Vonage Holdings Corp. (NYSE:VG) Q2 2016 Earnings Conference Call August 2, 2016 8:30 AM ET
Alan Masarek - CEO
Dave Pearson - CFO and Treasurer
Joe Redling - COO
Tony Jamous - President of Nexmo
Hunter Blankenbaker - VP, IR
George Sutton - Craig-Hallum
Gregory Burns - Sidoti & Company
Catharine Trebnick - Dougherty & Company
Richard Valera - Needham & Company
Tim Horan - Oppenheimer & Co.
Dimitry Netis – William Blair
Michael Latimore - Northland Capital Markets
Michael Rollins - Citigroup
Good day, ladies and gentlemen, and welcome to the Vonage Holdings' Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this call will be recorded.
I would now like to introduce your host for today’s conference, Mr. Hunter Blankenbaker, Vice President of Investor Relations. You may begin.
Great. Thanks, Catherine, and good morning and welcome to our second quarter 2016 earnings conference call. Speaking on the call this morning will be Alan Masarek, Chief Executive Officer; and Dave Pearson, CFO. Also joining us are Joe Redling, our Chief Operating Officer; Clark Peterson, President of Enterprise; and Tony Jamous, President of Nexmo.
Alan will discuss our strategy and second quarter results and Dave will provide a more detailed view on our second quarter financial results. Slides that accompany today’s discussion are available on the IR Web site. At the conclusion of our prepared remarks, we would 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 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 on the IR Web site.
With that, I’d like to turn the call over to Alan.
Thanks, Hunter. Good morning, everyone. Thanks for joining us. It’s great to be with you today to discuss our progress. I’m pleased with our results and we’ve demonstrated continued momentum in the execution of our strategy. Most notably, the closing of the acquisition of Nexmo, a global leader in Communications Platform as a Service, or CPaaS.
We embarked on our transformation to business just two and a half years ago. When I joined as CEO, we outlined the strategy to become the clear leader in cloud communications for business. Our plans were based on three simple elements. One, leverage our corporate assets to create competitive advantages in our move to business. Two, create a winning value proposition in cloud communications for business. And three, execute with precision.
I’ve been pleased with our performance against these three core elements, particularly given that we’ve executed this transformation so quickly. I will now review each of these three in more detail. Number one, leveraging our corporate assets to create competitive advantage in our move to business.
First, consider the strength of the Vonage brand. A recent branding study showed Vonage’s aided brand awareness among prospective business customers at greater than 60%. This level of awareness demonstrates that we’ve repositioned Vonage into a leading business services brand.
Next, consider the strong cash flows we generate from consumer services. These cash flows have enabled us to invest more than $600 million in acquisitions and share repurchases over the past two and half years. And the operating margin and related cash flows within consumer services have increased significantly.
And finally, consider the strength of the Vonage voice network, which gives us specific advantages versus other UCaaS and CPaaS competitors. Our voice network terminates more than 15 billion voice minutes per year with very high quality yet at very low cost.
Number two, create a winning value proposition in cloud communications. With the closing of the Nexmo acquisition we’ve created a powerful and differentiated value proposition because we can seamlessly integrate the entire business communications value chain.
There are three elements to this value chain. First, moving of employee e-based company communications to the cloud. Second, the integrating of those cloud-based employee communications with and into the other cloud-based workflow tools, like productivity and CRM, that businesses use every day. And third, you have to integrate a company’s customer communications into the previous two.
As communications started shifting to the cloud, the first part of the value chain to move was the on-premise PBX. The cloudifying [ph] of the PBX is now generally referred to as Unified Communications as a Service, and UCaaS solutions are mostly focused on a company’s internal employee-based communications. We’ve built a broad suite of UCaaS solutions serving 74,000 business customers ranging from large enterprises down to small SMBs.
The next critical part of the business communications value chain is the integration of cloud communication in the cloud-based workflow tools, like productivity and CRM, that businesses use each and every day. We are now deeply integrated with wildly used productivity and CRM tools, like Salesforce, Google for Work, Office 365, Zendesk, Oracle Sales Cloud, Netsuite, Clio, JobDiva, Bullhorn and others.
The third and final piece of the business communications value chain delivered via our latest acquisition Nexmo enables businesses to communicate more effectively with their customers by embedding communications functionality into their customer facing mobile apps, Web sites and business processes. This delivery model is referred to as Communications Platform as a Service or CPaaS.
All three elements of the business communications value chain are compelling on their own and we will continue to sell UCaaS and CPaaS separately. However, the integration of UCaaS and CPaaS into a single solution creates the most vertically integrated communications company in our industry with scale and capabilities that can deliver better business outcomes for our customers.
We believe the seamless end-to-end integration of the business communications value chain can deliver truly differentiated solutions that will leapfrog the competition. Now to illustrate this differentiation; consider the frustrations of the disjointed and disconnected communications we all so frequently experience and I’ll use booking and airline ticket online as a simple example.
So assume I’m online trying to book a flight next week. I want to fly say from our Vonage office in Hong Kong to the Vonage office in Singapore. I’m several minutes into the online session and I have a problem. What do I do? I call the airline’s 800 number and then I need to completely reintroduce myself to the agent, because he or she has no information, no context regarding what I was trying to accomplish online.
Now, imagine a world where when I hit the click-to-call button within the airline’s Web site, the agent answers and says, Hi Mr. Masarek. I see you’re trying to book a flight from Hong Kong to Singapore next Thursday, how can I help? The experience is obviously and vastly superior. But how do we do this?
We’ll do this by integrating the entire business communications value chain. The airline incorporates Nexmo’s programmable voice API into their Web site, and Nexmo’s API’s route the call through our UCaaS call routing functions so that the phone call goes directly to the agent handling international flights in Asia. Then, once the flight is booked, it’s automatically integrated into the airline’s CRM system.
This is the future of business communications and it’s enabled by the fusion of UCaaS and CPaaS. Vonage has assembled a robust solution set to make this happen and we expect it will deliver excellent revenue and earnings growth for many years to come.
Now number three, execute with precision. While I’m truly excited about our vision and the assets we have assembled to fulfill it, we’ve been laser-focused on execution. I’ve been encouraged by our executional performance, particularly given the rapid pace of acquisitions and follow-on integrations.
We expect our organic growth rates to increase over time as we complete these integrations. And while there is more work to do, we are building a truly differentiated solution set.
With that as a backdrop, I’m pleased to report that Vonage business Q2 revenue was $86 million, a 75% increase year-over-year. Pro forma, as if we had owned Nexmo for the entire quarter, Vonage business accounted for 40% of total Vonage revenue and this compares to zero just two and a half years ago.
Looking ahead to next year, we expect Vonage business revenues to exceed consumer services revenues and this is going to be an important milestone in our broader transformation from consumer to business.
As in earlier quarters we added a great number of new customers. During the quarter, we added nearly 8,700 new logos, ranging from small SMBs to large enterprises. The wide breadth of customer additions demonstrates the success of our go-to-market strategy with two purpose-built platforms, targeting the specific needs of different market segments.
And among larger customers, we’re seeing strength in our bookings and sales pipeline, and our current customer base represents significant market presence. In fact, as we exited Q2 nearly 40% of Vonage business revenue came from customers with at least 50 seats, more than 20% of revenue came from customers with at least 250 seats and more than 10% of revenue came from customers with at least 1,000 seats.
Now to elaborate on that sales mix, we serve a wide array of large companies. We have particular strength in key verticals like retail, real estate, finance, healthcare and education.
Recent wins include a nationally recognized retail brand with 200 locations in the U.S., a major home services retailer with 35 locations and 400 employees, a wellness healthcare provider with over 1,000 locations where Vonage is one of only two approved providers, a private liberal arts college in New York City with 600 employees, a large recruiting firm with 19 offices in the U.S., and the largest municipal media company in the U.S. with 21 offices and nearly 1,000 employees.
I’m also encouraged with the early results from our sales force expansion. Since the beginning of the year, we’ve opened sales offices in five new cities and we expect another three by end of year. I see upside in sales as more of our sales teams ramp to full quota and become more productive.
With respect to Nexmo, we completed the acquisition just two months ago and we’re really excited to be executing on a shared vision. We are investing in the acceleration of Nexmo’s growth by pulling forward anticipated 2017 investments into this year. And this is in order to fund growth in engineering, sales, marketing, and developer relations. And as part of our larger plan to accelerate our collective Vonage business growth.
As we’ve described in earlier calls, Vonage and Nexmo are particularly complementary and will serve as force multipliers for one another. For example, by pairing Nexmo’s API with our underlying voice network, Nexmo’s APIs can deliver a higher quality, lower cost voice experience than what is competitively available today.
Our quality and cost advantages stem from our large scale, couple with direct pairing relationships with carriers and our lower cost termination rates. Nexmo intends to release new voice API products during Q3 that will be targeted at U.S.-based customers who can best utilize Vonage’s voice quality and cost advantages.
Next, we’ll enhance Nexmo’s distribution by leveraging Vonage businesses’ 350 sales resources across all our sales channels. Over time we’ll offer Nexmo solutions to Vonage’s 74,000 business customers to enhance their customer communications and make their businesses more productive.
Finally, Nexmo accelerates Vonage’s enterprise opportunities. We know that more than one-third of customers in our enterprise pipeline use CPaaS solutions today. And our ability to combine CPaaS and UCaaS enables Vonage to more deeply integrate with our customers.
In fact, by integrating our customers’ business communications we help them cultivate more personalized relationships with their customers, which has never been more important than in today’s digital world where personal interactions are often lost.
Now let me comment briefly on results in consumer services where we continued our disciplined focus on increasing profitability and cash generation. The two main levers we have our subscriber acquisition costs and customer churn, and I’m pleased with our progress in each.
In Q2, we added approximately 55,000 new gross subscribers and lowered our customer acquisition costs once again. Customer account churn for the quarter was 2.1%, our best consumer services churn in any quarter in 10 years. This performance reflects our focus on adding stickier customers and then retaining them with good customer service.
Our tenured customers, defined as those with us for more than two years, now represent 76% of our consumer base and is the highest in our history. We continue to have very high confidence in the long-term cash flow generation capacity of consumer services.
In closing, I’m pleased with the quarter’s results and I’m happy with our team’s execution. I’m truly excited about the opportunities ahead. The solution set we’ve assembled is unprecedented in our industry. We have high quality assets across both UCaaS and CPaaS. And as a result, we intend to deliver the broadest service offerings in our industry.
We have more integration work to do, yet my bullishness about our competitive positioning and our future opportunity continues to increase and we well positioned to capture the rapid shift to cloud communications happening within all business segments.
Now, I’ll turn the call over to Dave to discuss our second quarter financials in more detail.
Thanks, Alan, and good morning, everyone. I’m pleased to review our financial results for the second quarter of 2016. Before I do, I’d like to note that the quarterly growth rates reflected in our presentation slides and during our prepared remarks or on a year-over-year basis was otherwise noted as sequential.
Let’s move to Slide 4. Consolidated revenues for the second quarter were 234 million, up 12 million. Vonage business revenue was $86 million, a 75% increase. Vonage business revenues include approximately one month of revenue from Nexmo, which contributed $8 million. Vonage business revenue without Nexmo was $78 million, a 59% year-over-year increase.
Nexmo revenue for the full quarter grew 43% year-over-year. Vonage business average revenue per seat, excluding the revenue contribution from Nexmo, is $45.52, up from $42.28 year-over-year due to the acquisition of iCore and organic growth in the midmarket and enterprise space.
Business ARPU was also up sequentially from $44.50 benefitting from a $500,000 one-time payment we received in the quarter from a customer that was acquired. Average revenue per line and consumer was $26.61, down from $27.79 in the year ago quarter but roughly flat to $26.68 in the prior quarter. This is our smallest sequential decline since the fourth quarter of 2014.
Moving to Slide 5. Revenue churn for Vonage business was 1.4%, up from 1.3% year-over-year and sequentially. This is due to increased churn with essentials where we continue to see strong gross add economics. Vonage business grew total seats to 578,000, up 44% reflecting both organic and inorganic growth.
Customer churn and consumer was 2.1%, down from 2.2% in the year ago quarter and sequentially. This is the best consumer churn in 10 years and reflects the high quality of new customers we are adding as well as the stability of our tenured base. We expect churn to continue to fluctuate based on seasonal and competitive factors, but to stay in this general range. We ended the quarter with 1.8 million in consumer subscriber lines consistent with our expectations and our increased investment in business.
Now moving to income statement and cost items. Cost of service was $76 million, up from $64 million due to higher cost of telephony services from the much higher number of business seats and Nexmo termination costs. We've integrated the networks of all of the acquired UCaaS companies and 100% of our UCaaS traffic is routed through the Vonage network.
With respect to Nexmo, we will begin moving its U.S. voice traffic on to the same core network in the next week with international voice traffic to follow later this quarter. These moves will increase voice quality and further reduce voice costs. A fully redundant 10-gig backbone and broad geographically distributed network of pops are significant assets that maximize voice quality. On cost, the ability to host their own phone numbers eliminates rental charges and pairing the termination partners turns U.S. per minute termination costs by up to two thirds.
Turning to Slide 6. Sales and marketing expense for the second quarter was $83 million, down $1 million. This basically flat number is a result of continued optimization and reduction of our consumer sales and marketing spend, offset by meaningful ramping of business sales and marketing spend over the same period.
Consumer subscriber acquisition costs declined over 20% consistent with the lower sales and marketing spend and the shift to more efficient media channels. Business sales and marketing costs continue to shift towards sales and specifically investments in building a larger field sales force.
We expect sales and marketing to increase in the second half of the year as we continue to expand field sales into additional markets and invest in initiatives to accelerate Nexmo’s growth. As Alan discussed, these investments in Nexmo represent our decision to pull forward plan 2017 investments into 2016 to further accelerate Nexmo’s growth.
General and administrative expense for the second quarter was $35 million. This is up $8 million reflecting the addition of iCore and Nexmo G&A expenses and Nexmo acquisition-related expense, including professional fees and amortization of stock and cash-based field consideration to employees.
Moving to Slide 7. This quarter we instituted a new nomenclature for our key performance metric, adjusted OIBDA or operating income before depreciation and amortization. As with our prior non-GAAP performance measure, adjusted EBITDA, which it replaces, is meant to reflect the operating cash generation of our business.
Adjusted EBITDA and adjusted OIBDA are the same number. Each excludes the same non-cash items such as stock compensation as well as one-time cash expenses such as advisory fees, investing deal consideration and cash. This change in metric is intended to comply with recent SEC compliance and disclosure interpretations of non-GAAP financial measures.
Adjusted OIBDA for the second quarter was $40 million, a 5% increase. This reflects another quarter of strong cash flow from consumer which on an allocated basis accounted for more than 100% of OIBDA. In the predictability of the levers of cash flow and consumer, including churn, ARPU, costs, and acquisition costs, we continue to believe we can reduce approximately $600 million of after-tax free cash flow from this business through 2020 and have material terminal value at that point.
Adjusted net income was $18 million or $0.08 per share. The adjusted net income metric removes additional non-cash items such as amortization of intangibles from acquired companies and acquisition-related costs. Consistent with the recent SEC CDI, adjusted net income now includes GAAP taxes. Vonage is not a material cash taxpayer due to our $626 million NOL.
Moving to Slide 8. CapEx for the quarter, including the acquisition and development of software assets, was $10 million. This is up $4 million due to higher spend on network infrastructure and systems improvements and success-based purchases of premier licenses.
As discussed at the beginning of the year, we are undertaking a consolidation of our data center infrastructure, cost of which is primarily in CapEx and we made a significant investment in equipment for this project in the quarter.
CapEx for building improvements to our New Jersey headquarters that will be refunded by our landlord under the terms of our lease renewal was approximately $500,000. Adjusted OIBDA minus capital expenditures was $30 million reflecting the strong cash flow capacity of our business.
Free cash flow, which we define as net cash provided by operating activities minus capital expenditures and acquisition and development of software assets, was $14 million, down $15 million. Our increase in adjusted OIBDA was more than offset by the increase in capital expenditures and the increase in one-time acquisition-related costs.
In the second quarter, we took advantage of the stock pull back in May to repurchase 5.7 million shares for $25 million at an average price of $4.31 per share. This with highly accretive relative to the current share price and the price of which we issued shares to the Nexmo acquisition.
In fact, between accelerated buybacks and discretionary cash we put into the acquisition, and entirely offset any dilution to our share count and the stock issued to Nexmo’s institutional shareholders. This means that all the stock net of the buyback provided in the transaction is allocated to Nexmo employees and this stock and deferred deal consideration cash is subject divesting or other restrictions.
Through the first six quarters of our four-year $100 million buyback program authorized at the start of 2015, we have repurchased almost half of the authorization. Since beginning our repurchase program in August 2012, we have bought back 56 million shares of Vonage stock, over 20% of shares outstanding for $181 million at a highly accretive average price of $3.26. Our buyback has provided strong returns for shareholders and continues to be a flexible capital allocation tool to be deployed at management’s discretion.
Cash, cash equivalents and marketable securities as of June 30 are $34 million, including $2 million in restricted cash and $8 million in marketable securities. Net debt was $333 million and we ended the quarter with net debt to trailing adjusted OIBDA of 2.2 times.
During the quarter, we closed a new $450 million credit facility consisting of a $125 million term loan and 325 million revolver. This loan and the cash flow generation impacted is highly strategic, enabling us to borrow at a low cost of capital of less than 3.5% and provides the flexibility to acquire assets like Nexmo using primarily cash.
Our strong cash flow, cash position and revolving debt facility give Vonage significant financial capacity and strategic teaching flexibility, which we believe are competitive advantages.
That concludes my prepared remarks. I’ll now turn the call over to Hunter to initiate the Q&A.
Great. Thank you, Dave. Catherine, we’re ready for the Q&A please.
Thank you. [Operator Instructions]. Our first question comes from George Sutton with Craig-Hallum. Your line is open.
Thank you. Good morning, guys. Nice results. So, Alan, I thought it was compelling when you discussed the combination of network quality that you can provide along with the cost advantages when you pair your network with the APIs from Nexmo. I wondered if you could be a little more granular in terms of what kinds of advantages those might be when we think from a cost perspective and quality perspective?
Let me ask Dave to take that.
Sure. So it really is there two sides of this. First is on U.S. voice where we think there’s a significant opportunity and to-date, Nexmo has been primarily focused on the outside the U.S. market and SMS. That continues to be a very good market and one where Nexmo has a very strong presence. And we believe that over time we can lower those SMS costs of Nexmo through our carrier relationships and other network elements we have. However, I think what we were focused on in our commentary is really the opportunity in U.S. voice – Alan mentioned that we’ll have a new product that will address that market and underpinning that will be our U.S. voice network, which is our bread and butter today. That network does a few things that are advantageous. And first of all, it’s got a redundant backbone, so it’s got very high quality and it’s redundant. Secondly, we peer with many if not most of the major carriers. That’s a quality advantage where there’s a direct handoff but it’s also a cost advantage where the call is now going out over the public switch network and the agreements that we have at these counterparties lead to termination costs that are about a third of what they’d be out in the market. In addition, we no longer were ramping our use of our own phone numbers. So over time, we will no longer be renting phone numbers. And phone numbers are very valuable particularly in CPaaS where the use of proxy numbers is very common. So when a customer is communicating with Uber or with Air B&B with their counterparties that going to provide the service, there’s typically a proxy number in there to keep privacy and to stop revenue leakage. And the ability to own those phone numbers which get used over and over again is a cost saving. So those numbers can cost roughly $0.05 per month per number. And when you start talking about having hundreds of thousands of those, those costs add up.
I appreciate the level of clarity. That’s very helpful. As a follow up, Dave, you mentioned 2017 investments that Nexmo would have been making you’re moving to 2016. Can you give us a little bit more specificity on the dollars and any specificity on the types of investments you’re making? Thanks.
Sure. We talked – when we acquired Nexmo in the following month, we talked about a small EBITDA loss for the year under our ownership which in the couple-million-dollar range. We’ll be adding several million dollars, call it, $3 million to $5 million of investment to that number in the second half of 2016. That was money that was earmarked for 2017 that we’re pulling forward. So 2017 will be that much better in terms of EBITDA contribution from Nexmo but we also believe that these investments will lead to higher growth in 2017. We’ve not quantified that growth yet, we’re going through our budgeting cycle now. But we’ll be able to as we get closer to the end of the year. As we think about where those investments are going, it’s really developer awareness, lead generation and enterprise sales footprint. And some of that is synergizing to what we already have and some of that is new assets. And I also just wanted to note as it relates to the additional investment in Nexmo, we’ve not changed our EBITDA guidance for the year. This is a priority for us to invest in Nexmo and our EBITDA guidance continues to be at least 150 million including that accelerated investment.
Perfect. Thanks, guys.
Thank you. Our next question comes from Greg Burns with Sidoti. Your line is open.
Good morning. I just wanted to follow up a little bit on the Nexmo voice initiative in the U.S.? When you look at your customer deployment, do customers typically go with one CPaaS vendor or do they use multiple, and then just use the one that’s least cost? And can you maybe talk about how sticky these customers typically are and maybe what you need to do to win away some business from some of the other CPaaS vendors that are out there that are more voice focused currently? Thank you.
Greg, let me ask Tony to answer that.
Thank you, Alan. It clearly depends on the use case. So if it’s an outbound only use case [indiscernible] a reminder for voice, then the stickiness here is really primarily and how good the API is. When it’s an inbound use case, like Dave was mentioning a proxy communication, you have a virtual number in the middle connecting buyer and seller or it’s an inbound call, then there is higher stickiness related to the phone number that involves in the API that adds on top of the quality of the [indiscernible] and the quality of the network.
Okay. And with your experience, what is the churn like for a customer? How low is the churn when Nexmo is experienced?
So churn is, it depends how you define churn, right? So total churn is very, very low which a customer stopped using the API completely. You have two other type of churn; one would be a natural churn where a customer activity is changing with their own activity. For instance would be let’s say a customer is acquiring less users this quarter than the last quarter or they have invested less in marketing than the previous quarter. And then there is the competitive churn where a customer would be using more API vendors at the same time. So looking at these three types of churn, the first one, the total churn is nearly zero; the natural churn is a big part of the churn we see in the market because it really depends on the customer activity and investment. And the third churn would be the competitive churn, which is the one that we focus on mainly all the time.
Okay. Thank you.
Thank you. Our next question comes from Catharine Trebnick with Dougherty. Your line is open.
Thank you very much for taking my call and nice print. A quick question. Dave, could you go back to some housekeeping items? You ran through a percentage of number of VBS businesses that were over 1,250 and I didn’t quite catch all of them? And then I have a follow-on question please.
Hi, Catharine. It’s Alan. It was in my prepared comments. So roughly 40% of revenues are at least 50 seats, 20% of revenues are at least 250 seats and more than 10% of revenues are at least 1,000 seats.
Okay. Thanks. And then my question is it seems like if you go back to the way things were maybe a year ago, you had Vocalocity in the rollout. So, how is the traction between going forward your SMB versus your larger opportunities? And what does that funnel look like, how strong is that? And then the follow-on is it looks like that you have cap to BroadSoft from the three different acquisitions and you’ve integrated into the network. So do you feel some of the earlier issues with the integration are being resolved and you’re still more comfortable about the outlook going forward? Thanks.
First of all, Catharine, our strategy is to sell up and down sort of the range of business customers, from small SMBs all the way up to large enterprises. So in those prepared comments, we were reporting on that that we added 8,700 logos in the quarter alone, yet 40% of our revenues are midmarket size greater than 50 seats, 20% are even larger companies greater than 250 seats and 10% more than 1,000. And then highlighting some of those recent wins, so that it’s happening on a larger company. So it’s clearly happening on both ends and we’re investing to accomplish just that. So as I mentioned there are 350 sales resources in the company. Those are between inside sales who mostly target on the SMB side and then three varieties of outside sales people; field sales, channel managers and enterprise sales folks who are really going after the large whales. So that’s the stated strategy and that’s the whole notion of having two stacks to go after the respective ends of the market. From an integration point of view, through these six acquisitions over the last two and a half years, we believe we’ve put together the fullest solution set. Now it’s up to us to scale it and will be opportunistically looking at acquisitions. But clearly the focus is on scaling it. And so as I like to say, every day is a good day because we’ve put more and more of the integration work behind us and we cited some examples about that where all of the UCaaS acquisitions are now on the network. And all the BSS and OSS systems have either been fully harmonized or are continuing to be harmonized. So it’s just a process that we’re going through that I’ve been very pleased with the results.
All right. Thank you. I’ll catch you after the call. I appreciate it.
Thank you. Our next question comes from Rick Valera with Needham & Company. Your line is open.
Thank you. Good morning, gentlemen. Just wanted to confirm that you’re reiterating all of the guidance, the 2016 guidance from last quarter. I heard you explicitly reiterate the EBITDA but just the other metrics that you gave last quarter.
The other two prongs of our guidance was consolidated revenue for the year, GAAP of 950 million to 960 million. That remains our range. And then combined business revenue of 365 million to 370 million, which remains as well. I would say on the business side there is probably some upside to that number given that in the case of Nexmo, we talked about GAAP revenue for our year under our ownership in the mid- to high-40s. We did close the deal a week to 10 days earlier than was embedded in that guidance, so we picked up a little bit of revenue there. There was $3.5 million reclass that will pick up about $3.5 million of additional revenue that was counted under Nexmo’s accounting as net, which we decided in consultation with BDO [ph] and their accountants should be counted as gross, but it will have an impact on gross margin percent but keep gross margin dollars the same, but add about $3.5 million of revenue to the second half. So if you think about mid- to high-40s and you add on those dollars, there’s some upside to the 365 million to 370 million in business.
So the first piece just to clarify, Dave, was the 8 million that you got in this quarter or not all of that 8 million?
Not all, but some of that 8 million was embedded in our guidance.
Yes, about a week to 10 days’ worth of the quarter was not in our guidance. So we picked up, call it 1 million to 2 million. And revenue was 7.67 million and we owned the company for exactly four weeks. So we picked up a little bit there and then the 3.5 on the reclass and then the business has been strong year-to-date.
Got it. I appreciate all that clarification, Dave. And Alan, just wanted to revisit the idea of the voice – your new voice API in North America and the ease with which you may be able to attract new customers to that. One I guess is the ease with which new customers could switch on it just from a sort of mechanical, technical standpoint? The other is your ability to sort of get to these customers and convince them to try your API. So can you discuss maybe the mechanics of, one, maybe the simplicity of actually them switching over to your API, which I think you’ve already hit on a little? But also how do you get to these prospective customers and convince them to try out your API?
Rick, let me ask Tony to take that.
Thank you, Alan. So building programmable voice is not something that has existed for 20 years. This is a new trend enabled by the API economy. But the existing programmable API in the market, today they use what you call the markup [ph] language programming approach that is easier for the developer but today, if you want to rebuild a new programmable voice API and build this on an even easier Web-based technology, like for instance [indiscernible]. And that lowers the barrier to entry for any developer even non-cell core, non-communication developer to be able to fill these programmable voice scenarios and use cases. And that’s why we lowered that barrier to entry. The second part of your question is how do we create that demand, and there’s really two ways of looking at it. The first one is around creating developer awareness and we’re accelerating our investment in that area. The second one is around a direct sales approach. We’re also accelerating our investment with the Vonage combined efforts around that in the next few quarters.
In addition that, I mentioned before the 350 sales resources within Vonage, it serves as a force multiplier for Nexmo. We’ve got this disproportionately strong presence among these sales resources in North America. Each of those sales people, whether they’re on the phone as an inside sales person or knocking on doors as a field sales person, has an opportunity to identify whether there is a CPaaS play with that particular customer. And as we mentioned, we’ve got 74,000 existing customers. So we see this opportunity as a force multiplier to be a very substantial one. [Indiscernible] is a higher quality solution because we compare it with our network and we have a lower cost structure, so that gives us additional flexibility as well.
Got it. And one just quick follow up, if I could. So do you plan to incentivize your existing Vonage business sales people with either a quota or some kind of spiff to motivate them to try to do some Nexmo sales?
Absolutely, and it’s already underway as well as training, so that – we have appointed services folks who are involved in upselling existing customers who get enterprise sales people. We’ve got sales engineers in addition to all the other folks that I mentioned. And so there’s a great deal of training there going on just to build that level of awareness and create lead sharing and then the related commissions inside the broader sales organization.
Great. Thanks very much for taking the questions, gentlemen.
Thank you. Our next question comes from Timothy Horan Oppenheimer & Co. Your line is open.
Thanks, guys. Just following up on that, can you give us a little bit more color how Nexmo compares to Twilio now and maybe where you might be a year from now? And how similar are the businesses? Thanks.
Let me ask Tony to take that as well.
Twilio is our direct competitor. We’re very similar from the services, the corporate to the customer and the broader development community. How we will be different in a year from now I think the biggest question on the table is brand awareness. Twilio has invested a large sum of VC capital in building their brand awareness in the U.S. market. Nexmo is a less known brand here. However, with the Vonage combination we can earn a substantial brand awareness additionally investing more in terms of building up our developer awareness and developed community in the U.S. going forward.
And maybe at the service level, are they better at some things than you are or vice-versa? How does the actual service compare?
Sure. So when you look at it from the component of what is important for the client, first and foremost what’s important is really the quality of the API and the developer experience. And this is where Twilio have invested a major amount of capital in building one of the best developer experience out there and we’re improving on that front going forward. However, the second part of the service when a customer is looking at it, is the quality of the communication itself. The developer communication [ph] is great when you’re starting as a developer but going forward as you run the service and you upgrade the service, you need to have a substantial global reach, and even have a sustained quality of communication. And this is where with our network specifically on the international side and our technology, we are able to provide a high quality of service from that point of view.
Great color and thank you.
Thank you. Our next question comes from Dmitry Netis with William Blair. Your line is open.
Great quarter gentlemen.
A couple of housekeeping questions and then just normal questions. On the housekeeping front, will we expect you to provide a breakout of Nexmo going forward? Will you be providing that?
So in August, we will be filing an 8-K as necessary by the SEC rules with pro formas for Nexmo. So you’ll see an income statement for Nexmo and a pro forma with Vonage through the first quarter of 2016. In our Q, you will see going forward in the next two Qs, Nexmo revenue, Nexmo net income. And then in the K you’ll see pro formas again for the year 2016 versus the year 2015. So there will be quite a bit of information out there just based on the legal filings that we need to make. In general, as it relates more to recording and KPIs, we’ll certainly be providing commentary on top of those numbers. We are – as we talked about, we’re running Nexmo increasingly every day as part of Vonage business. And so the general way we’re going to approach reporting, which we’re still working through, is on a combined basis. But there will be a good amount of Nexmo information out there on the standalone basis as well.
Okay, that’s great to hear. And then secondly, you mentioned Nexmo had a nice uptick on closure being a couple of days, 10 days earlier and there’s bit of an upside from a reclass as you look through the year. So given the guidance that was pretty much maintained, what does that tell us about the UCaaS side of the business, the regular sort of PBS cloud, PBX business? Can you comment a little bit on that and why – maybe you haven’t raised the guidance or maintain the guidance? What is the sort of ebbs and flows in that business then?
Sure. We hit our objectives – and Alan and Joe can comment more about the operations in the qualitative side. But we hit our objectives for the second quarter and there is no change in our guidance other than the Nexmo piece, which was two kind of mathematical additions plus a bit more of a tailwind than we thought.
Okay. Can you give us a bit of – can you calculate for us what the organic growth may have been for Vonage business, UCaaS side of Vonage business? So I’d assume the Simple Signal and Telesphere are probably grandfathered in at this point, but iCore was there. So if you exclude that, would there be growth in the VB side, excluding Nexmo?
So if you exclude iCore, growth in Vonage business, ex-Nexmo, was about 25% organic. Sorry, excluding Nexmo, it was 25. And if you include iCore, it was lower than that where it’s still an asset that we acquired at a very low price and are continuing to address the growth there.
Okay. So excluding iCore, 25, I got you. Okay. And then my last question would be probably on the gross margin side of things. Could you update us where the gross margins are on UCaaS side and where they are going sometime next year? What do you think you can get them to next year? I know you’re not commenting on Nexmo GMs at this point, but on a cloud CPaaS side, if you provide some color there, it would be great. And then also are we still expecting a breakeven out of Vonage business by, what, second half of '17 I think was kind of the expectation going in?
I’ll take the last part of that first. So yes, Vonage business will be breakeven or better at some point in 2017. That’s one. Two, gross margins in consumer and business did not change in the quarter. The consolidated gross margin was down simply because business is lower than the average and consumer is higher than the average, and business was a greater proportion of the revenue and of the margin. So that accounted for the decline as well as adding Nexmo into the mix, which has structurally lower gross margin but we believe we can start to address. I just want to be clear that in 2017 we expect Vonage – sitting here today – and we’re starting our budgeting process. But sitting here today we expect Vonage business with Nexmo to be profitable in 2017 on a full year basis. So it will crossover at some point in the year and be profitable for the year.
Thank you. Our next question comes from Mike Latimore with Northland Capital. Your line is open.
Great. Thanks a lot. So just on the UCaaS business, ex-Nexmo, so you said about 40% over 50 seats. Does that mean that the essentials is about 60% of total now or is that a different number?
Hi, Mike. It’s Alan. It doesn’t quite split out that way. Essentials sells far more small accounts than it does large accounts, but it will sell larger accounts. It’s simply based upon the feature set that a particular customer requires. But on balance – so generally that’s directionally accurate that in terms of number of accounts, the ones that are smaller than 50 are going to heavily weighted towards essentials and the ones greater than 50 are going to be heavily weighted towards premier.
And it is also fair to assume essentials is growing faster than that 25% rate you just mentioned?
It’s growing faster than premier on a consolidated basis. So if you combined everything in, essentials would be faster and premier would be slower. The essentials growth rate by itself is in the 20s.
Okay, got it. And then on kind of the distribution into the U.S. market for Nexmo, what is the general strategy about getting more presence among developers at this point, let’s say, and give a little more detail on that would be great?
Let me turn it over to Tony. We have over 130,000 developers but Tony should comment.
Sure. There’s two components to that. One is the developer awareness and the second is the developer experience. So the developer awareness is really around building the community. And in the community you can build it through offline events, developer events that you go to when you sponsor and you create [indiscernible]. And the online events is really to be present on the developer forums. So a developer asks questions and expect the support from API providers. That’s on the developer awareness. And the developer experience is really about does the developer have all the tools they need to start calling right away. Will the time for their first API call is shortened and this is really about the online experience, about the documentation, the sample call that we provide, the call libraries we provide, the SDK for a better mobile experience. So all this contributes to provide a better and optimal developer experience. And these two together, developer awareness and developer experience enable us to win as a developer.
Great. And just last is on acquisition strategy generally, you’re going to be busy obviously with Nexmo here but is there a possibility you would do another acquisition this year or it would be later? And then secondly, what would be sort of the top priority from an acquisition standpoint at this point?
Sure. It’s certainly possible. We feel like Nexmo was a unique asset, a number two player in a very high growth industry with the number three player very far behind Nexmo. So that was a priority and clearly the best use of our next $200 million. We still have financial flexibility and we continue to we believe see everything that’s coming out in the BroadSoft world and look at what’s relevant. So we don’t feel like we need to do anything or that anything is imminent, but we look at it now on a buy versus sell basis, if something were compelling and digestible on the BroadSoft side, we would certainly act on that. We also continue to look at things that are more technology and product enhancements but the main focus continues to be on the BroadSoft side and really a buy versus sell.
Thank you. Our next question comes from Michael Rollins with Citi. Your line is open.
Hi. Thanks for taking the question. Good morning. Just wanted to ask you just a little bit more about the gross sales. So if you had to look at how gross sales on the business side performed versus your expectation in volume and yield, if you could summarize that? And then as you look forward and you look at your dashboard of what’s going on with your business operations, can you share with us maybe a couple of key items on a dashboard that gives you the confidence that business revenue growth came through from the second quarter levels? Thanks.
Hi, Mike. It’s Alan, let me start and I’ll turn it over to Joe. The key thing you deal with on volume and yield from a sales point of view is you have to think about the maturity of our channels. So inside sales, which we’ve owned for the longest period of time and is more a digital region and is tied – when the brand has been immediately helpful, that’s far more optimized. It’s an easier business to run. We’ve owned it a lot longer. And it matches the normal sales motion of what we have done from so many years in consumer. On the outside sales side, it’s all about – it’s really a cohort analysis of our sales people. And we track that one to four months of experience, five to nine and greater than 10 months of experience because as those sales people come up to ramp, we don’t even expect full quota for the first four months of them being with us. And the challenge right now – it’s not really a challenge, it’s sort of state of play, it’s the least mature channel and the cohort is more heavily weighted on the immature end of the cohort analysis. So what gives us bullishness is that those sales teams are ramping and will become more and more mature over time. Now, of course, we’re adding more markets and we’ve identified five markets we’ve opened in the first half of the year and expect to do three more by the end of the year. So we’re still ramping very quickly but that’s the way we track this and we have very, very good instrumentation about what a sales person in a particular cohort, what their productivity is and what we expect to do as they get into the next cohort. Joe?
This is Joe. Alan did a great job explaining it. It’s really the aging of our sales team and the productivity improvement. So the markets we’ve added this year were predominately in the second quarter. So you’re talking about when you have eight new markets with six months of ramp, it’s very immaterial in terms of the productivity you see in years. So it’s really a '17 efficiency play there. So we continue to invest aggressively and we’ll also look at new markets as we go into '17. So we are seeing – we hit our numbers in Q2, we felt good about that. We think we have a strong pipeline and I think as we scale these sales channels, we’ll see improved productivity.
Thanks very much.
Thank you. There are no further questions in the queue. I’d like to turn the call back to Hunter for any closing remarks.
Okay. Thanks, Catherine. Thank you everyone for joining today. We look forward to speaking throughout the quarter and again next quarter on the call. Thank you.
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone, have a great day.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!