Vonage Holdings Corp.
Q4 2016 Earnings Call Transcript

Published: 14 Feb 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Vonage Holdings' Fourth Quarter and Full-Year 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 be given at that time. As a reminder, this conference is being recorded. I would now like to hand the floor over to Hunter Blankenbaker, Vice President of Investor Relations. Please go ahead.

[Hunter Blankenbaker:]

Okay, great. Thanks, Karen. Good morning and welcome to our fourth quarter and year end 2016 earnings conference call. Speaking on our call this morning will be Alan Masarek, Chief Executive Officer; and Dave Pearson, CFO. Also joining us are Joe Redling, our Chief Operating Officer and Tony Jamous, President of Nexmo. Alan will discuss our strategy, full-year, and fourth quarter results, and Dave will provide a more detailed view on our full-year and fourth quarter financial results as well as our 2017 guidance. Slides that accompany today’s discussion are available on the IR Web site. At the conclusion of our prepared remarks, we’ll 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 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 making -- we will be referring to non-GAAP financial measures. A reconciliation to GAAP is available in the fourth quarter earnings press release or the fourth quarter earnings slides posted to the IR Web site. With that, I will turn the call over to Alan.

[Alan Masarek:]

Thanks, Hunter. Good morning, everyone, and thanks for joining us. 2016 was a pivotal year for Vonage. We’ve established the foundation for long-term growth and leadership in cloud communications. Three key strengths that’s driven our success. First, our ability to leverage corporate assets from our consumer segment including our highly aware brand, strong cash flows and the scale of the Vonage voice network. These assets have propelled our transformation. Second, our ability to acquire great companies at attractive prices and grow them organically. And third, our ability to create a unique value proposition to drive better outcomes for our business customers. We are going to use slides today to accompany our remarks. So please let's move to Slide 3 to discuss 2016 highlights. Our team continues to deliver strong operational and financial results. We grew consolidated revenues to $956 million, a 7% increase in our third consecutive year of topline growth. For Vonage business, revenues increased 72% year-over-year. Adjusted OIBDA was $160 million, an 11% increase. We completed the acquisition of Nexmo, which continues to grow rapidly achieving 46% pro forma year-over-year annual revenue growth. Even more important than a strong revenue growth, Nexmo expands our capabilities by combining UCaaS and CPaaS into an integrated solution, which gives Vonage the right set of assets necessary to win in cloud communications. In addition to our product investments, we also used our strong cash flows to invest further in our growth, including significant investments in our sales infrastructure. We also strengthened our Board with the addition of two new Directors with substantial B2B experience. Gary Steele, CEO of Proofpoint and Hamid Akhavan, the former CEO of Unify and former CEO of T-Mobile. Lastly, as was press released this morning, we are partnering with Amazon Web Services to combine our UCaaS products with Amazon's new collaboration suite named Amazon Chime to provide unmatched productivity to business use. I will provide more on the Amazon deal in a moment. But let's first move to Slide 4 to discuss our most important strategic initiative, which is the continued build out of our product offerings to enhance our customer value proposition and to drive growth. With the acquisition of Nexmo, now known as The Vonage API platform, customers can choose between two service delivery options for their communication needs. They can buy Vonage as a UCaaS subscription or they can access our Vonage API platform and consume our cloud communication services as programmable modules delivered via software APIs. When combined with our ability to tie into other cloud-based workplace tools like CRM and productivity, Vonage integrates the entire business communications value chain. From employee communications that maximize productivity to the direct engagement with customers that CPaaS provide. When combined with MPLS network as well as voice services over customers own broadband networks via our SmartWAN solutions. We create a truly differentiated offering that strengthens relationships with our customers. As I reflect back on the year, I'm proud of our teams accomplishments. We’ve assembled the most comprehensive product offering in the cloud communications market and we continue to build a team capable of executing on our enormous opportunity. Now let's move to Slide 5, to discuss Vonage business. This year we significantly built out sales infrastructure and distribution channels. We ended 2016 with field sales offices in 12 markets. We expect to open nine more cities in 2017, bringing our total to 21 markets. We recently hired Kenny Wyatt, formerly President of Business Solutions with CenturyLink as our Chief Revenue Officer. Kenny brings a wealth of experience in enterprise communications, sales, and operations, and will benefit from Kenny's deep, omni-channel sales experience for customer segments ranging from SMB to larger enterprise. Vonage business had a strong quarter of revenue growth. We delivered Q4 revenues of $111 million, a 56% year-over-year increase. Vonage business accounted for 45% of consolidated revenues in the quarter and we expect business revenues to overtake consumer revenues this year. Now let’s move to Slide 6, let me highlight several fourth quarter accomplishments within our UCaaS family of products. First, as I mentioned, we entered into a strategic partnership with Amazon Web Services that was announced via AWS press release this morning. AWS launched Amazon Chime, their web conferencing and collaboration suite that provides audio conferencing, video collaboration services. Vonage is AWS's UCaaS launch partner for Amazon Chime. Our partnership with AWS is industry shaping, because the integration of our UCaaS solutions with Amazon's collaboration tools brings unmatched productivity to business users. We believe AWS chose us as its UCaaS partner, because our leadership in cloud voice communications matches well with Amazon's leadership in cloud services. The bundled Vonage plus Amazon Chime product offerings will be available late in Q2. Vonage will sell the bundle offering through our sales channels and Amazon will sell the bundle through its web assets. Moving to Slide 7, our enterprise sales team won PartyCity, the world's largest supplier of decorated party goods. PartyCity selected us for their 3,500 users across 900 locations replacing their incumbent cloud provider because of our ability to unify all their stores on one hosted cloud platform, guaranteeing QoS with Vonage's SmartWAN solution over broadband as well as our MPLS network. Our channel sales team have secured a new contract with Telarus, one of the largest master agents in the U.S., in which Vonage was selected as the supplier of UCaaS services to one of the largest public property-casualty insurance companies in the U.S. And finally, we continue to see good growth from existing customers, one of the best examples is WeWork, which added more than 1,000 seats in Q4 bringing the total to 9,000 seats across the U.S., Canada, Germany, and the U.K. Now let's turn to Nexmo, The Vonage API platform on Slide 8 where the team also delivered strong results. In Q4, Vonage API platform revenues were $27 million, a 43% year-over-year increase. We continue to build on the momentum of our merger with Nexmo and our combined teams are delivering across three key initiatives. First, we expanded our portfolio of voice API with substantial increases in functionality. Second, we significantly increased our distribution footprint by aggressively entering the U.S market, leveraging the strength of the Vonage sales force and voice network advantages, revenue from US-based customers increased 24% sequentially in the quarter. Third, we meaningfully increased the brand awareness of the Vonage API platform. In fact, by increasing investments in digital marketing and developer relations and by leveraging the strength of the Vonage brand, we significantly increased our number of registered developers to 207,000. We’ve also seen excellent growth from existing Nexmo customers. Notable among these, Nexmo has had a relationship with Amazon Web Services that predates our Amazon Chime deal. For AWS Nexmo enables the delivery of SMS messages as part of AWS's simple notification service. In Q4, messages delivered on behalf of AWS increased 73% sequentially. Regarding VAPI, which is our Voice API, we’re seeing strong traction and the sales pipeline in the U.S is much higher than any other markets, because of our marketing efforts and lead sharing between salesforces. We also delivered more VAPI functionality during the quarter by adding direct support for Web sites. In Q4, IBM Watson used WebSocket support in our voice API and delivered voice-enabled experiences through their Watson Artificial intelligence applications. Finally, on Slide 9. You can see how our strategy comes together by integrating the entire business communications value chain. We integrate customer facing communications via CPaaS and to employee communications via UCaaS into the other cloud-based workplace tools such as CRM productivity. We are seeing early success from customers who are choosing Vonage, because we offer both CPaaS and UCaaS solutions. For example, Electronic Restoration Services selected Vonage for their 250 seats UCaaS deployment and they’re also using our SMS APIs to enable contextual communications with their customers to improve customer engagement. We've also added CPaaS solutions to an existing 1,000 seats UCaaS customer, which has resulted in improved workforce management. I cite these examples, because combining our UCaaS and CPaaS solutions has meaningfully improved our customer conversations in ways our competitors will struggle to match. Lastly, let me review our results in our consumer segment, where we continue to execute well. Revenue was a $136 million, a 14% decline and in line with our expectations. We ended the quarter with 1.7 million subscribers, 78% of which are tenured, meaning they’ve been with us for more than two years. For the full-year of 2016, churn was 2.2%, which is in historic low. These results continue to highlight the consumer segment cash flow generating ability, while the segment concurrently delivers us massive voice scale which enables direct peering with major carriers. These peering relationships give us quality and cost advantages over the competition that translate into our UCaaS and CPaaS product lines, particularly for our rollout of our voice API in the U.S. To summarize, we had a very strong 2016 and we’re well positioned for 2017. Our sales infrastructure, solutions set and brand building we accomplished last year, serve as the base in a multiyear growth opportunity, and we expect 2017 financial performance to reflect our focus on strong service revenue growth in Vonage business and continue harvesting of cash flow from consumer. I am truly excited about our vision and the assets we've assembled to fulfill it. In just three years we built the largest revenue base in cloud communications as compared to our pure play competitors and I believe the most strategic product offering by integrating our UCaaS and CPaaS solutions. While we’ve accomplished much, there is more to do to realize our full potential. And it's incredibly energizing to think about all the opportunity that remains in front of us. Thanks again for your support. Now, I will turn the call to Dave for more detail on our financial results and 2017 guidance.

[Dave Pearson:]

Thanks, Alan and good morning everyone. 2016 was the year in which we achieved our financial goals of producing record revenue strong cash flow, while funding organic growth and strategic acquisitions. Before we review the results for the fourth quarter and full-year 2016, I’d like to discuss the additional information we will be reporting starting today both for the year 2016 and going forward. As noted on Page 10, consistent with Vonage's continued transformation into a leader in business cloud communications, we’re providing more visibility into financial trends in the business and consumer segments. For each of consumer and business, which represents our UCaaS and CPaaS product offerings we will report both revenue and cost of service, each broken down by type. We believe this additional information in conjunction with our other KPIs will provide greater transparency into our progress and insights into our execution in each segment. As in the past, I would also like to note that the 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 11. Consolidated revenue for the fourth quarter was $247 million, up $17 million or 7% due to organic business growth and the addition of Nexmo. For the full-year, consolidated revenue was $956 million, also up 7%. The increase was due to substantially higher business revenue, partially offset by planned reductions in consumer revenue. Moving to Slide 12. Let me now turn to our segment financial results for the fourth quarter starting with Vonage business, which consist of our UCaaS and CPaaS products. Segment results can be found in table 2 of our press release. We're now providing the following business revenue and direct cost metrics. Service, product, which consists of customer premise equipment, broadband access and MPLS, professional services and shipping and handling and contributions to the Universal Service Fund or USF which are a pass through. Vonage business total revenue was $111 million, a 56% increase. Of this, $84 million was UCaaS, which grew 18% organically and $27 million was CPaaS, which grew 43% organically or pro forma. UCaaS revenue in the quarter was impacted by several one-timers, including SLA credits and bad debt write-offs. 4Q is a seasonally high quarter for CPaaS and certain corporate customers are on special holiday campaigns. Service revenue, which includes all UCaaS and CPaaS revenue grew 69% to $92 million. Service margin during the fourth quarter was 58%, down from 73%. This decline in service margin is due entirely to the acquisition of Nexmo as The API product currently has lower gross margins. For the full-year, Vonage business revenue was $376 million, a 72% increase. Service revenue was $302 million, up 77% reflecting significant organic growth in UCaaS and the June 6 acquisition and subsequent organic growth of Nexmo. Fourth quarter average UCaaS revenue per seat was $44.65, flat from $44.79 a year-ago. Revenue churn was 1.4%, flat sequentially and up from 1.1% in the year ago quarter. Vonage business grew total seats to 638,000, up 18% reflecting strong organic growth. As Alan noted, CPaaS registered developers increased dramatically in 4Q to 207,000. Moving to Slide 13, we’re now providing the following consumer revenue and direct cost metrics. Service, product, which consists primarily of VOIP routers provided to new customers and USF. Total consumer revenue for the fourth quarter was $136 million, down 14%. For the full-year, total consumer revenue was $579 million, also down 14% both consistent with our expectations. Consumer service margin for the fourth quarter and the year 2016 was 81%, reflecting our ability to hold margins relatively stable despite a declining topline. Consumer customer churn for the fourth quarter was 2.2% consistent with the prior and year-ago quarters. We expect churn to continue to fluctuate based on seasonal and competitive factors, but to stay in this general range. Consumer average revenue per line in 4Q is $26.11, down from $26.93 year-over-year due to lower USF, which is a pass-through. Turning to Slide 14, let me now build up to adjusted OIBDA. Consolidated sales and marketing expense for the fourth quarter was $84 million, down $6 million. This decline reflects the continued shift to more efficient media channels and from marketing to sales. For the full-year, sales and marketing was down $17 million, reflecting much more efficient media spend, partially offset by significant investments in salesforce headcount across all sales channels. General and administrative expense for the fourth quarter were $34 million, up $4 million. Full-year G&A was $123 million, up $14 million. This increase reflects the addition of Nexmo and in the case of the full-year Nexmo acquisition related costs. Fourth quarter adjusted OIBDA was $37 million, up $3 million. Full-year adjusted OIBDA was $160 million, up 11%. Adjusted net income for the quarter was $7 million, or $0.03 per share, down $1 million. Full-year adjusted net income was $45 million or $0.21 per share, up 15% from $39 million or $0.18 per share in the prior year. The adjusted net income metric removes non-cash items such as amortization of intangibles from acquired companies and acquisition related items. We also recorded an adjustment to income taxes related to these exclusions. Turning ahead to Slide 16, CapEx for the quarter was $9 million. For the year, CapEx was $38 million, net of reimbursable headquarters improvements up from $34 million. This year we advanced or completed several important capital projects including consolidating down to four key U.S data centers, including our central data center at our New Jersey headquarters and building certain field sales offices as well as deploying success based capital into Broadworks licenses and CPE. Free cash flow which we define as net cash provided by operating activities minus capital expenditures and acquisition and development of software assets was $13 million in the fourth quarter, down from $32 million due to a $15 million prepayment to acquire a long-term hosting capacity at advantageous pricing and other working capital uses. Free cash flow for the year was $49 million, down from $96 million reflecting the previously mentioned prepayment and other working capital uses. Adjusted OIBDA minus CapEx was $28 million in the fourth quarter, up $8 million or 42% and $122 million for 2016, up $13 million or 12%. In 2016, we returned $33 million to shareholders through our buyback program repurchasing 7.4 million shares at the highly accretive average price of $4.43 per share. This represents one-third of our four year $100 million authorization, which we're halfway through after two years of execution. Since beginning the repurchase of stock in August 2012, we’ve bought back 56 million shares of Vonage stock for $181 million, the highly accretive average price of $3.26. our buyback has provided strong returns for shareholders and it continues to be one of the components of our capital allocation plan to be deployed at management's discretion. Cash, cash equivalents and marketable securities as of December 31 were $32 million. The data center capacity and other cash prepayments totaling over $17 million sit on the balance sheet as prepaid expenses until the service is utilized. In addition, we made a $1 million phone sale associated with a pending enterprise customer contract which sits in deferred revenue and will be recognized as revenue in the future. Taking all of these items into account, net debt was $294 million and we ended the quarter with net debt to trailing adjusted OIBDA of 1.8x. The $450 million credit facility we put in place in the middle of 2016 continue to provide significant committed borrowing capacity. Moving on to guidance on Slide 17, our expectations for the full-year 2017 are as follows

[Hunter Blankenbaker:]

Okay, great. Thank you, Dave. Karen, let's please turn it over to the Q&A session.

[Operator:]

Certainly. [Operator Instructions] Our first question for today comes from the line of George Sutton from Craig-Hallum.

[George Sutton:]

Thank you. And Dave, I appreciate the additional disclosures. So, Alan, you -- for the first time at least that I’ve heard you say this, you’re starting to talk about UCaaS and CPaaS as sort of an either/or model and some of the discussions you’re having with customers are driven by that. Can you go into a little more detail on that? In another words, are you literally coming and saying we got this or this and we can be very flexible in terms of how we set you up? Is that effectively what you're saying?

[Alan Masarek:]

George, no its not. It's actually not an either/or. What I was trying to say that they are very complementary, and so when you go into a customer, they generally require both. All customers are communicating to their customers, of course, and also looking to bring their employee based communications to the cloud, their PBX system to the cloud. So what we’re finding is it's just changing the customer conversation. So there is an opportunity to syllable. That was really the rationale for when we bought Nexmo was that you saw this convergence between the need to link external customer facing communications with the internal employee based communications. So it's really not an either/or, it's both, but you can get the lead from one or the other, of course.

[George Sutton:]

Got you. Okay. I just want to make sure I understood that. And then, as my follow-up I will migrate over to Amazon and just give us a better sense in terms of being a launch partner, what sort of resource dedication do you have to them? What sort of resource dedication did they have to you? My assumption is you will be reselling their services, I don't believe they will be reselling your services, but I just want to be clear about that.

[Alan Masarek:]

It’s a shared deal. They'll be reselling the bundle, they will be, excuse me, selling the bundle through their web assets, while we will be selling the bundle as well through all of our channels. So it really is one plus one equals three proposition.

[George Sutton:]

Perfect. Okay. Thanks, guys.

[Operator:]

Thank you. And our next question comes from the line of Rich Valera from Needham & Company.

[Richard Valera:]

Thank you. I just wonder if you could give a little more color on the growth expectations for the respective parts of the business segment, particularly Nexmo and UCaaS, and maybe relate them to the fourth quarter growth rates? I think they were 43% and 18% respectively, but how do we expect those to trend into '17?

[Dave Pearson:]

Hi, Rich. Its Dave. So, first of all, we’re thinking about this, we’re in a very dynamic and competitive market and we're thinking about increasingly CPaaS and UCaaS as one business across which we’re dynamically able to allocate capital. That being said, as we sit here today, CPaaS looks like a mid 30% organic grower and UCaaS looks like a mid teen percent organic grower. On UCaaS service revenue will actually grow a bit faster, mid to high teens. As I mentioned in my script, it will be a bit less access and a bit less product and service which is MMR is what we’re focused on.

[Richard Valera:]

I know you mentioned Dave, that you were going to deploy access more selectively in '17. Why is that?

[Dave Pearson:]

Sure. Yes, it's not about withholding it in any way. It's really about the fact that the salesforce now has Essentials and Premier as kind of both products, the pure over the top products and the fully integrated QoS product in their sales bag across the sales channels. And so where it fits for a customer and they don't need QoS, we’ve got the ability to sell them Essentials, we’ve also in some cases have the ability to sell the Premier product over the top or without QoS. So it's simply making sure that the -- that it’s the right application for access, because there is cost that comes along with that. But we continue to believe in the right circumstances that it is the right product and especially in the Enterprise where people are very concerned about quality you’re still going to see access.

[Alan Masarek:]

I will just add one follow-up to that. It's our SmartWAN tools which is SD WAN software-defined wide area networking, we branded as SmartWAN, let's us provide QoS even in a broadband situation. So, it's less necessary at times to pull the private circuit in that office to have a dedicated voice line SmartWAN can handle that. Now, in certain situations you to pull the private circuit when others you can provide QoS via SmartWAN. So you sort of think about the gradations of delivery, you go from sheer over the top, up the SmartWAN delivery, up further to leading -- to actually pull a private circuit and sell access. And because of the growth in SmartWAN, we’re seeing a lot of success and that’s really why you’re going to see less sale of that or a slower growth in access.

[Richard Valera:]

Got it. Thanks for that clarification.

[Operator:]

Thank you. And our next question comes from the line of Catharine Trebnick from Dougherty.

[Catharine Trebnick:]

Hi, guys. Thanks for taking my question. Can you just give us a little bit more background on what percentage of revenue you expect Amazon Chime could be by the end of 2017 for modeling purposes? Thanks.

[Alan Masarek:]

Hey, Catharine. Its Alan. I can't give you a percentage. The product we expect will release the end of Q2 and we're going to initially distributed to our base of customers as a -- an added element of functionality for free. And then they'll be selling and Amazon will be selling it through their web assets where they become a distribution channel for us. We're very excited about the prospect, but we don't know how successful it's going to be. So we can't provide a percentage, if you will, in terms of how significant it's going to be, but this is a important strategic relationship.

[Catharine Trebnick:]

And then in addition to them, how much of Nexmo might be folded into the Amazon Chime opportunity going forward?

[Alan Masarek:]

It's really not a Nexmo issue relative to the Chime situation. The Chime is a marriage between the UCaaS solution and the Chime -- audio conferencing, video and collaboration system. We separately have a lot of business through Nexmo with Amazon Web Services. I mentioned on the call, AWS has as one of their products, their simple notification service where we provide the SMS delivery for them. That is growing substantially. As I mentioned, that was up -- the volume of messages was up 73% sequentially in the quarter.

[Catharine Trebnick:]

All right. Thank you, Alan. I will catch you guys on the post call. Bye, bye.

[Alan Masarek:]

Thanks, Catharine.

[Operator:]

Thank you. And our next question comes from the line of Dmitry Netis from William Blair.

[Dmitry Netis:]

Can you guys hear me?

[Alan Masarek:]

Yes.

[Dmitry Netis:]

Okay. Thank you. Couple of questions. I joined a little bit late, so I apologize if I’m being repetitive. But for Nexmo, what are you guys projecting in 2017? The Street was baking in $124 million, I’m wondering are you still in that range lower or higher, and whether you’re going to continue to report? It sounds like maybe not, since you’re talking about unifying UCaaS and CPaaS into one reporting segment, but it doesn’t look like Nexmo will be split up going forward. Is that correct?

[Dave Pearson:]

So the plan is to report the way we reported today, which is business as one segment and increasingly where we’ve put the two operations together. We will be giving color from a product perspective on CPaaS and UCaaS where it's relevant. We did answer before a question on CPaaS growth and we said it was going to be on an organic basis, so pro forma if we owned it for all of 2016, it will grow in the mid 30s. The implication there, as you recall when we bought it, we said that we thought it would do in 2017, because we’re buying it at 2x between a $115 million and $125 million of revenue in 2017. The mid 30s implies the very upper end of that guidance.

[Dmitry Netis:]

Got it. Okay, Dave. Thanks. And then, just in general, and if I take that comment, roll that into your guidance for 2017 and look where UCaaS is shaping [ph] out, consumer slightly down from what the Street has been predicting as well, I don’t think you will be penalized too much for that, given sort of the trajectory of that business there. But the expectation has been for both Vonage business, UCaaS side of the business there as well as Nexmo to reaccelerate in terms of organic growth going into '17. So is there anywhere along the line maybe second half that you would feel now that you got that guidance? I don’t want to put words in your mouth, do you feel that’s a conservative guide, to give you a little bit of room to outperform those numbers going through the year and show that growth that you’ve outlined last year?

[Alan Masarek:]

I think we put together and communicated an achievable plan and throughout the year we did a lot of building in 2016, we still had building to do in 2017 and we got a new CRO and we feel very, very good about that. So we will be updating as we go, but there is certainly that opportunity.

[Dmitry Netis:]

Okay, great. And then a couple more, on the -- looking at the EPS missing by about two penny here, that’s entirely due to taxes? It seems like, but maybe I'm missing something, but if you could comment on that, Dave. And then that the prepayment that you mentioned that affected your free cash flow. Can you walk me over that one, once again and whether that’s still going to recur or is that one-time thing that …

[Dave Pearson:]

Sure.

[Dmitry Netis:]

… you expect to recur in '17 timeframe?

[Dave Pearson:]

So yes, on net income, that difference is tax, is GAAP taxes. And just in general, net income has a lot of noise in it right now, because we made acquisitions, so we’ve amortization. We also have payments. As you recall, a portion of the considerations in Nexmo employees, and they owned a big part of the company, vests over the course of the year as an incentive tool, so that’s also in G&A and net income. As it relates to the prepayments, this was for a hosting capacity and several other products that we're able to acquire the services in bulk. We do not expect that'll be a regular occurrence and for instance this hosting capacity, it’s the amount which we pre-purchased is counted in years, not months. So I would not expect those types of payments occur on a regular basis and that will be bled off of the balance sheet into our operating cost as they’re consumed.

[Operator:]

Thank you. And our next question comes from the line of Greg Burns from Sidoti.

[Gregory Burns:]

Good morning. When we look at the EBITDA guidance for 2017, is more than 100% of that still coming from consumer or are we -- can we read or is the business segment is going to be a break even for 2017 or still at a little loss? Could you give us a little more color on the complexion of that EBITDA guidance?

[Dave Pearson:]

Yes. So, first of all, yes, we can. We are a functional organization and you know we are able to segment from a gross margin perspective it's much more difficult to pull apart below that and get to OIBDA. But if you use some simplified allocation assumptions, obviously you have a lot of cash flow coming from consumer, you’re going to be around breakeven in business, and you’re going to be investing in Nexmo. Those are the three components that go into the 165.

[Gregory Burns:]

Okay. So business ex Nexmo, UCaaS is about at a breakeven and Nexmo's …?

[Dave Pearson:]

Yes, breakeven to positive in UCaaS.

[Gregory Burns:]

Okay.

[Dave Pearson:]

Investment in Nexmo and highly positive in consumer.

[Gregory Burns:]

Okay. And then, I just wanted to dig in on the slowdown in the UCaaS growth. I guess, this quarter there was some items impacting it. Could you just touch on those items again? And then, just looking into 2017, is it something you are proactively doing, where we’re only going to see kind of a mid to high teens type growth as opposed to kind of what we saw in 2016, or is it just scale or market related issues that are kind of weighing on the growth number for next year?

[Dave Pearson:]

Sure. So just to unpack the numbers, and then Alan can comment on this as well. If you look just -- if you go to table 2 in the press release, and you look at service revenue versus product revenue, you will actually -- in business, and you take out Nexmo which is the revenue of which is footnoted, you will actually see this product revenue that went down in the quarter. If you look at service revenue, it's actually up $2.6 million just in UCaaS in the quarter to that $2.6 million of organic growth you add service credits, which were $300,000 to $400,000 elevated in the fourth quarter, so you then got a quarter that has $3 million of service growth and did not benefit from some one-timers that we had in 3Q, which included a USF increase which is not in service, but it's in total and some other equalization of fees. So when you put that altogether, we actually had a strong organic growth quarter in UCaaS. The other component that is working against, that you’re seeing in product is bad debt on equipment. So we had about $300,000 there, but that cost a $600,000 swing because that $300,000 was -- it was $300,000 higher in 3Q and it should have been and we took that out of 4Q, so that actually made a $600,000 swing there. In addition, on equipment, we are increasingly moving to a rental model, so you’re taking money out of in quarter and you’re spreading it over subsequent quarter. So you can -- really a lot of the difference relative to expectations within product for the reasons that I cited. In terms of long-term growth and growth for the year, really goes back to what we said before, which is we believe this is an achievable plan that reflects a fully built machine at the low-end -- at the lower end of the market where we're absolutely doing everything we can and feel like we have a very, very strong position in that market and then continues to build out and continued execution of the longer sales cycles at the midmarket and particularly in the enterprise.

[Operator:]

Thank you. And our next question comes from the line of Tim Horan from Oppenheimer.

[Tim Horan:]

Thank, guys. Can you give us more color on the Amazon relationship? Are they actually going to be using you for voice services, are they reselling your voice network? And the $15 price point that they have, is that kind of embedded with your service in that new product, the churn product? Thanks.

[Alan Masarek:]

Hey, Tim. Its Alan. So they -- I mentioned before to an earlier question, they will sell our product, our UCaaS solution bundled with Chime on their web assets. What we’re doing is we’re taking their premium Chime and providing it free to our base and the -- as just a value adder. The opportunity is for us to then take a product that they sell at their premium at $15 and we can then go to our base and say here is this amount of value that is provided at no additional cost.

[Tim Horan:]

So would your voice capabilities embedded with Chime, how much are they going to be charging for that?

[Alan Masarek:]

We will not -- well, they will be charging what we charge in effect, because they’re not going to -- we cannot obviously have them create channel conflict in the sale of our products. So that’s all been addressed in the deal and this has been a relationship, it's been underway for very long, it's been in the works for a very long period of time, they actually have an incentive to sell our product as well as a distribution channel for us.

[Tim Horan:]

So your product embedded with Chime, what do you think they’re going to be charging for that?

[Joe Redling:]

It will be our -- this is Joe, it will be our standard pricing. We are actually their UCaaS provider in their web assets. So those links will come into our channel and we will be pricing that based on the number of seats just like we did today in our own channel. So we control the pricing of the entire process.

[Tim Horan:]

Okay. Are they your customers or Amazon's customers, who chose then?

[Joe Redling:]

They’re our customers.

[Tim Horan:]

Okay. Sorry, that makes a lot more sense. And is this going to be more of a global offering or is it more U.S based?

[Joe Redling:]

U.S based.

[Operator:]

Thank you. And our next question comes from the line of Mike Latimore from Northland Capital Markets.

[Michael Latimore:]

Hey, guys. Thanks a lot. On the UCaaS business, is it -- should we assume Essentials and Premier growth at a similar rate, or do you think one will clearly grow faster than the other in '17?

[Alan Masarek:]

I think it's fairly even. Clearly there's a lot less friction at the lower end and so that is a positive for Essentials and historically it has grown faster. At the same time, our data and our experience shows that the upper end of the market is actually growing faster now to just the TAM and the adoption because it's earlier. So those two things are cancelling each other out for the year at a high-level.

[Michael Latimore:]

Got it. And then, again with regard to Amazon Chime, do you think that offering is more attractive to the Essentials or Premier base? And also, I mean, you guys already have conferencing [ph] applications. So I guess, if a customer wants to have the conferencing feature, how do you sort of position Chime versus what you already have?

[Alan Masarek:]

Yes, Mike. So, obviously the collaboration suite, this productivity suite is pretty compelling. We think it's you really got to get above 10, 20 seats for this type of suite, so what we’re excited about is across both our platforms, whether it's Essentials or Premier, this is an option we think will be very attractive to the customer base. So on the Essential side we believe that helps us to move up market to a 10 plus 20 plus seat through our inside sales channel that is filling a collaboration suite void we had before. So we think that’s a very positive thing for us on that side. We do have collaboration features through our Premier offering, but either one of those will be up to the customer's choice to choose. So it gives us both a much richer feature set for what I would call the small to mid, which is 10, 20, 30, 40 seats that we can put across all our channel. So it gives us advantages across all.

[Michael Latimore:]

Yes, okay. Thanks.

[Operator:]

Thank you. And our next question comes from the line of Will Power from Baird.

[William Power:]

Great. Thanks. Just a couple of questions. I know you’ve gotten asked this a couple of times, but just thinking about the UCaaS market, some of your competitors have been talking about accelerating growth in the mid market and enterprise. It sounds like you’re seeing that to a degree, but you’re not perhaps manifested to the same degree on the revenue growth outlook for 2017. So, I was just trying to understand, is there anything new competitively from Skype or others or some of your other competitors? And, again, just trying to -- just parse the growth rate expectations for '17, versus what you’ve had here over the last one to two years?

[Alan Masarek:]

No, we’ve not seen a change in the competitive landscape, make clearly as I’ve just noted the mid market in enterprise is -- has lower penetration and therefore it is growing faster. The competition there is intense. It is more intense than it is at the lower end, but it hasn’t increased or decreased as of late. I would say that our model is one that where we’ve been very focused on building a balanced set of sales channels. I think you’ve seen various competitors swing very hard away from direct and towards channel. We’ve been doing a lot of state work to make sure that we're very balanced across that and I think that that takes a little bit more time, but I think it will put us in very good stead in terms of the infrastructure. The other thing is that we mentioned it a little bit before, but that lot of enterprises the key for them to go to the cloud is having that QoS, because they’re just not willing to be over the top. And so, we think that is the approach that we offer at the high-end with Premier. At the same time, those entities that want QoS also tend to have a longer sales cycle and when you are offering access and that type of service delivery, which these companies want, you also have a longer install cycle. So you’re just seeing that in the numbers and I think that help to explain the difference.

[William Power:]

Okay. And then, maybe just quickly on the buyback from here, what’s the key driver? What kind of underpins, the plans to utilize the rest of that timing or magnitude as you look over the next 12 to 24 months?

[Dave Pearson:]

Sure. So the Board authorized two years ago $100 million and we intend to execute that $100 million buyback. We, after two years we're at exactly halfway through it, we're exactly -- we bought almost exactly half the amount of stock. So we intend to continue to execute that. I think for the last several quarters we reached up and bought Nexmo, which was an irreplaceable asset and used cash to do it. We decided that the strategic flexibility was important and we wanted to use some of that capital to deleverage over the last couple of quarters, and also have the flexibility to do what we did back in May when the stock hold back we acquired well over $20 million of stock in a two weeks period not only providing -- I think a very good backstop to investors, but also just making some highly accretive trades. We want to continue to have that ability, we want to continue to delever, so really it’s a question of balancing those things. But we fully intend to execute on the $100 million and two years from now, be finished with the program.

[Operator:]

Thank you. And our next question comes from the line of Adam Ilkowitz from Citi.

[Adam Ilkowitz:]

Hi. Thanks for taking the question. I was wondering -- you were talking about the costs and the investments being made to Nexmo. If we look at your service revenue margin in business as you reported, how would we look at just the UCaaS side of the business? Do you feel you are at a margin that is similar to a peer level, or your consumer business or if not, how long would it take to get there? And is the question more about scale, or is it about something else? Thank you.

[Alan Masarek:]

Sure. So you we are -- you get a sense of what service margin is without Nexmo when you look back to the fourth quarter of last year, that’s the UCaaS business by itself, although its improved since then just with bigger scale. And Nexmo, we talked about and with Nexmo service margin and gross margin are the same, because there is no USF and there is no product or service delivery or anything like that. We made a filing over the summer which after the acquisition, which talk specifically about Nexmo gross margin and service margin and that right now during this land grab [ph] phase is in the 20% area. We think that there is near and medium-term upside to those numbers. But clearly during this land grab, we’re trying to optimize adoption of the APIs and repositioning Nexmo or diversifying Nexmo into other markets and in particular U.S voice. That has the benefits of greater -- of a longer tail of customers, greater diversity in customers, but it also happens to be where the higher margin is -- voice is, it’s a higher-margin product, U.S is a higher-margin market. And for us in U.S voice that’s where we really get the advantages of our network, which is where I think there's is a good amount of margin accretion. So as that mix shift occurs towards U.S voice and its going to take time, because we’re still growing on the international SMS side as well, and we get the benefits of scale, you’re going to start to see that gross margin or service margin go up.

[Adam Ilkowitz:]

And just one final one, you mentioned on the slides, in talking about your own remarks about having financial flexibility, and you talked about the buyback program being somewhat dependent on M&A. Can you just talk about the landscape, and what, if anything you need, whether it's from a product or geographical standpoint, what interests you in the market these days? Thanks.

[Alan Masarek:]

Sure. So we, first of all, we think see everything, just based on our position in the industry and the fact that we’ve been acquisitive, and so really falls into the three categories. One is continued UCaaS consolidation and that’s there the assets of the smaller players are not getting more expensive. And so those are things that we can execute on, but that’s -- those are purely -- in general, they’re purely customer acquisition or sales force acquisition place for us. So they’re almost like organic growth, you're just increasing organic growth. Second would be things like Nexmo that are technology driven, add-ons or product enhancements. We don't feel like we need to do anything there, for instance in contact center we got very good products there. Some are embedded in Broadsoft, simple versions are embedded in central, and then we’ve retail relationships where necessary. But we still look at things like that like Nexmo and technology enhancements, don't feel like we have to do anything. And the last piece would be industry consolidation and as we think that’s heating up, and there won't be as many UCaaS companies in two years as there are today. Again, we don't feel like we need to do anything there or that there's anything eminent, but we think it's going to happen and with our balance sheet and cash flow, we can be a driver and control our own destiny in that if it occurs.

[Operator:]

Thank you. And this concludes our question-and-answer session for today. I’d like to turn the conference over back to Hunter Blankenbaker for any closing comments.

[Hunter Blankenbaker:]

Okay. Thank you, Karen, and that concludes our call today. We look forward to speaking you throughout the quarter as well as next quarter. Thank you.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone have a good day.