Good day, and welcome to the Vonage Holdings Corp Second Quarter 2017 Earnings Call and Webcast. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Hunter Blankenbaker. Please go ahead, sir.

Okay, thanks Denise, and good morning and welcome to our second quarter 2017 earnings conference call. Speaking on the call this morning will be Alan Masarek, Chief Executive Officer; and Dave Pearson, CFO. Also joining us are Kenny Wyatt, our Chief Revenue Officer; and Tony Jamous, our President of Nexmo. Alan is going to discuss our strategy and second quarter results, and Dave will provide a more detailed view on our second quarter financial results and annual guidance. Slides that accompany today’s discussions are available on the IR website. At the conclusion of our prepared remarks, we will be happy to take your questions. As referenced on Slide 2, I would like to remind everyone that statements made during this call may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management’s expectations, depends on assumptions that may be incorrect or imprecise, and are subject to risks and uncertainties that could cause actual results to differ materially. More information about these risks and uncertainties is highlighted on the second page of the slides and contained in our SEC filings. We caution listeners not to rely unduly on these statements, and disclaim any intent or obligation to update them. During this call, we will be referring to non-GAAP financial measures. A reconciliation to GAAP is available in the second quarter earnings press release or the second quarter earnings slides posted to the IR website. With that, I would like to turn the call over to Alan.

Thanks, Hunter. Good morning and thanks for joining us today. Q2 was a very strong quarter. Vonage Business delivered revenues of $124 million representing 23% organic growth. Consolidated Vonage delivered revenues of $252 million, an 8% GAAP increase, and our 9th consecutive quarter of year-over-year growth, and adjusted OIBDA was $41 million. I am also pleased to report that in this third quarter, we will reach a key milestone in our transformation into a business cloud communications company with a majority of our revenue coming from the Vonage Business segment. Within Vonage Business, we’re building on our strength in SMB by executing a series of priorities to accelerated UCaaS revenue growth within mid-market and enterprise segments, while also driving strong revenue growth in CPaaS from long tail developers and enterprise customers. Concurrently, our consumer services segment is starting to stabilize. We continue to maximize cash flows while using our highly aware brand and low cost global telecom networks to accelerate revenue growth in Vonage Business. Before we jump into results, I’ll highlight a few notable accomplishments that reflect strong execution against these priorities. First, we are accelerating sales in enterprise. In Q2 alone we signed four enterprise deals which in aggregate represent more than $30 million in total contract value. This is over and above the four enterprise deals we announced last quarter, which had aggregate contract values of $20 million. Enterprise deals are becoming a larger and larger contributor to our UCaaS growth engine. We’re winning in enterprise because we offer a manage UCaaS solution that guarantees quality of service and increasingly because we can couple this solution with our CPaaS tools to drive better business outcomes for our customers. Second, we are accelerating CPaaS revenue growth. Vonage’s API platform delivered very strong revenues in Q2 with an organic…

Thank Alan and good morning everyone. pleased to review our financial results for the second quarter of 2017. As in the past, quarterly growth rates reflected in our presentation slides during our prepared remarks are on a year-over-year basis unless otherwise noted as sequential. With that, let’s begin on Slide 7. Consolidated revenue for the second quarter was $252 million, up $18 million or 8% due to the organic growth of our UCaaS business, the addition of Nexmo in June of last year and subsequent growth and a change to the way we reported Nexmo wholesale trade revenues. Moving to Slide 8. Let me now turn to our segment financial results, starting with Vonage Business, which consists of our UCaaS and CPaaS products. Vonage Business’ total revenue was $124 million, representing 49% of total Vonage revenue, 44% GAAP and 23% organic increase. UCaaS revenue was $89 million, reflecting organic service revenue growth of 19% and total organic growth of 16%. These organic growth numbers reflect the completion of the sale of our hosted infrastructure business on May 31, which removed all of June revenue for $500,000 on the quarter and the adjustment of onetime revenue impacting items from the comparable 2016 quarter. We included a table in the press release and on Slide 14 of today’s presentation, showing revenue from the hosted infrastructure business over the last five quarters and the onetime items to facilitate pro forma analysis. Second quarter average UCaaS revenue per seat was $43.99, down from $44.76 a year ago, the difference coming from our plan to sell access more selectively and the removal of one month of hosted infrastructure revenue from the sale in June. Revenue churn was 1.4%, flat sequentially and year-over-year. Vonage Business grew total seats to 683,000, with higher sequential seat additions in…

Okay. Thank you, Dave. Denise, let’s please initiate Q&A.

[Operator Instructions] And we have a question from George Sutton. Please go ahead, sir, from Craig-Hallum.

Good morning guys, a very nice result. So I wondered if you could update us on your sales productivity thoughts. Obviously, there were some challenges in the middle of last year. It looks like we’re starting to see the things that we had hope to see, which is some improvement there?

George, hey, this is Alan. Let me introduce Kenny Wyatt, our new Chief Revenue Officer, and I’ll have him answer that.

Yes. Good morning, George. We’re seeing nice trends northbound – as it relates to sales productivity and it’s both on new reps that we are hiring as well as the existing reps. As Alan mentioned, we continue to expand on the UCaaS side as well as the CPaaS, but I’ll focus on UCaaS just for a second because I think based on your question. We continue to expand end markets, marching towards that 21 that we mentioned towards the end of the year. And we’re seeing very, very nice productivity as a result of that. I will just give you a quick stat. In the field, which is just our feet on the street in the mid-market for instance. We are seeing 25% to 30% sequential productivity growth this year from first quarter to second quarter. So expect to continue to see northbound trend as it relates to new reps that we’re adding as well.

Okay. Super. And I’m curious, as we’ve seen others in this space report that everyone’s investing in sales, everyone’s investing in distribution. There is a bit of land grab scenario. How are you finding that the CACs [ph] are trending in the different areas than the SMB and mid-market enterprise areas?

Yes, it’s David. Tax are relatively stable. I would say across those various sales channels. Clearly, in the downmarket it is growing slower, but there’s less competition in the upmarket. There is certainly competition, but we think we have a differentiated product and the growth there is accelerating. And so those – the tax are relatively stable across the two.

Perfect. That’s it from me. Thanks guys.

Thanks George.

Next question is from Timothy Horan from Oppenheimer. Please go ahead.

Thanks guys. Can you give a little bit more color more on the consumer market, maybe what customers are using for – maybe percentage of customers that are international and your visibility there, because that’s – big C change this quarter, I guess, a little bit more how sustainable it is? And then maybe sales expense and engineering expense came in a little below kind of what we expected. Just maybe some color on that too. Thanks.

David?

Sure. On the consumer side, about 40% of our base in the U.S. and we have a base in Canada and the UK, which is relatively small as well. But 40% of our U.S. base are still international long-distance callers. About half of those callers are to India. So that continues to be a big part of our base in a big sustainable part of our business. I would note that, the greater proportion of our new adds is coming from people in the U.S. domestic callers in the U.S. and in Canada and in the UK, its simply see the value proposition relative to the cable bundle and the utility of having a home phone as an adjunct to the family cell phone, in particular to have one number that belongs to a location or to a family. I think the biggest development for us besides churn is that the ARPU is relatively stable, whereas, we had substitution going on of domestic callers or ILD callers. We’re not seeing that trend. The base is essentially acting the same way – the different components of the base are acting relatively the same way right now.

Yes. The expense, provide us a little bit more color on trends?

Yes. On the sales and engineering spend, I mean, the engineering moves up and down based on how much we are capitalizing in any given quarter. And some of that – also engineering splits, some of it’s actually in sales and marketing if it’s really about sustaining the product. So all you see on the engineering and development side is what’s going into new product development, which is why that moves around. We have resources that work on both kind of product extensions as well as new products. On the sales side, it really is the shift away from TV into much more efficient channels, offset by putting new salespeople and who aren’t yet productive.

Great. Just a follow-up with the consumer. I guess, domestically people wanting to have a home number, is this kind of a new trend or is it been helped by over the top video do you think? Or what do you think causing that?

Yes, I think over the time, video is certainly helping. I think, cable having gotten a lot of penetration and people having already cut the cord. Those trends are neither accelerating nor deaccelerating. That trend is relatively stable. So that’s what we’re seeing.

Thank you.

The next question is from Will Power from Baird. Please go ahead.

Great, thanks. Just a couple of questions. But maybe first one on the CPaaS business, strong organic growth. I guess, I wondered if you can give any further color on early success with the voice API, both as you look at the U.S. market and as you look at perhaps up-selling messaging customers overseas? What kind of success you’re having with voice outside the U.S. too?

Hey, Will, this is Alan. So we’re seeing success sort of across the board. The whole notion of voice is a principally – this is the build year and you’re going to see more of it from a revenue point of view in 2018 as we’ve said. But if you will, sort of thinking about turning the whole balance sheet from being almost a pure SMS company as recently as a year ago, now it’s being a platform company that moves across messaging and voice, that has – we have added infrastructure across the board, salespeople are familiar with voice, pushing out our marketing messages, adding developers, registered developers as I spoke about on the voice side. So you’re seeing green shoots across the board in the U.S. and outside; and I’ll comment on the couple of areas outside United States, where we expected to be meaningful revenue contributors next year. This is more kind of your sample year and we expect it to be meaningful next year.

Okay. That sounds good. And then, I guess, on the UCaaS side, maybe I missed this, but anyway to break out your growth rates between Premier or Essentials? And more specifically, within Premier what you’re using in mid-market Enterprise growth? And you had four nice size wins that you’re alluded to, but as we think about revenue pull through, how do we think about the Enterprise revenue growth outlook?

Sure. As it relates to Premier and Essentials, the trends are as I referenced before, the trends are relatively similar right now. Essentials had been the faster growing of the two, but they’re starting to converge in terms of growth rate as the Premier business and our sales infrastructure gets more upmarket, gets more mature, and that market grows faster. And Essentials continues to have outsize market share in the lower market, albeit growing a bit slower. So we are seeing those two come together. As I mentioned in my script, we also had – we had sequential seat addition gains in both that were relatively the percentage increase in seats in both, which are relatively similar. I would also just note that we talked about – in our guidance, we talked about selling less access and selling it more selectively only when it’s necessary. Access only grew about 5% in the quarter and that was by design. So service – that’s why service revenue and Premier and Essentials together grow a lot faster.

Okay. And when you look at the four large deals that you announced in the quarter, maybe, any kind of color with respect to the competitive dynamics there? I mean, are you – is it legacy premise-based providers? Is it other pure cloud providers? Maybe just a little color who you’re running up against? And I know you cited MPLS and security reliability is some of the factors. But any other color as that what’s differentiating you from some of the other key players out there?

Well, let me start and I’ll turn it over to Kenny. The – and your question is sort of all the about answer, where you’re seeing like the RFP and big Fortune 500 financial services company was across both cloud and on-prem vendors. We are seeing sort of all the same competitors that you are aware of in most of these large deals. What differentiates us are two sort of key elements in these larger deals. First is the fact that we can provide a fully managed solution versus over the top. If you are a sort of traditional distributed Enterprise in a bunch of different locations and multiple geographies, many of those types of companies insist on the vendor being able to provide one throat to choke and to manage both the connectivity and the communication. So the over-the-top guys just can’t sort of get to first base there. That is different. You may still – it’s different than other – sometimes large seat deployments that may be several hundred fast food restaurants or something that has in aggregate a lot of seats, but it’s like several hundred little tiny businesses, so over-the-top is perfectly fine. So we can differentiate in those enterprises that require a managed solution. The other is CPaaS. CPaaS continues to be kind of the extra arrow in our quiver that strategically differentiates us because we go to a customer not just with cloud defining the PBX or the contact center, but now being able to talk about how we can help them with better their business outcomes because the purview of CPaaS has been on customer communications. That has fundamentally changed the nature of the conversation with these customers.

Okay, that’s great. Thank you.

Next question is from Mike Latimore from Northland Capital Markets. Please go ahead.

Yes. Thanks a lot, excellent quarter. Just to be clear on the change in guidance, that’s all related to Nexmo. Is that right?

Yes.

Okay, got it. And then the big UCaaS deals in the quarter, do they all come from your direct sales efforts?

Direct sales and enterprise, yes.

Yes, okay, great. And then can you give us some color on how many – how much of your kind of API bookings or deals is coming through cross-selling into the UCaaS base? I know you had some notable in there. But I’m just trying to get some sense of the magnitude overall?

I ask Kenny to take that?

Yes. Mike, good morning. Yes. I’d tell telling you that we are just starting down the journey of cross-selling the portfolio and I’ll give you a couple of key points. One is – as Alan mentioned in his script, we are introducing even as we speak CPaaS bundles or CPaaS finished product, if you will, to our UCaaS distribution teams across the channel, across the direct sales team and so forth. So we’re taking the CPaaS product to every single sales pursuit starting this quarter. That will do two things. One is obviously generate new leads to the CPaaS sales teams, but also further differentiate our value proposition in the marketplace on the UCaaS side. I see pretty quick conversions happening technically between these two portfolios. The lot of that will happen obviously in the advanced contact centers and others. But we are just starting on the journey, if you will, cross-selling the portfolio across both sales teams.

Thank you.

Our next question is from Catharine Trebnick from Dougherty. Please go ahead.

Thank you. Thanks for taking my question. Quick one for you on, where any of the four deals you won last quarter have those large deals started deployment? One of the issues, I know, a year ago, was service delivery. I’m just wanting to make sure it seems like that is really crisp up and you guys are well machine, but just wanted to make sure the newer deals started deployment? Thanks.

Yes, Catharine, good morning. As you know, it’s Kenny. As you know, these are extremely complex deal as you move further up in the enterprise space, the complexity of the deals kind of the integration, but also replacing an incumbent and so forth, is exponential. And so these are multi-month if not sometimes multi-quarter type implementation for all these seven-figure and above deals that we’ve announced over the last two quarters. I will tell you this, you hit on an interesting point. One of these key success points of winning, for instance of renewing and winning additional business from MyEyeDr is excellence and execution on the postcontract side of ball, right? So winning the deal as it relates to value proposition is really half the battle. It’s building a reputation in the marketplace of a service delivery and installation execution, which we have, which has given us frankly tailwinds to renew and winning incremental business like MyEyeDr and existing customers who continues to vote with their checkbook, frankly, to make sure that the clinical parts of their IT are well taken care of.

All right. Thank you. And then it seems like the Nexmo business is moving outside the U.S. is pretty nicely. And we’ve been your enhancing it. What about the UCaaS capabilities? Or what’s the strategy on that? Thanks, Alan.

Hi, Catharine. So first of all, Nexmo has been outside the United States. So if you recall the time of the acquisition, they had 94% of all traffic terminated by Nexmo was outside the United States. It was a very – company was very focused globally to start with. We now are moving our UCaaS capabilities outside the United States as well. We’ve been doing that quite a sometime. We have a large presence in the UK. And then we actually have capability on UCaaS in 28 countries, where we have – and we don’t sell directly in all those markets, but we sell across the regions in the world. So we’ve got lots of customers in APAC, lots of customers in both Eastern and Western Europe, pretty much all over the world. So it is growing. Our focus initially was on – initially was those domestic – U.S. domestic global multinationals and then supporting them offices overseas. Now though we are increasingly having, again, servicing those customers in those overseas markets and end markets. So it’s expanding pretty quickly and you’ll see from even our hiring and our office opening. The fact that we are opening three offices in China, or now, just a hired a General Manager of all of APAC, our country manager for Germany, they’re just elements of building on infrastructure that is required in order to have a true global footprint. So the nice thing is Nexmo was this huge sort of kick off to that because it has such a strong base outside of the United States. And we’re kind of drafting off the back of that.

[Operator Instructions] Our next question is from Greg Burns from Sidoti & Company. Please go ahead.

Good morning. Just a question about your distribution strategy. It seems like some of the peers listening to are pushing more heavily towards the channel. I just wanted to understand what you think the advantages of having a more balanced mix and more – a greater direct presence in the market is for Vonage? Thank you.

Good morning, it’s Kenny. We are taking a multipronged detect to the marketplace. So we’re levering the channel as you mentioned. In fact, we for the first time, we’ve now launched CPaaS bundle the same one that one mentioned earlier to our traditional kind of UCaaS partners. But we’re also leveraging direct distribution. The deals that we’ve mentioned this morning on the call, largely came from of our direct site or The Street that have invested across the markets we’ve mentioned as well as in the Enterprise space. We are investing in other influences in the marketplace, consultants and ISPs and other, if you will, to make sure, that we have as much leverage and as much as many points of distribution we possibly can with to the marketplace. So I’m not fixated on one point of distribution. I firmly believe that given all the segments that we serve from the very low SMB all the way to the large Enterprise by differently across those segments. Therefore, we’re going to take full advantage of all those distribution points.

Okay, thank you. And then in terms of some of the global expansion you’re going on, particularly in the Asia-Pacific region, do have the infrastructure in place? Or do you have enough data centers globally to serve all these markets? Or do we need to continue to invest in global infrastructure?

This is Alan. We will continue to global infrastructure. As I just mentioned, we just opened a data center in EMEA and we’re adding point sales, but that will be an ongoing effort.

Okay, thank you.

Our next question is from Dmitry Netis from William Blair. Please go ahead sir.

Nice to see. Great quarter guys. Couple of questions. I want to follow-up on the voice side of Nexmo, the voice API. I think you’ve answered some of the questions there. But what I picked up which appears to be quite interesting you offered a couple of anecdotes that are in China. Is their anything specific to China there that you’re winning customers, your local presence vis-à-vis your competitive backdrop? Anything you can point to your success in that region with the interesting this year, and also as you move here to the U.S. I think, you’re making big strides. But have you been successful with some of the bigger mobile brands, right selling brands here in the U.S. as far as get voice API product goes.

So, let me start and then I’ll turn it over to Tony. The – remember when Nexmo started, it really focused outside of the United States in the sense going truly wasn’t. And so from a market share point of view, just for instance, Nexmo is the clear market share leader in Asia. So where we have existing presence in Hong Kong, Singapore, in terms of staffing, now we are opening as I mentioned, three new offices in China itself. So we have established a legal entity in China to be able to open those offices and again, hiring staffing in China itself. I think of the companies that we have over there Wowway, Tencent, Alibaba, the ones I mentioned as well, today on Cheetah Mobile, Hungama and Renren et cetera. So we are making great strives there, but it is off a very strong base and what’s interesting about our strength is that and this really goes also to our additions of those long tail developers. We continue to add the bulk of these long-term developers outside of the United States. So we have such a footprint kind of rest of world that is – we just have a bigger base to build from. I mean coming into United States, obviously, that’s the strength of Vonage from a distribution, from a network perspective and from a brand perspective and we become that force multiplier for Nexmo in the United States. As I mentioned in the earlier question, the WAPI work we are sort of a major sampling across the board and – but you are going to see more relevant revenues next year on WAPI. This is more kind of the year of trial and sampling and such. Tony, do you want to add to that?

Yes, sure. Hi, Dmitry good morning. So easy answer here is the three component of why we’re winning in Asia. So first is the availability of the network. So for this customer base in Asia, they need to communicate with customers in Asia or outside Asia. So we have firstly, the network that enabled them to do so. Secondly, we have the functionalities with the Voice API to enable them to build programable communication and in Asia, I believe, with the network we have and we have a unique value proposition for these customers like, GoMo, like Renren, like Cheetah Mobile that were mentioned in the earnings script, I’ll like to provide these functionalities. And thirdly, is early presence on the ground, as you know, in Asia, doing business is different than doing business in other areas in the world. So you need to have local presence, understand their local culture and as Alan mentioned, we’ve been in Asia since few years now and we strengthening our presence right now with opening up these offices and strengthening the leadership that we have experienced in Asia for some time. So, and as you look at the global markets, we have the majority of our revenue outside of the U.S. and as the market grow, I believe, we’re well positioned to capture that growth coming from outside the U.S. and with our brands, with knowledge in the SQL, so we also have the opportunity to continue to generate that interesting market share in the United States.

Okay. Very good. One question on the UCaaS said, if I may. And I don’t mean to sound cynical here, but when you announced with MyEyeDr with a $25 million in total contract value, multi-year contract. The second and then the other three sorry, two, was with the Fortune 500 financial services win, which if I do the math equates to less than $5 million in total contract value. That was a 2,400-seat deployment, the MyEyeDr you mentioned was 5000-seat deployment. So what am I missing here in terms of the disconnect as far as the QCV goes for the financial services contract? Is this a small deployment? Or is this a land-and-expand strategy? Anything you can comment to why the size isn’t quite as big as the first when you mentioned?

So, Dmitry I’ll take that. What we’re missing is the ARPUs are very, very different. So if you go back – if you, for instance, advance contact center in a location the price points per head are much, much higher than if you’re just doing a basic UCaaS install. Also in certain locations you are providing circuit and that’s going to bump up the ARPU a lot and others you may not be. So it’s very difficult to sort of say take the standard ARPU and apply it against the big base. In the big financial services company, obviously they got lot more than 2,400 employees it is a land-and-expand strategy. All right, let’s give them the last thing, again, MyEyeDr situation is a five-year term, while last quarter – the big residential real estate holding company was a three-year term.

Okay. That’s very helpful clarification. And maybe today one last question on the gross margin. How should we think that – you may have mentioned, I apologize if I missed it, because I joined a little bit late – how should we think about those gross margins successfully end the year. Dave, color a commentary, you can give us clearly next more you accelerates here into the year-end. What should we – why should with think as far as the range as we end the year?

Sure. So that’s the gross margin dilution that comes from the Nexmo acquisition just happened. So those are in the numbers for the quarter. For the rest of the year, we are looking at gross margin on a business side to be a relatively stable in the low 50’s. What you are seeing underneath that is gross margins in both UCaaS on an allocated basis CPaaS everything is mixed together today and every day it goes by – there are more mixed together. But you see the CPaaS product growing faster. So there is a bit of dilution there offset by the fact that every quarter we are improving margins or striving to improve margins on all of our products, those things are basically offsetting each other, margins ought to be for the rest of the year in business in the low 50s. It just consistent with what we just reported on the service side.

Next question comes from Rich Valera from Needham & Company. Please go ahead.

Yes. Thank you. So last quarter you talked about potentially bringing down your OIBDA target for the year, as you eyed making incremental investments for growth, I think specifically in the CPaaS business. I see a reaffirm that, I’m just wondering – is that because you expect other parts of the business to be more profitable, which would effectively absorb those investments? Or do you decide kind of not to make those incremental investments? Thanks.

Yes. So we are reaffirming OIBDA guidance and we increased revenue guidance. Some of that was the change in reporting treatment. But some of that was organic as well. So we’re seeing the higher growth. There’s a bit more investment going into the CPaaS product on sales infrastructure and so on, and we planned at the start of the year. But we’re getting outside growth for that – or just proportionate growth for that. We think it’s setting us up well for 2018 and yes, the other parts of our business are doing very well. So that’s why we’re in a position to reaffirm.

Got it. And then just in terms of $15 million increase, I mean, should we think about the $4 million roughly benefit you got from that accounting change as caring to the rest of the year. So think of it’s about $12 million of accounting change in $3 million organic there?

Yes. Roughly, that’s correct. I mean the revenue in under discussion of the $3.9 million essentially trading revenue where we have aggregators come to us and say, I have bunch of small customers, they do business with us it’s a larger customer under certain pricing circumstances. That’s an inherently kind of more volatile part of the business and that’s why we call it trading. But yes, it assumes a relatively stable contribution of revenue from that than organic growth on top of that.

Okay. Great, that’s it for me. Thanks, gentlemen.

And ladies and gentlemen, this will conclude our question-and-answer session for today. I’d like to turn the conference back over to Hunter Blankenbaker for any closing remarks.

Okay. Thanks, Denise and that does wrap up the Q&A portion of today’s call. We look forward to seeing many of you in the coming months at various investor conferences. And for those that are unable to attend these events will be webcast and you can follow our comments at the Vonage Investor Relations website. Please contact us if you need any additional details. And thanks, again, for joining today.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.