Ericsson Lm Telephone Co Q1 FY2020 Earnings Call

Good day, ladies and gentlemen, and welcome to the Vonage First Quarter 2020 Earnings Conference Call. For your information, today's call is being recorded. At this time, I would like to turn the conference over to your host Mr. Hunter Blankenbaker. Please go ahead, sir.

Great. Thank you, Elaine. Good morning and welcome to our first quarter 2020 earnings conference call. Speaking on the call this morning is Alan Masarek, Chief Executive Officer; and Dave Pearson, CFO. Also joining us is Omar Javaid, President of the API Platform; and Rodolpho Cardenuto, President of the Applications Group. Alan will discuss our strategy and first quarter results and Dave will provide a more detailed view on our first quarter and 2020 guidance. Slides that accompany today's discussion are available on the IR website. 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 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 first quarter earnings press release or the first quarter earnings slides posted on the IR website. Additionally, during prepared remarks today, all comparisons to prior periods are year-over-year, unless otherwise noted as sequential. So with that, I'll turn the call over to Alan.

Thanks, Hunter. Good morning. I want to extend my best wishes to everyone and hope you are safe, healthy, and taking necessary precautions. It's important to support others in need as we take care of ourselves. To our 2,400 employees, thank you for your commitment during these unprecedented times. I am proud of your response to the crisis and how you have supported the company, each other, and our customers. You enabled our business continuity plans almost overnight, and our technology allowed all 2,400 of you around the globe to work productively from your homes. Great job, and thank you so much. Now, turning to our results, the first quarter showed strong performance across the company. Business segment revenues reached $210 million, with API Platform revenues increasing by 44% due to high-value APIs. Application service revenue grew by 10%, slightly above our expectations. Overall, revenues totaled $297 million, including $14 million from USF fees, and we achieved adjusted EBITDA of $39 million. Looking at the long term, we believe that responses to COVID will speed up the digital transformation of the global economy, and Vonage is well-positioned to assist in this transformation. We see two favorable long-term trends for Vonage. The first is the growing demand for remotely delivered services, such as telehealth, distance learning, and remote fitness. The second trend is the rise of remote work, as businesses adapt to employees' demands for remote options and to ensure business continuity. For instance, video communications have become essential in a remote world, and Vonage’s video API traffic has surged due to the rise of these services. In telehealth alone, video API usage skyrocketed more than 700% in March compared to February. Furthermore, with a more dispersed workforce, cloud-based communications are vital. The priority of business continuity amid COVID will hasten the transition from traditional systems to cloud-based solutions. We anticipate this trend will increase, even among enterprises with large, centralized workforces, as they respond to continuity concerns by moving to the cloud. While we anticipate long-term benefits, we are not unaffected by short-term challenges posed by COVID. Early in the first quarter, we experienced traffic declines in the APAC region, and while some recovery began in late March, we noticed volume reductions in the U.S. and EMEA simultaneously. We continue to see weaknesses in sectors such as travel, hospitality, and consumer discretionary, but we have not experienced significant customer churn. In fact, business segment churn improved to 0.8%, a record low. Although churn has improved, we have had to offer support to certain customers in affected sectors through one-time credits and extended payment terms. Lastly, our sales pipeline relies heavily on in-person events with partners, including over 100 events each year with Salesforce. With these events now being virtual, we have seen some softness in our pipeline, which has been further impacted by longer sales and installation cycles. Despite these various challenges related to COVID, we have good visibility into anticipated results for the second quarter. When providing full-year guidance, we remain cautious, not due to any long-term weaknesses in our business but because of the uncertainty surrounding macroeconomic conditions in the latter half of the year.

Thanks, Alan and good morning everyone. Let's begin with a review of the first quarter on slide 7. First quarter Vonage business total revenue was $210 million or $206 million ex-USF, which was ahead of guidance and represents 71% of total revenue and a 20% increase. I would note that beginning in this first quarter, we began reporting USF as a separate line item on our income statement in order to highlight our operating performance. USF revenues continue to be a pure pass-through that generate no gross margin. These pass-through revenues did decline in Q1, but for positive reasons as we concluded a study that determined that our offering is mostly software, meaning lower USF fees charged to our customers. From Slide 8, business service revenue increased 23%. Service revenue growth is our focus as we deemphasize access circuits and sell fewer desk phones. API Platform revenue, all of which is service was $86 million in the first quarter, up 44% GAAP. First quarter total revenue from applications was $124 million or $120 million ex-USF. Of this, $110 million was service revenue, which increased 10% GAAP. Moving to slide 9. Vonage business segment revenue churn was 0.8% positive versus 1.2% in the prior year and year ago quarters and monthly service revenue per customer was up 16% to $475. These KPIs are consistent in demonstrating our move upmarket. On slide 10, business service margin in the first quarter was 53%, down 3% year-over-year, but flat sequentially. This was the fourth straight quarter of flat or better business service margin, reflecting the move to our own higher-margin products. Moving to slide 11. Consumer revenue was $87 million or $77 million excluding USF. Churn of 1.8% was favorable year-over-year despite targeted price increases implemented in the first quarter, which increased average monthly revenues per line by $0.92 from the prior year. We ended the quarter with approximately one million consumer subscriber lines, two-year plus tenured customers now represent 92% of our consumer base and five-year plus customers are 74%. Turning to slide 13. Consolidated revenues for the first quarter were $297 million, representing a 9% increase ex-USF. Now moving to income statement cost items on Slide 14. Consolidated sales and marketing expense for the first quarter was $86 million, down $10 million. This is primarily due to moving brand spend to later in the year and the cancellation of in-person events both due to COVID. Engineering and development costs were $19 million, up $3 million. E&D expense, plus capitalized software totaled $29 million, which represented 15% of business service revenue. General and administrative expense for the first quarter was $41 million, up $5 million. These increases primarily reflect the impact of a full quarter of noncash stock compensation associated with new voice media employees. Turning ahead to slide 15. GAAP net loss was $4 million, lower than the $1 million in the prior year. And adjusted net income for the quarter was $12 million or $0.05 per diluted share, down $3 million. The decreases were primarily due to a stock compensation-related tax benefit in the prior year quarter. First quarter adjusted EBITDA was $39 million, up $8 million year-over-year. Moving to slide 16. CapEx for the quarter was $13 million, up $2 million, due primarily to the aforementioned development of new functionality on the Vonage Communications Platform, resulting in adjusted EBITDA minus CapEx of $26 million. On slide 17, we ended the quarter with $567 million of net debt, up sequentially due to our customary annual bonus and equity award tax settlement payments, all of which are made in the first quarter. As of March 31, our cash balance was $43 million, resulting in net debt of 3.4 times LTM-adjusted EBITDA, leaving us approximately $150 million of liquidity under our borrowing covenant. We intend to reduce net debt as the year progresses. Moving on to guidance on slide 19. As Alan noted, we are updating 2020 guidance to reflect the estimated impact of the COVID-19 crisis. We are seeing positive catalysts from growth in remotely delivered services and remote work. Our high product utility is evidenced by exploding video usage, and lower logo churn, offset by elevated levels of payment deferrals and credits, and temporary demand declines in hospitality and travel-related sectors. We are seeing some customers accelerate their move to the cloud and others put their decision to shift to the cloud on hold focused on their own operations. With the visibility we have today, we project the net effect of these dynamics to result in 2020 GAAP business revenues in the range of $855 million to $880 million. Within this number, we expect business USF of $17 million. For consumer, our outlook has increased slightly as we project 2020 revenue in the $325 million area with USF fees of $34 million included. As with the business segment, we are not currently seeing a churn impact in the consumer segment and home phone minute usage has gone up during COVID. We expect full year 2020 adjusted EBITDA of between $150 million and $155 million. We can maintain this high level of adjusted EBITDA, because the provision to overall revenue is a modest 3%, and our costs are highly variable, particularly with controllable expenses like T&E. With regard to the second quarter, we expect business segment revenues in the range of $213 million to $216 million, including USF of $4 million. Consumer revenues in the $82 million area, including USF of $8 million and adjusted EBITDA in the $36 million area. To be clear, our earnings guidance reflects continued investment in long-life assets like engineering and sales capacity, with the necessary marketing to ensure we can quickly rebound from macroeconomic weakness caused by COVID. In the short term, we have shared with you the visibility we have, including the benefits of a significant subscription base and experience with the impacts of COVID in Q1. Long term, I'm confident that our strategic positioning is stronger as we emerge from this crisis.

Okay. Great. Thank you, Dave. Elaine, if we could please turn to the first question.

Thanks guys and thanks for the call and the guidance. Maybe I missed this, but can you talk a little bit more about the mix or percentage of revenue you think that's at risk maybe the restaurant business or travel business? And secondly, the API business is really strong. Can you just talk about how those trends have progressed here and at this growth rate is it anywhere near sustainable? And then, lastly, it sounds like Alan, obviously you think it's a very positive longer term and some of the negative impacts you're seeing here will actually be major tailwinds in 18 months or so when we're through this. Can you talk about longer-term in next maybe two three years from now where you hope business service revenues get to? Thank you.

So, thanks Tim. Dave, why don't you take the first? And then I think Omar you can speak to the API strength and I'll finish off in sort of the long-term view.

Yeah, absolutely. So, the difference in API revenue relative to how we saw the year baked into the guidance we just gave is in the mid-teens millions of dollars. And that is primarily comprised of customers in the travel and hospitality industry. What we have seen is a drop-off in usage from those companies offset by two things. And that is almost entirely SMS usage, and that's been offset by the exploding video usage that we saw, and higher usage from primarily U.S. customers of the SMS product to interact with their customers. And those happen to be global digital leaders just not in the travel and leisure space. As it relates to apps just to expand the concept on exposure, we haven't given many credits and the ones that we have given do tend to be concentrated in the hospitality and restaurant space. But those are customers that we're in very close touch with and we baked into our guidance, the request that they've made, and the request that we think we're going to get for credits.

Yes. Thank you, Alan. Hi, everyone. I hope you're all well. As to the long-term sustainability, I think what we're seeing, if you just refer to Alan's opening remarks that what this crisis has it's really accelerated a lot of digital transformation spending, and I think what you're seeing for a lot of companies and we're seeing this all over the world. Obviously, the industry that were affected the most like travel hospitality, let's sort of set them aside for a second, but we're seeing a ton of interest and a ton of activity and real activity. Basically, these projects the way that we've seen them even with say long-term prospects this was on their list. Now, this is on the top of their list, these digital transformation initiatives. And so we're – on the API side particularly, we're seeing a lot of that. So I think that bodes well for the long term.

Thanks, Omar. Regarding the long-term perspective, I believe the trends we've highlighted are permanent, indicating that remote work is here to stay. This does not mean that people won't return to offices, but the shift toward virtualizing the workforce will continue to grow. The same applies to services delivered remotely, such as telehealth and distance learning. While individuals will still visit doctors and attend school in person, these trends will undergo positive and lasting changes, resulting in faster growth than we experienced before COVID. So, we see both permanent and temporary aspects. On the temporary side, industries that were impacted will eventually recover. The timing remains unclear, but sectors like travel, hospitality, and consumer discretionary will return to normalcy. For long-term growth, we anticipate benefiting from these trends, as Omar mentioned about the ongoing strength in API related to digital transformation. We will also continue to navigate what I call a U-shaped recovery, shifting our revenue base in applications from downmarket to upmarket. In this quarter, 64% of bookings were from mid-market and enterprise, which is an increase from 62% in the previous quarter. The growth rate was 39%, and as the nature of our bookings evolves, we expect our revenue composition to change accordingly. Thank you for those questions. Let's proceed.

Thank you. Our next question comes from Catharine Trebnick of Dougherty. Please go ahead.

Thank you for the presentation and for allowing me to ask my question. I would like to better understand the entire sales cycle. We are currently in Q2, and I noted in your prepared remarks that the sales cycle has slowed down. You mentioned that there were still many in-person calls, but with the introduction of your new video meeting application, it seems like there could be a greater opportunity to close sales and conduct more proof-of-concepts online. Could you elaborate on this for us and clarify whether this adaptation will be a permanent shift in your approach? Thank you.

Let me start and then I'll turn it to Rodolpho. Our go-to-market traditionally, as I mentioned in my remarks, have been dependent on in-person events. I commented on 100-or-so sales force events, but there's several hundred beyond that in other partner events that we participate in. All of that is obviously virtualized. And so in our world that has maybe a bit more challenging. Now our products work really well in this environment, but that sales process has created some softness on the front end. We think that the softness is not that great on the one hand, our tools and the need for digital transformation we benefit by on the other. And over some period of time obviously post COVID, these events are going to be restored. But let me turn it over to Rodolpho. He can give you more color on this.

Thank you, Alan. Initially, after COVID, many companies were exploring how to connect with us and reassess the sales cycle. They also needed to manage contract negotiations and signatures. Our innovative approach to the sales cycle, aided by our technology, allowed us to engage our customers effectively. We enhanced our technology concept by integrating unified communications in our call center interactions. As Alan mentioned, we transitioned from in-person meetings to digital events, and I believe we have nearly returned to a normal sales cycle after experiencing some delays.

Thanks Rodolpho. Let's go to the next question.

Yes. One more. So, your consumer strategic review, where are you on that?

Dave, why don't you take that?

Yes. Absolutely. That is going according to the plan that we laid out in February. There's no COVID-related delay to the process nor the hypothesis behind it. So the phase we're in right now is the one that we outlined, which is working intensively with our consultants and advisers to understand what the asset actually would be to divest of. Should we decide to confirm that path and exactly what the options are for how to do that? So, it's a lot of operational items and that is going according to plan and we'll update as we go.

Okay. Thank you. Keep the good work. Appreciate it.

Thanks, Catharine. Thanks, Dave.

Thank you. Our next question comes from Samad Samana of Jefferies. Please go ahead.

Hi. Good morning. Thanks for taking my questions. I hope everyone is doing well. You mentioned that there are factors to consider regarding vertical exposure. Could you help us understand what percentage of your exposure is to industries like hospitality, retail, and consumer travel? This would help us think about it going forward.

Dave, why don't you take that?

Yes, absolutely. On the API side, we have about 20% exposure to travel and hospitality, which is typical for the industry. However, there are offsets, such as ride-sharing companies that, while reducing ride-sharing, are increasing their food delivery services. We view this as a temporary situation, and while it's hard to pinpoint when things will improve, we are taking a cautious approach. Our API business is geographically diverse, which has been beneficial as COVID has impacted different regions at different times. On the applications side, our exposure to these industries is lower, but we do have customers in retail and the restaurant sector, which represent a smaller portion of our business compared to API. We are aware of where these customers stand regarding potential credit requests.

Great. That's really helpful. And then Alan I think I heard you mention a new integration with ServiceNow. Clearly, they're one of the best owned companies in enterprise software. I'm curious if you could maybe double-click on that and just help us understand what the relationship there is and if there will be any joint go-to-market efforts, et cetera?

Thanks Samad. Let me ask Rodolpho to take that.

Yes, we will have a go-to-market engagement with them. The relationship we are building with ServiceNow is very similar to our current relationship with Salesforce.com regarding CRM. We have developed a deep integration into ServiceNow's Customer Service Management (CSM) platform, and as you know, some of our CRM customers are also CSM customers of ServiceNow. We plan to engage deeply with them. We have a go-to-market strategy in place and will have more announcements next week, and I will follow up on that.

Great, that's exciting. Thanks for taking the questions and congrats on the good quarter.

Thanks Samad. Thanks.

Our next question comes from Rich Valera of Needham & Company. Please go ahead.

Thank you. Good morning and congratulations on a nice sprint in a challenging environment to say the least. I was hoping you could provide a little more color on the percentage of total API business that comes from the kind of high-value applications kind of where that is today and if you could give any sense of where you think that could go over time since it's clearly a faster-growing cohort of that business.

Let me ask Dave to answer that.

Yes, absolutely. Omar can certainly provide some color. So, high-value right now is in the mid-teens percent of our API revenue base. And again, that's growing dramatically faster than SMS and most any other product that we have. The other thing I'd point out is that high-value is a much more U.S.-oriented product. It works everywhere but the success we're having is disproportionately in the U.S. whereas our SMS base has historically been disproportionately in APAC. So, if you think about our strategy of moving to more high-value products and being more geographically diverse which includes a bigger base in the U.S. this trend that we're seeing right now is helping us execute on both parameters of that strategy.

Got it, that's very helpful. And just in terms of the near-term headwinds you guys are seeing I wonder if you could in any way try to quantify a little more what you're seeing in terms of bookings or pipeline changes as you've entered the second quarter in the month of April relative to entering the first quarter of the year just to give us any sense of how those business conditions have changed over the last quarter.

Dave let me ask you to take that as well?

Yes. Rodolpho can provide additional details, but I mentioned a mid-teen difference. For quarters two through four, there's a mid-teens difference on API compared to the previous year, which is relatively modest in the non-subscription business. On the applications side, our guidance includes a high teens difference from what we observed at the beginning of the year. This difference falls into two categories. One category is lower installs and bookings, and the other is churn, which mainly consists of down-sell churn. We're not experiencing higher logo churn. Rather, some customers who intended to add five seats are either not doing so or are temporarily reducing their seats while still remaining customers and utilizing credits. So, the difference in guidance is roughly equally attributed to lower installs and bookings on one side and down-sell churn and credits on the other. Rodolpho can comment further on the bookings environment specifically.

Yes. Yes. My comment is just like you said. We bake it in everything in our guidance now. But what we see is a challenged environment in Q2 due to the business closures and business that are not open up for us to do business. So, there is discharge of business in Q2. But we are benefiting from Q1 because we are actually harvesting in Q2 what we see that in Q1. But 2Q is going to be a challenged one. So, then we recover in Q3 and then we'll recover even better in Q4. There is this slope in Q2 due to the COVID social distancing policies.

Great, that's very helpful color. Just one more if I could for you Dave. Can you say how much access and product revenue is baked into the 2Q business guidance and the full year?

I’m not going to provide a specific number, but it is decreasing gradually. First, the numbers I mentioned in my prepared comments would naturally decline, and they will decrease at a slightly faster rate due to the impact on overall service revenues and customer accounts. However, we don’t anticipate any significant or disproportionate changes. For example, we’re not observing people reducing their seat counts and simultaneously removing their access. The access metrics remain closely linked. On the product side, I expect a bit more rapid decline due to COVID, since many of our current installations do not include desk phones. This factor is incorporated into our guidance as well.

Okay. Thanks for the clarification. Thanks guys.

Thank you. We will now take our next question from Alex Kurtz of KeyBanc.

Thanks guys. So I guess no three or four questions for me. I just hope that you're all safe and healthy.

Thanks, Alex.

So the full year guidance why provide that? I mean, I think pretty clear that a lot of your peers all of your competitors are pulling full year, so maybe a little bit of context around that. And then on the API side, just pricing in the marketplace. It's always been a discussion point about your platform relative to your largest competitor and how you're thinking about margin and pricing going forward through rest of the year? Thank you.

Dave why don't I ask you to take that?

Yes, absolutely. I know Omar can address the API pricing question. When it comes to providing full year guidance, our main principles are that we believe we have solid visibility on our business. With our subscription model on the application side, we are currently in a stable position regarding bookings. Events in the second quarter significantly influence the remainder of the year, and sales activities conducted in the latter part of the year impact 2021. This gives us good visibility due to the subscription nature of our business. Regarding the API side, it's worth noting that one of our comparables withdrew their annual guidance, and they are not a subscription business. However, we believe we possess sufficient visibility to provide a range, although it is fairly wide due to global uncertainty. Considering the geographical diversity we've observed and having four months of data, we felt confident in releasing that figure. As a guiding principle, we also thought it was important to share our observations and best assessment in this context.

Dave, let me explain a bit about the API side. I think your question was about how we're considering margins and pricing for the rest of the year. Based on what we've observed so far, particularly in Asia Pacific, we feel optimistic. In general, we are confident about our margins and pricing for the remainder of the year. My confidence regarding the API comes from our experience in Asia Pacific. If that trend continues globally, we haven't noticed any pressure on margins or pricing there, and we haven't observed it here either. This is our current perspective for the year ahead.

Okay. Thanks, Omar.

Thank you. Our next question comes from Sterling Auty of JPMorgan. Please go ahead.

Hi, guys. This is Matt on for Sterling. Thanks for taking the question. In terms of the possible implementation delays, what parts of the product portfolio do you see having the greatest risk? And what is happening on the average implementation time frames? Thanks.

So Rodolpho, why don't you take that? Your question really is limited just to the applications side because similar for the install issues don't exist on the API side.

Yes, sure. What we see now is a delay there is this lagging, especially the CCaaS world that our companies are committing to us. So we are signing the contracts, but they are waiting for their business to actually recover or to reopen to start the installation. So while we see now, the lagging of the installation, it's different than the lagging that we saw before, which was more of a professional service or implementation side of the business. Now it is more of a recovery or reopening of the business. That's also baked into our outlook and our guidance.

Got it. That makes sense. And then just one follow-up for me. In terms of headcount, where are you guys trending in terms of your plan for the next couple of quarters? Has that changed relative to what you had previously? Thanks.

I'm glad you asked that question, because the simple answer is our headcount plans are virtually unchanged. Specifically, we are not making any COVID-related layoffs and do not anticipate furloughing our employees. Currently, we have around 225 open positions we are actively recruiting for across the organization. The key point is that our EBITDA guidance includes ongoing investment in long-life assets, such as product engineering and sales capacity. We are also investing in marketing, including media and personnel, to support our recovery from COVID. This approach is reflected in our EBITDA guidance.

Great. Thanks so much guys. Appreciate the color.

Thank you.

Thank you. We take our next question from Meta Marshall of Morgan Stanley. Please go ahead.

Hi. This is Erik on for Meta. Thanks for taking our questions. Maybe just going back to the strength we saw in applications in the quarter. Was that largely more contact center functionality, or were there other drivers that were more impactful there?

Erik, thanks for the question. Let me ask Rodolpho to take that.

In terms of the strength of the quarter in contracts?

In Q1 I think.

In Q1, we had a very strong quarter in the contact center, particularly with 41 enterprise deals closed, 15 of which were over $1 million in total contract value. The strength of our portfolio is evident when we integrate unified communications with contact center solutions. This combination enhances our offerings, showcasing the robustness of our solutions.

Okay. That's helpful. Thank you. And then maybe just on some of the areas where you have kind of managed costs. I know you noted that a large number of those has been largely just due to variable cost in nature, but have there been any areas where you can maybe made more permanent changes and kind of efficiencies that we should be mindful of?

Let me talk about that as well. Our adjusted EBITDA guidance reflects what I previously discussed with Matt regarding ongoing hiring. The structure of our organization allows our cost structure to be highly variable. For example, we are unique among application providers because our infrastructure is entirely based on public cloud, with much less reliance on private cloud. This means that our infrastructure costs are fully variable, which helps us maintain profitability even in light of some projected softness in back-end revenues. We're benefiting from reduced travel and entertainment expenses as people are unable to travel. This is a result of our variable cost structure and cuts in lower priority areas like travel and entertainment. I want to emphasize again that COVID will be a short-term disruption. The long-term outlook for our business remains very positive. Therefore, we do not plan to reduce our investments in long-term assets, specifically in engineering, product development, sales capacity, and the marketing efforts necessary to rebound after COVID. This principle has guided us as we've updated our budget and outlook for the year.

Helpful. Great. Thank you.

Thank you. We take our next question from Ryan MacWilliams of Stephens Inc.

Thanks for taking the questions. Just one for me today. Alan, impressive to see business churn declined in the quarter and I like your comments on the long-term pull forward of cloud adoption across communications. From your point of view, how do you see this increased demand playing out for customers who have so far have been hesitant to move to the cloud? Would UCaaS maybe see stronger initial adoption versus contact center? And would you expect this pull forward to happen quicker with SMB customers compared to in large enterprises? Thanks.

Ryan, thanks. Great question. The long-term trends that I cited are really very positive for cloud communications in general and Vonage specifically, because those two trends are, again, remote work and remotely delivered services. In my view, the remote work side, clearly, there's going to be greater demand from employees for the opportunity to work remotely. This crisis is going to sort of undeniably accelerate that trend, which existed pre-COVID, but it's going to accelerate that trend. But I think the business continuity concerns are what are going to be really interesting, particularly among the large enterprises and I mentioned this in my comments. As those in cloud communications, as we played with large enterprises, cloud has been the most successful in large enterprises that have very distributed workforces or distributed locations. So take for example a 5,000-person company, but it's a retailer. And so maybe those 5,000 people are spread across 500 retail stores. In that scenario, cloud is absolutely necessary and a far lower cost of ownership than prem. Now, if those 5,000 employees were sitting under a single roof in one location, that's been really where the premise-based competitors have focused. And my view is COVID is going to be a tipping point for even those concentrated large enterprises because of business continuity concerns. You can just imagine the audit committees, particularly at public companies, looking to their management teams and saying, are you prepared, God forbid, this ever happen again, whether it be pandemic or natural disaster like a hurricane? I think we've hit that tipping point where things are going to move to the cloud. And again, I think the broader topic about remotely-delivered services, I think, that's a tipping point as well, where you're going to see, again, the need to program in communications. I've cited examples around video and I leaned in hard to telehealth, but we see this in the education market, tutoring, just everywhere. I mean, I see it globally. We think this trend is going to be an ongoing permanent trend as well. So we fundamentally believe the world is going to be a changed place and the way we're structured as a company, as this cloud communications platform able to address both trends. I think, we're uniquely set up to benefit from it.

Appreciate the color. Congrats on the quarter. Thanks.

Thank you.

Thank you. We will now take our next question from Will Power of Baird.

Okay. Great. Yes. Just a couple of quick follow-up questions. I think, Al and Dave, probably both of you, as you reference on the customer credits, deferred payments, is that principally allocated or related to the Applications Services segment, or are you seeing that on the API side as well? So I just want to get a little more color there to start.

Dave why don't you take that?

Yes, absolutely. When we mention credit, we are specifically referring to the applications side. Typically, a customer will ask if they can receive a credit if their restaurant is closed for the month. It's pretty straightforward. We have also accounted for both what we know and what we anticipate might occur in the future. Additionally, we took a $1 million charge for bad debt this quarter, which applies across the entire complex. We always maintain a bad debt accrual, and we increased that accrual by $1 million to cover both applications and API bad debt, in addition to what we have already set aside.

Okay. Got you. And then I wanted to just come back on Applications Services, the guidance for the second half of the year and the challenges you expected. I'm wondering if you could just help us unpack or break that down between what you're seeing or expecting in SMB versus enterprise. Because you referenced some of the SMB-related pressures, but you also referenced lengthening sales cycles, which I suspect is more enterprise-centric. So I just wanted to try to get a little more color there as to how that breaks down between those two segments.

Dave, let me ask you to start on that.

Yes. Regarding the distinction between upmarket and downmarket, Rodolpho should address that as well. There is some elevated churn among SMBs, but this is being balanced out by improved logo churn in the upmarket. The dilution we discussed, which relates to service churn rather than logo churn, is more prominent in the upmarket. Consequently, the impact is somewhat proportionate between the upmarket and downmarket, especially during the COVID situation. Our strategy remains focused on targeting the upmarket, where we believe the benefits of utility, business continuity, and working from home are more significant.

Yeah. Okay. That makes sense. Thank you all.

Thanks Will.

Thank you. We'll take our next question from James Breen of William Blair. Please go ahead.

Hi. Thanks taking my questions. Just a couple, on the discussions that you're having with the channel partners one, is there any noticeable difference in terms of the competitive environment given what's happening right now? Are enterprises focusing on certain providers that have scale and size? And then, do you see sort of a pent-up demand where there are enterprises currently dealing with the pandemic saying we should have switched to a Vonage product earlier and we didn't. We'll be back there in the fall or whenever this sort of alleviates. They give you sort of confidence that, there is a little bit of a bubble built there that they will be back to guys once things normalize a bit. Thanks.

Rodolpho, why don't you take that on, both the competitive environment and the likelihood of being, their pent-up demand.

We haven't noticed much change in the competitive landscape; it's largely the same. As I mentioned earlier, we experienced a downturn in Q2 due to business closures and social distancing measures. However, as Alan indicated, we hope to see a rebound in Q3 or possibly Q4. We are getting ready for that rebound as business conditions improve. We've been discussing with our customers and partners about being prepared for both partial and full recoveries by the end of this year. We're ready for this, particularly with our partners, and especially now that we are expanding our Total Addressable Market with ServiceNow in addition to our Salesforce offerings. This gives us more market opportunities, and our partners are very pleased with this development.

Okay. Thank you.

Welcome. Next question.

Our next question comes from George Sutton of Craig-Hallum. Please go ahead.

Thank you. Having not been more than a few miles from my house for weeks, and having no haircut et cetera I'm reeling a bit from your permanence comments, Alan, but I get your point, so relative to the channel one of the issues that we always have is getting clients to understand the differences, amongst all the providers. And we've picked up, a couple that we thought were important. I just want to see if you could address them and that's smart number capability. And some of your security protocols seem to be differentiators in the market. And I wondered if you could elaborate on that?

Sure. I believe that when we talk to our telecommunications master agent channel, we always emphasize that if they think of Salesforce, they should think of Vonage, as we stand out in the market. It can be challenging for a channel partner to distinguish a straightforward UCaaS installation for about 100 employees, as pure UCaaS solutions tend to be quite similar. However, we have a significant differentiation in our contact center, especially within a Salesforce setting, and we are noticing this increasingly pulls in UCaaS opportunities. That's why I mentioned our recent release that combines UCaaS and CCaaS solutions, allowing for shared call control, single sign-on, presence, and directory synchronization. This means that whether you’re an agent or an employee, you can function within the same system. These differentiators are what we promote through our channel, and they appear to contribute to improved close rates. Apologies for the lengthy explanation, but Rodolpho, do you have anything to add?

Not much more to add, but you covered it all. A significant differentiator is the nearly embedded solution of Salesforce, and we’re doing the same with ServiceNow as we launch our integration. You will see CRM and CSM with this integrated solution in the system, which has been well received by the market and our customers. Additionally, our own integrated unified communications and contact center solutions, as we mentioned earlier, represent a major differentiator for us. We refer to it as the 3Cs: continuity, contingency, and compliance. Security plays a role in both continuity and contingency efforts, which are our primary focuses. Everything is also packaged with compliance regarding data privacy and security, which is crucial for our enterprise clients. This is why we have seen strong adoption within enterprises.

Thank you. Alan, thank you, Rodolpho. And now I'd like to turn the call back over to, Mr. Hunter Blankenbaker for any additional or closing remarks.

Okay. Great, that wraps up the Q&A portion of today's call. And we look forward to visiting many of you in the coming months at several virtual investor conferences which will be webcast. You can follow our comments on the Vonage Investor Relations website. Please contact us if you need any additional details and thank you again for joining today.

Thank you. Ladies and gentlemen, that will conclude today's conference call. Thank you for your participation. You may now disconnect.