Got it. And one quick one for Ravi. Ravi, if I back up the acquisition related numbers, the implied growth is sort of in the 7% range organic, I think from Telo correctly played over here in Europe. But if that's right, just a little color on how you think the split plays out between Telo, the office business. You’ve always given sort of Talkatone growth, but just between those two segments obviously put plays out? Thanks guys. Thanks for taking my questions.

Absolutely Bhavan. So in terms of the split between Office and Telo, we do expect Office growth to drive the overall growth. So it should continue to grow at a much faster pace. In fiscal 2018 it has grown in high 50%, 59% in subscription and services. And there's a lot of large numbers, so we do expect the number to be slightly lower, but still much faster than the residential Telo growth. We have done a decent job in fiscal 2018 with residential growth of 10%, 12% year-over-year growth and we do expect it to be – I think Eric had previously mentioned that in the past our goal is always to do as fast as possible, but we had previously given guidance of mid to high single-digit growth and we do expect that to continue in fiscal 2019.

Got it. Thanks guys. Thank you.

Thank you.

[Operator Instructions] Your next question comes from Josh Nichols with B. Riley. Your line is open.

Yes. Thanks for taking my question. Couple things. Are you looking to add some additional features to the home security platform to run that out before you market, maybe outside the Telo base? And then also could you talk a little bit about how we should think about the margin profile both on the hardware side and the subscription and services side? Is that becomes a larger percentage of sales in the back half of this fiscal year?

Sure. I will take the first part of that. We made several announcement with CES including a siren, a smoke detector, a garage door opener, and geofencing capability. We do want to get four of those things out in the marketplace in the first half of this year. The longest pole will be smoke detector because of the certifications that needs to go through. The Garage Door Sensor, we did that in partnership with VTech and that's already available. Geofencing out in beta to some customers now and the rest are of that is coming. The second thing we really want to do in the first half of the year is make it possible to sell home security in a bundle with sensors and such for someone who wants home security, but doesn't necessarily want phone service. And so today in order to buy our home security solution, you have to buy our phone service first. So we're working on making that a standalone capability in the product. That allows us to sell in different places in stores and sell with the focus on home security. And then once we get a customer, obviously we will try to educate them on the great benefits we can bring on the phone side as well. And then the third thing we're doing is kind of two elements to this, we are integrating our Remote 911 capability into the Butterfleye app for people who use the Butterfleye camera standalone, and we're also integrating the alerts from Butterfleye cameras into the home security app when people use the full solution together. So that a motion sensor goes off, will turn the camera on or et cetera. You can take it through. So all that stuff we want to get done in the first half of this year and I believe at that point we will have our baseline strategy for home security in place and we'll have a quite strong solution in the market actually. We have several other things we want to work on for home security through the balance of this year and next year, and I think some of those things will really extend this farther than others, but I don't think they're key to the baseline strategy at this time. So last year we pushed out the home security strategy a little bit due to the focus on WeWork, and I'm really excited that now we're back rolling on it and we can see not too far out being where we want to be.

Josh, in terms of gross margins, in Q4 we had negative 19% gross margin on hardware side, product side, and subscription services margins was 70%. Going forward, we do expect product margins to stay relatively consistent to what we have seen in Q4, it’s around 20% margin, it could go negative 20% or negative 25%. But we don't expect it to change too much from there. And with subscription services between Butterfleye and Voxter and some WeWork adding in Spain, things like that, we do expect some investments where we will continue to make in fiscal 2019. So going forward, I think the margins what you have seen in the last 12 to 18 months of growth, we are putting more investments this year than what you have seen in the past because of some of these new growth opportunities ahead of us. So I think expecting around 70% gross margin for subscription services is reasonable expectation at this time.

Thanks. And then last question, I know historically the Company has talked a lot about gaining some leverage on the operating model, I know obviously there's a couple investments to make this year, last year as well with like WeWork. But how does – when are we going to start seeing some leverage a little bit more on the sales and marketing, and R&D? Now that I know as extra recurring revenue surpassed $100 million, but spend as a percentage of revenue has gone up?

Yes. This is Eric. We monitor and target our spend to achieve certain goals for growth. We look at last year, we generated cash from operations a little over $3 million. I’d rather invest that in growth then drive increased cash at this time. So we are expanding on multiple fronts as we've talked about here and that is going to take some investment. We had wanted to get more R&D leverage in this fiscal year than we're probably going to get. And that's because with the two acquisitions, which bring particularly R&D expense with them until we start to ramp sales and marketing. We're going to have to incorporate that into our model. But otherwise I think we are investing for growth and we're excited about where that’s going to take us. Maybe Ravi has more to say on this?

I think just to add to Eric’s point, we are getting leverage on the gross margin overall as subscription services getting bigger and then G&A obviously. And on the R&D side, it’s more investments as Eric said between Voxter and Butterfleye, that's where the investment is going in fiscal 2019 on the R&D side. And this is a year for us to invest into home security also along with office, so this is the marketing investment that we believe is the right investment to make here.

Sounds good. Thanks for taking my questions. Yes, sorry.

This is Eric. We're careful not to get out too far ahead on our skis here. We’re very careful about managing our spend to make sure we're getting the productivity we want from it. Thank you.

Your next question comes from Nikolay Beliov with Bank of America Merrill Lynch. Your line is open.

The lower residential growth rate, it really accelerated a little bit from 11% to 13%. Can you please help us on that a little bit in terms of the contribution number one from the pricing impact you talked about and number two the home security business, is it like a point or two of additional growth from each or something like that?

Nikolay, this is Ravi. If I understood your question correctly, the incremental growth in Telo from 10%, 11%, to 13% this year in subscription services. That incremental growth was same price changes we did to our customers, our customer did not see any price increase, but we change the structure of the pricing. That was the driver. And there was a small element of home security also adding in, but it was the smaller of the two factors in terms of driving the growth. Fiscal 2019, we expect differently given we are. As Eric said, the base line home security product solution is almost there and then we were going to invest more into it and we should expect to see more and more results coming in, in terms of growth rates for Telo.

Got it. And in terms of the guidance between subscription revenue growth and product revenue growth, you talked about the hit from ASC 606. Can you give us a little bit more color on total subscription revenue growth and baked into the guidance versus product revenue growth?

Product revenue is not expected to grow on a dollar basis much, so there will be some additional revenue which will come in from the camera sales. Product revenue is going to grow very small and all the growth is going to happen in subscription services. Mind you there's one more thing, which is not coming out. In fiscal 2018, we are roughly $2 million of business promoter before we divested that business also. So if you were to look at apples-to-apples comparison fiscal 2018 without business promoter would be $112.5 million of revenue total which included probably $12 million plus of product revenue and fiscal 2019 has zero Business Promoter revenue. So most of the growth in the business is coming from subscription services and product is growing, but slightly very small.

Got it. That’s helpful. And Eric one question for you. On Voxter, when I go on their website and when I try to understand their architecture since more like a hosted solution and they've been around for a while with limited success. And I guess why were you drawn to their product architecture, which seems very different from Plug 'n' Play type DNA that you guys have? That's number one. And number two, what gives you confidence that you can do better than they have done over the last 10 plus years?

Yes. I think they've actually been extremely successful. If you look at their marquee customer lists, and I also believe that the way they've architected their platform is pretty unique. You can go to any location in the world within a company that has locations around the world, sit down, put your credentials into the IP phone that's sitting there and it will automatically be setup to serve you as the user that happens to be there at that moment. They also have an extremely strong network for failover from one side to the other amongst multiple datacenters around the world. So they’ve architecture a platform that I think very powerful and there are some things about it that I think will help it to come together with what we do on Ooma Office at the core guts level of the platform relatively easily. So we're pretty excited about it as a platform. What gives me – it excites me about Voxter is really other than the things I've already said, two or three things. One is I think the way they're approaching the UCaaS space is a good strategy for a smaller player. One about company being able to customize efficiently, being able to customize efficiently, being able to white label through channel partners, being able to do special things in vertical market that has special requirements, I think that is a winning strategy versus trying to go head-to-head with larger players. Secondly, I quite like the fact that they've basically been mostly an engineering organization with very little effort on sales and marketing. Mostly our sales and marketing has come through word of mouth you know honesty. And so I think with Ooma’s position in the marketplace and resources, we can – it's a perfect marriage between what we can do in combination with them to take them to the next level. And then thirdly, and this is a more minor point, but I think it's worth noting. They're located up in Vancouver and that's a much lower cost structure location to be based and we're excited to now have part of Ooma located in Canada and Vancouver the opportunity as a site for us to build around that and I think to be as competitive as anyone in the marketplace given that's where we're based. So I think for those reasons it's a good opportunity. What also drove us to this is as we've built the channel for Ooma Office and that's obviously still work in progress too. And as we've continued our sales and marketing for Ooma Office, we come across customers we have to say no too. And now we can maximize our sales and marketing spend if a customer – whatever customer needs we can pretty much provide it and that's exciting for us. So I think it's going to fit very well with our strategy over the next couple years.

Got it. Thank you.

Thank you. End of Q&A

This concludes today's conference call. You may now disconnect.