Good morning and welcome to the Vonage Holdings Corp. Third Quarter 2017 Earnings Conference Call. 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 today’s event is being recorded. I would now like to turn the conference over to Hunter Blankenbaker, Vice President, Investor Relations. Please go ahead, sir.

Okay, great. Thanks Rocco. Good morning and welcome to our third quarter 2017 earnings conference call. Speaking on our 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, President of Nexmo, the Vonage API platform. Alan will discuss our strategy and third quarter results, and Dave will provide more detailed view on our third quarter financial results and 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, depend 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 those 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. During this call, we will be referring to non-GAAP financial measures. A reconciliation to GAAP is available in the third quarter earnings press release or the earnings slides posted on the IR website. With that, I will turn the call over to Alan.

Thank you, Hunter, good morning. I’m proud to announce that in addition to delivering record results this quarter, for the first time, Vonage Business revenues exceed those of Consumer Services. I would like to thank our employees, our board and of course, you, our investors for supporting our team, while we transform Vonage into the market leader in business cloud communications. Now a few highlights of the quarter. Vonage consolidated revenues were $253 million, our 10th consecutive quarter of year-over-year growth. Vonage Business revenues were $129 million, representing 51% of total revenue and 22% growth. And adjusted OIBDA was $51 million, our best ever. And we now forecast 2017 consolidated revenues to exceed $1 billion. Now let’s start off with a review of our strategy. Simply stated, our strategy is to use our cloud communication services to deliver better business outcomes to our customers. Our approach integrates our UCaaS services into our customers’ cloud-based CRM and productivity tools, and then uses our CPaaS services from Nexmo to directly link with our customers’ customers. Our end-to-end solution helps customers navigate their own digital transformations. It enabled them to operate better and to engage their customers in new connected ways. In fact, new research by IDC proves that companies using both UCaaS and CPaaS can improve time-to-market, customer satisfaction and profits more than 30%. And our sales focus is organized around four customer segments: The first is enterprise, targeting customers larger than 1,000 seats. Second is mid-market, defined as 50 to 1,000 seats. Third is small business, those with fewer than 50 seats. The fourth segment is for CPaaS customers, who use Nexmo, the Vonage API platform either as a stand-alone service integrated into their existing products or integrated with our UCaaS services. Now to highlight specifics by customer segment, let’s start…

Thanks, Alan, and good morning, everyone. I’m pleased to review our financial results for the third quarter of 2017. As in the past, quarterly growth rates reflected in our presentation slides and during our prepared remarks on a year-over-year basis, unless otherwise noted as sequential. With that, let’s begin on Slide 6. Consolidated revenue for the third quarter was $253 million, up $5 million due to the organic growth of our UCaaS and CPaaS businesses, more than offsetting the decline in Consumer Services. Now that business is the larger segment and is growing significantly faster than consumer is declining, we will begin to see expanding organic top line growth. This quarter, we not only achieved a crossover in revenue contribution, we also saw gross margin gains across all of our products, giving us high confidence in the ability to grow cash flow along with revenue. Moving to Slide 7, let me now turn to our segment financial results starting with Vonage Business, which consist of our UCaaS and CPaaS products. Vonage Business total revenue was $129 million, representing 51% of total Vonage revenue and a 22% GAAP increase. UCaaS revenue was $91 million, led by service revenue of $71 million, which grew at an organic rate of 16%. Service revenue, which does not include access, which we are growing slower by design for USF, which is a pass-through is a metric on which management is most focused and which is most comparable to our UCaaS competitors. The organic growth numbers reflect the completion of the sale of our hosted infrastructure business on May 31, which removes $1.6 million of revenue, and the adjustment of one-time items from the comparable 2016 quarter. As we have done in the past, we included a table in the press release and on Slide 13…

Okay, great. Thanks, Dave. Rocco, let’s turn it over to questions. And as a reminder, let’s please keep it to one question and one follow-up. Thank you.

Absolutely sir. We will now begin the question-and-answer session. [Operator Instructions] Today’s first question comes from George Sutton of Craig-Hallum. Please go ahead.

Thank you, quite nice results guys. So you are early in the space to make investments in direct sales going back 12, 18 months ago. And it sounds like, there may be an increased focus on building out indirect even more. Can you just give us a sense of the ROI that you’ve been seeing on these investments thus far? And I’ll give my second question in a related here, and I’ll quote Alan. You said that the enterprise pipeline is building really well. I was wondering, if you could quantify that a little bit? Thank you.

Hey, George, it’s Alan. Let me have Kenny Wyatt answer that.

Hey, George, good morning. As I mentioned last quarter, we continue to expand the direct sales team, I think we’ve intimated 21 markets by the end of the year – or we’re certainly marching towards that. And we’re making investments. You saw announcement this quarter, the new Channel Chief that we brought in from the software industry, as we continue to try to change the paradigm, if you will, how we sell-through indirect. I view this in a very omnichannel lens. Right, I view this as, we’ve got multiple segments that Alan laid out. Three specific segments in the UCaaS space, one in the CPaaS space that we have to execute across a variety of different distribution methods in order to maximize bookings and eventually revenue. So yes, we continue to expand direct sales team as promised and, I think you’ll start to see us be better indexed, if you will, in the indirect side and continue to build that piece of the business. Regarding enterprise pipeline, you saw the nice trend, obviously, Alan mentioned 30% increase in revenues year-over-year on enterprise. As we continue to see adoption in that space and we define enterprise as above a 1,000 seats, as we continue to see adoption increase in the enterprise space, the pipeline, the funnel is also increasing sequentially quarter-over-quarter as well as year-over-year. We announced, I think you remember in second quarter, some nice enterprise wins. We continue to see those seven-figure deals increase both in the pipeline as well as, as we execute all those on a quarterly basis.

Just as kind of a quick follow-up to that you are seeing the ROI in the direct sales that you’re hoping to see?

Absolutely. I think the focus for me, since I’ve been here the last couple of quarters has really been the productivity of that investment that we made, right? So we – I think we’ve done a nice job of expanding across key cities, where we see market adoption, at least, in North America. Now my emphasis has been how do we make that investment that much more productive, right? We do that through analytics. We do that through sales tools. We’re doing that through teaming with our indirect partners, right, so – in order to increase velocity of the closes of those field sales resources. So the answer is, yes, we’re seeing those ROI realized.

Thanks, guys.

And our next question today comes from Dmitry Netis of William Blair. Please go ahead.

Thank you very much, guys. Nice quarter. Couple of quick ones from me. Alan, just, if you could give us a sense of the impact you may foresee from this BroadSoft, Cisco combination. How are you guys thinking about your relationship going forward? Is there any change immediate or potentially longer-term from this? Give us a little bit of an update of your thinking around the stack that you’re using from BroadSoft? And then I have a follow-up.

Okay. So – hey Dmitry, so I don’t think the impact is problematic at all. And we’ve talked about this before. Remember, we have more than half of our revenues are on Vonage Essentials today. And as I talked very specifically about my prepared remarks, we’re moving that up. We want our own technology to be up to – able to serve up to the enterprise, up to the 1,000 seats. With BroadSoft itself, the partnership continues very strongly. And we have a contract with seven more years to run that guarantees our pricing and their support of the software that the use. When Cisco bought them, the first thing that they announced was they will continue to support service provider distribution approach. So we are – one, we have a terrific relationship with them anyways and we’ve been great partners, and we’ll continue to be great partners for the enterprise. But we’re also naturally hedged because we have our own technology, which is moving up, up and up. And then we are contractually protected. So we think at the end of the day, where BroadSoft went is actually a good thing, ultimately, because Cisco will continue to invest in their development and it’s going to support the service provider distribution.

Okay, great. And then my follow-up is on Nexmo side. I think just to clarify, you did say organically that business grew 45%?

Yes.

Okay, great. And as I look into the VAPI piece of the business, I mean that’s a newer product for you. You had mentioned it increased 3x. How did grow potentially here in the U.S., I know your presence was mostly in Asia and internationally, where you had a big installed base of SMS customers. You’re coming in domestically here, voice is going to be one of the bigger drivers. Have you seen traction in voice here in the U.S.? And also what is the competitive advantage on the voice side potentially over some of the competitors which all – that also have some network assets just like you are and are coming on to market here as well. So give just a sense of that.

Let me start and I’ll turn it over to Tony. So way to characterize VAPI in 2017 is sort of when the build and test year, and it’s going to be meaningful, we believe, as a revenue contributor worldwide, not just in United States in 2018. What makes me so excited is that we post a 45% organic growth rate, yet the materiality from a revenue contribution point of view of VAPI in 2017 is not there yet. It’s going very quickly, being tested across the board, being deployed in large accounts, but it’s late in the year and it’s off of basically a 0 base. So to be able to hit the organic growth rates without it is what really is, again, an element of what drives my enthusiasm going forward. How we competitively position it and some of the wins? Let me turn over to Tony, he can talk about that.

Hi Dmitry, this is Tony speaking here. I think talking about the competitive advantage, you mentioned the network, and indeed in the U.S. specifically, we have to rely on the Vonage network, but unlike others in the market, we also have a global network. As you recall, Nexmo when acquired by Vonage, the majority of revenue was coming from overseas and we spent years building that network. So it’s really a global network, not only in the U.S. And the second differentiator is really on the functionalities that this API provides that enables higher level of used cases. So to give you an example, we are the only API in the market that supports WebSocket, which enable the developer to get access to the audio stream in realtime and that opens up application, such as artificial intelligence, voice, chatbots and have the potential to really disrupt market such as IVR market. So instead of going through a menu that is static, you can then have a natural language conversation with a machine. So expanding the number of used cases and the global network and adding all these functionalities enable us to differentiate in the long-term.

And our next question today comes from Greg Burns of Sidoti & Company. Please go ahead.

Hi. I just had a question about the strong profit performance this quarter. It looks like it’s going to continue into the fourth quarter. But it’s just a timing issue where so may be some investments haven’t been made that you expect spending to increase? Or is just kind of the level of profitability we can expect from the business as we move into 2018? Thank you.

Yes, it’s primarily a level of profitability. I would say that we expect EBITDA margins this year and consistent with the guidance we just gave to be in the high teens. It can move around quarter-to-quarter. It was higher this quarter. I would expect it to be consistent within our guidance for next quarter to be consistent with this quarter. But I think you are seeing a permanently lower level of sales and marketing in consumer. I think we’ve stabilized that at this point. We’ll see sales and marketing go up in business on an allocated basis, but at the same time, consolidated revenue will be growing. We’ve had a lot of noise and one-time items in our G&A, including amortization of Nexmo, contingent consideration, most of that’s done. We’re down below $1 million per quarter. And so, we expect to be in this G&A context for some time to come. But I will say that having made the operational improvements, some of the choices that we made in consumer that this type of profitability in terms of dollars, we think, we can sustain growing EBITDA in within the crossover between consumer and business.

Okay, thank you. And then in terms – you mentioned VAPI as being your lever for growth on the CPaaS business. You also touched on launching the Reach products, where are you in terms of the sell opportunity between your UCaaS and CPaaS solutions? And how do you see that playing out next year?

Let me ask Kenny take that.

As we mentioned, we launched this quarter for the first time, what I call a finished product on CPaaS. And if you think about it, really is we’re taking a number of used cases, putting them in a bundle and then taking that bundle or that used case, if you will, to buyers of UCaaS through our UCaaS distribution, in this case, primarily our field sales team as well as our channel. We have seen some early success on that, but I will tell you, it’s early, right. This is a different sale that we’re pushing through that distribution and we expect to see a lot more behind it, a few green shoots that we’ve seen here over the past month or so after launching that product.

All right, thank you.

And our next question today comes from Rich Valera of Needham & Company. Please go ahead.

Thank you, good morning. Alan, question around the $1.8 million of MRR in backlog. Backlog that you mentioned, I was hoping you could give some context for that? One, sort of, what is that comprised of? How does it compared to historical levels? And how quickly we think that can convert to revenue? Thanks.

So the backlog is primarily from enterprises. You think about – just because of the nature of the beast of enterprises, they tend to install over multiple quarters. So it’s not 100% from enterprises, but as you might expect, it’s mostly. If you look back to – I’ll just highlight two of the big deals that we mentioned over the last couple of quarters, the huge real estate company for over 20,000 seats. We said that was going to install over as many as six quarters and we did that two quarters ago. And then when we spoke about MyEyeDr, last quarter, again, it installs over multiple quarter. So the expectation is this $1.8 million of backlog will install over the next four quarters in the main. The whole strategy here in enterprise, quite frankly, but it’s across. I mean, obviously, the mid-market and small unit installments more quickly. But the – in enterprises to stack more and more enterprise wins. So that they will continue to feed revenue going forward, that’s precisely what’s happening. Because that $1.8 million backlog is much higher than it was a year ago, before we have these large enterprise wins.

Got it. That makes sense. And then you mentioned you are going to be at 20 of your 21 targeted markets, direct sales presence markets, you’re at 20 right now, and you’re going to be at 21 by the year end. Just wondering, if you can give any sort of qualitative sense of how we should expect those kind of spool up and become more productive as we had into 2018. What can we expect in terms of increased sales productivity out of these new markets that have been out of this year as we move into next year?

Kenny, take that.

Rich, it’s Kenny. We really have kind of land and expand approach in each one of these markets. Right, we are putting in handful of reps and a manager to make sure that we get as much productivity out of the reps as possible. Obviously, we’re softening the market with marketing campaigns, if you will, inside of the local markets. We are doing a lot of kind of guerilla marketing tactics, if you will, of softening that marketing and getting it ready for direct field channel to, sort of, attacking it as we enter those markets. But more importantly, we’re also using our indirect. This is probably a change in strategy that we’ve deployed in the past. We’re really using our channel partners as a way also to soften those markets as we move in there. Obviously, there is a lot of leverage in the indirect partners and we’re utilizing those in conjunction with our direct sales team to make sure we get full productivity out of those resources.

Got it. Thank you, nice results, gentlemen.

Thank you.

And our next question today comes from Michael Rollins of Citi Investment Research. Please go ahead.

Hi, thanks for taking the question. I was curious, if you could fast-forward a few years from now, if you look at the CPaaS, I would like to call quick-to-communicate category, what are going to be the key characteristics to be successful? Is it going to be low cost? Is it going to be product quality? Or would you expect that some of the competitors are all kind of look similar? How should we think about the factors of success? And then maybe walk us back or just some of the things that you’re doing strategically to get to that vision of the future? Thanks.

Tony, why don’t to take that please.

Sure. So if you fast-forward a few years, what we see as a shift in the market from the early adopter that’s created that market, which are vision native companies, your Uber and Airbnb marketplaces to the enterprise. And these other enterprises that are adopting this technology to build better customer engagement and experience requires you to have an enterprise sales model and enterprise capability. These are things like SLA, premium support, partnership with system integrators that enable them to gets done higher level of security is one. So I think, this is going to be enterprise, is going to be one area of differentiation to be able to capture that market as you probably [indiscernible] into the early majority. The second item is really the developer experience. As there is always a developer involved even within the enterprise. So enabling these developers to get stuff done to build these applications much faster than others is going to be reason [indiscernible] And thirdly, I would say, the number of used cases that the platform can enable, the more used cases you have, the bigger your addressable market. And it’s better as your ability to capture the growth of the market. So really, one is the enterprise ecosystem. Second is the developer experience. And third is number of used cases you can address.

Thanks very much.

[Operator Instructions] Today’s next question comes from Tim Horan of Oppenheimer. Please go ahead.

Tony, can you talk about the enterprise market. What you think your win rate is on full share there as enterprises are adopting versus your – I guess, versus your market share of your existing product? And to your point, I mean, the developer is really critical there. What are you offering to developers that’s maybe different than your primary competitor in that enterprise market? Thanks.

Sure. So gradually see the shift happening from these early adopters. The marketplace division made it into the enterprise and we see this adoption rate goes up actually. Of course, it’s a slower uptake when it comes to enterprise because they buy it differently, they need to have SLAs, sometimes they need consulting, but the – one enterprise can have multiple used cases. Because it’s organization and they are really on a path of modernizing their customer experience. And when it comes to the developer experience, specifically, if you go to our website and look at our developer center, you see not only we have documentation of our API, but we also have developer tools such as Tutorial, Quickstarts, SDK to enable better mobile experiences. So the developer doesn’t need to reinvent the wheel every time they want to build communication application, that speed up the time of development and provide more peace of mind for the developers – within the enterprise. Because increasingly you have this pressure on IT and the resources there are limited, so they need to have these tools to do things faster and better.

So not to put words in your mouth, but do you think you have better set of tools than your primary competitors at this point for enterprise customers?

Yes, I believe, we have a good developer center, at least, the new version that we actually went live a couple of months ago. We have good feedback from the developer community. And it’s also open source available for – on this hub. But this is just the beginning. We have a developer relation team that is growing, that keeps evolving the developer experience. And we’re going to see more of this coming in the next few quarters and years to continue providing this ultimate developer experience for our customers.

And – sorry, just a follow-up on – Dave, on your margins, just to clarify, do you think EBITDA margins can continue to expand off at this point, over the next couple of years, we had a goal again the 25%. And I guess specifically, where are we with business revenue – with business margins at this point, and where should be trending from here?

Yes. So I would expect EBITDA margins to stay in the high teens to kind of 20% context on a consolidated basis for the next several years. And again, the effect, which are the result of business getting more allocated profitability and consumer creeping down over time. And so that’s the area that we’re going to be in for the next couple of years. As it relates to business margin, we committed, and again, this is on an allocated basis because we’re a functional organization. But we committed to having business breakeven in 2017 before G&A allocation that’s UCaaS, and that’s where we will be with CPaaS, a slight drag on that. We are running that as 1 unit and looking at this as more of by customer segment as opposed to by product. But in general, we’re going to be holding business gross margin relatively steady given the mix shift that’s occurring between UCaaS and CPaaS of growing revenue substantially, so that will lead to higher profitability then having consumer. I would expect consumer contribution to come down at the same rate as revenue. We just missed revenue being down 12% instead of 13% in this quarter, given the rounding. And I would expect consumer revenue to continue – the decline rate to continue to improve and for profitability to essentially track that same trajectory.

Okay.

And our next question today comes from Michael Latimore of Northland Capital Markets. Please go ahead.

Yes, it’s a great quarter. Alan, I think you mentioned the potential for a business segment to – the growth rate to improve in the fourth quarter, was that specific to UCaaS or the overall business segment?

It’s overall.

Okay.

And we talked about factors, obviously, the CPaaS product is growing very well. And embedded in the guidance update that we did at the end of 2Q was closer to 40% growth for the year. It’s 45% in the last quarter and the fourth quarter tends to be a seasonally good one. UCaaS, we feel very good about the trajectory there. We are – there is a mix shift happening there in the sense that, as we talk, we’re deemphasizing access. And just to be clear, the access business essentially – the access product, essentially, did not grow in the third quarter and that was by design. Just so you can get a sense of the drag from that. So I think the way we look at it is the guidance on, as it relates to UCaaS and CPaaS that we gave at the start of the year updated for 2Q, and we continue to be in that range. But moreover, we said about UCaaS that it would grow in the mid-teens. And when you look at that doing the whole pro forma, that’s what we expect to deliver for the year and that service revenue will be 100 basis points plus better than that also pro forma. And that’s where we continue to outlook 2017.

Got it, thanks. And then you mentioned taking Essentials up to the 1,000 user seat range. When do you think the technology will be able to support up to 1,000 seat kind of customers?

By the end of 2018, it already does, I mean, for instance, we already sell accounts of that size. We already have done that on Essentials. What we’re doing though is the focus internally and how we create training of the sales people, commission plans, et cetera, is to focus them on our own technology. Now along the way, we are continuing to move its stability, scalability, audio quality, feature set, service delivery, and then the things I mentioned in cloud infrastructure, SmartWAN, et cetera. All that will make it ever more suitable for larger and larger accounts, that’s the focus and that will be happening throughout the year. When we start the year, we won’t be at 1,000 seats in terms of sort of the internal rule set and what the sales people are permitted to sell without getting some exception clear. But by the end of the year that number will should move up to the 1,000.

Okay, great. Thank you.

And our next question today comes from Will Power of Baird. Please go ahead.

Great, thanks. I just wanted to come back to some of the earlier CPaaS comments and success you’re continuing to have in Asia. I wonder if you could just help walk us through what some of the key drivers there are? What’s differentiating you are in that market versus some of the competitors that drive to kind of growth you’re seeing there. I guess the extension of that is maybe just a little more color on the U.S. and European markets, what you’re seeing from the CPaaS perspective there relative to the growth you’re seeing in Asia?

Okay. Tony, you want to grab that?

Yes, so on top of our differentiation, I spoke about earlier, specifically in Asia, we have a global network in some key markets that enable us to open up these markets that are – that is high quality and delivering on the promise of the used cases we provide. But additionally to that, we have local teams, as Alan mentioned on the earnings release, we have open offices in – two offices in China. We already have Singapore, Hong Kong, Europe and Tokyo. We are present in Seoul. So we have local teams with local expertise as we’ve been around for a few years, we’re just kind of troubling down on that market to help understand the local customer, to understand how to sell in local markets and how to support in local markets. And as you probably know, Asian customer behave differently than other customer, whether in their buying behavior or their expectation of support. So it’s important to have local touch to enable that market to grow and expand. And what’s driving the growth in Asia, if you see, really, the digital transformation in Asia is a trend that, in my opinion, will have much higher impact on the region because many countries and many enterprises are starting from scratch. They’re building our technology a set of buying some of the existing software packages. So it’s a great opportunity for us to enter and provide them in APIs to help them to do so faster than other regions.

Okay, thank you.

And our next question comes from Catharine Trebnick of Dougherty. Please go ahead.

Yes. Thanks for taking my question and good quarter, guys. Mine is, during the quarter or just before the quarter, Nexmo prices were increased. What gave the management team comfort in raising the prices and methodology behind that? Thank you.

Tony, you want to grab that?

Sure. So we look at our pricing from a competition standpoint, but also from the value we provide to our customers. If you take, for instance in SMS, in SMS, we can buy and message at any price you want, but you’re not going to – you won’t be able to get it at the quality required. So we believe that there had – that we had a gap between the value provided to the customer. And therefore, we close that gap by increasing some of the prices in certain countries.

Than outside Twilio being the competitor of Nexmo, are you seeing any other competitors are you think you are the pretty much the two go-to players? Thanks.

Tony?

So yes, we really see Twilio as the key competitor. When we – how we measure that is by, who are we competing with on yields. There is a small long tail of other providers. Some of them are regional. But we don’t see them on more than 10% of Twilio. We believe it’s a two race market right now. And that barriers to entry for newcomers is increasing. Think about how hard it is to build a developer experience, how hard it is to have high quality of service and a global network. All these are barriers to entry for many newcomers. And we primarily see Twilio on yields at the market right now.

Thank you. This concludes our question-and-answer session. I’d like to turn the conference back over to the management team for any closing remarks.

Okay. Thanks, Rocco. That does conclude our call for today. And we look forward to seeing many of you in the coming months at various investor conferences. For those that are unable to attend in person, these events will be webcast. Please contact if you need any additional details. Thank you.

And thank you, sir. This concludes today’s conference. We thank you all for attending today’s presentation. You may now disconnect your lines. Have a wonderful day.