Earnings Call Transcript - VG Q3 2021

Operator, Operator

Greetings. Welcome to Vonage Third Quarter 2021 Earnings Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to Monica Gould, Investor Relations. Thank you. You may begin.

Monica Gould, Investor Relations

Thank you, operator, and good morning, and welcome to our third quarter 2021 earnings conference call. Speaking on our call this morning is Rory Read, Chief Executive Officer; and Steve Lasher, Chief Financial Officer. Rory will discuss our strategy and third quarter results, and Steve will provide a more detailed view on our third quarter results, fourth quarter guidance, and updated full year 2021 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 these risks and uncertainties is highlighted on the second page of the slides and contained in our SEC filings. We caution listeners not to rely unduly on these statements and disclaim any intent or obligation to update. During this call, we will be referring to non-GAAP financial measures. A reconciliation to GAAP is available in the third quarter earnings press release or the third quarter earnings slides posted on the IR website. So with that, I'd like to turn the call over to Rory.

Rory Read, CEO

Thanks, Monica, and hello, everyone. Thank you for joining us today. Next-generation technology happens in waves that build upon each other. What is happening now is the convergence of the Internet, mobility, the cloud, and powerful 5G networks that is forming the digital transformation and intelligent communications wave, driving a secular change in the way businesses operate. Customers expect to digitally engage with companies to get the information they want and the channel they choose when they want it from anywhere. Similarly, employees expect seamless collaboration, engagement, and access to technology no matter where, when, or how they choose to work. To achieve this level of engagement, we believe all communication modes will be embedded in applications, workflows, and customer experiences through composable API-based programming techniques that enable businesses to move from transactional interactions to true ongoing engagement. We provide all of these capabilities through the Vonage Communications Platform, our single global cloud communications platform. Last month, we acquired Jumper.ai, a leader in conversational commerce. With Jumper, we have added significant technology, talent, and expertise to capitalize on this growing convergence of seamless shopping and conversations on services such as Messenger, WhatsApp, and Instagram. Jumper AI will accelerate our ability to enable our customers to differentiate themselves as social messaging becomes increasingly important to consumers as a frontline way of connecting with their favorite brands. Leading brands such as L'Oreal, Kiehl's, Disney, Axe, Dove, Ben & Jerry's, and Burger King use Jumper's technology to create personalized, unique digital engagement experiences for their customers, and this is just the beginning. We're truly delighted to welcome the Jumper team. Now let's review our third quarter Vonage Communication Platform results, where I'll focus my comments on our continued strong execution and the progress we are making on our strategic investment. VCP service revenues were $274 million, representing 25% year-over-year growth, up from 19% in 3Q a year ago. Third quarter VCP adjusted EBITDA was $5 million, a $19 million year-over-year improvement. VCP Rule of 40 this quarter was 27, more than doubled the 13 in the third quarter a year ago. We are ahead of the plan we laid out in our March Investor Day, and we are confident in our ability to continue to deliver on our commitments. API revenues increased 43% year-over-year to $155 million in the quarter. Our continued strong performance was driven by robust demand for our composable APIs from new and existing customers across all key industries, geographies, and customer sizes. While messaging growth was particularly strong in the quarter, we also saw strong adoption of our other APIs, particularly VoIP, verification for authentication, and our messaging API for customer engagement. I'll highlight just a few of the new customers for the quarter. A UK-based real estate and technology company is leveraging multiple Vonage APIs to build and differentiate their business. They are using our messaging API to facilitate connections between buyers and real estate agents, and they are using our video API to power virtual property viewings between agents and their customers. In the United States, Ping Identity, a Gartner Magic Quadrant leader in the access management software space, selected Vonage to provide two-factor authentication services for its customers, which now include 60% of the Fortune 100. In addition to our strong new customer growth, existing customers continued to expand on our platform. Third quarter dollar-based net expansion was 129%, driven by strength in e-commerce, travel, hospitality, logistics, and the social industry. We also saw increased momentum in several areas across fintech, including crypto trading platforms, digital lending, and payments. A great example is FinAccel, a digital lending pioneer in Southeast Asia, already a Vonage Voice API customer. FinAccel selected our SMS API and two-factor authentication capabilities to provide customers with account updates and password assistance. FinAccel also added our messaging API to power engagement with its customers over WhatsApp. Now moving to Unified Communications and Contact Center product, service revenue grew 8% ahead of expectations. Combined BBC and BCC cloud product growth was 13%, driven by improving micro and SMB growth along with strong mid-market and enterprise growth. We continue to make progress on our go-to-market initiatives. Total bookings were up year-over-year and sequentially. Within the channel, our momentum is building, highlighted by significant year-over-year bookings growth, with five out of our top ten deals, including three of our largest deals in the quarter coming from the channel. Given our improving trajectory, we're well positioned to accelerate revenue, to double digit growth in early 2022 as we shared during our investor day in March. Key to our bookings growth is our integrated Unified Communications and Contact Center solution, which continues to be a key differentiator. Ten of our top 15 wins this quarter included both UC and CC solutions. I'll highlight two examples. An innovative financial services firm chose Vonage to replace its legacy UC and CC infrastructure. The full scope of the Vonage Communications Platform, including the depth of our Salesforce integration and the ability to leverage our APIs for custom integrations were key differentiators in this seven-figure TTB deal. One of the largest roofing manufacturers in North America turned to Vonage and Salesforce to transform their customer service organization and leverage customer data to provide more proactive and intelligent customer support. Originally only a contact center deal, it became apparent to the customer that they needed to move to a full cloud offering to replace their legacy on-prem UC and CC solution. Last quarter, we discussed the importance that the Salesforce Service Cloud Voice Partner Telephony Program represents for Vonage. I'm pleased to share that we are seeing early success here, with several new wins and a strengthening pipeline. We had an exciting win with Stratton Finance, one of Australia's largest car and asset finance brokers. An existing Salesforce customer, the company selected Vonage for our Contact Center solution integrated with Service Cloud Voice and our Unified Communications solution. With Vonage and Salesforce, Stratton Finance will accelerate its digital transformation by creating an improved agent experience, better operational efficiency, and stronger customer engagement. Now moving on to product, our innovation engine continues to accelerate. During the quarter, we introduced an impressive number of new capabilities across our entire platform. I'll highlight just three. Our new AI virtual assistant for BBC is one of the first AI-driven conversational solutions to deliver enhanced self-service interactions for Unified Communications. This AI solution creates intelligent conversational experiences using natural language understanding and machine learning to engage every caller with applications using voice and text. We also launched Vonage Video Express to make it easier and faster for developers to access Vonage's video API for multiparty calls. Vonage Video Express democratizes video, making every web developer a video developer. Instead of taking days, weeks, or even months to integrate video into applications, developers can now integrate video within hours using just a few lines of code. Additionally, the Vonage Contact Center solution was one of the first to be selected by Google in its new Chrome Enterprise Recommended Contact Center category, integrating the Vonage contact center with Chrome OS devices and powering IT and contact center administrators to leverage a full suite of contact center capabilities remotely and enable agents to work from anywhere, enhancing the agent experience for better efficiency and productivity. In summary, we had another strong quarter and expect to finish 2021 well ahead of our original revenue projection due to improving execution, go-to-market focus, and product innovation. Vonage is in the right place at the right time in a large and rapidly growing market. As the world begins to ride this next technology wave around digital transformation and intelligent communication, the way we work, shop, learn, see a doctor, and even exercise has fundamentally changed. Businesses need to move beyond transaction and notification to digitally transform, to deliver personalized conversations on the customers' terms, as the demand for virtual engagement continues to grow. Whether it's getting medical attention through telehealth, tracking a package or a food delivery, booking a ride-sharing service, providing fraud protection, connecting the right customer to the right support agent, or enabling video and voice communications across thousands of office locations, Vonage does that. I would like to thank our talented team members around the world for their continued hard work and dedication. We're delivering on our commitment, executing our transformation plan, and investing for future growth. And every day we're actively looking at all options to create value for our customers, our team members, and our shareholders. I look forward to updating you on our continued progress. And with that, I'll turn it over to Steve.

Steve Lasher, CFO

Thank you, Rory. And good morning, everyone. I'll start with a review of the third quarter results and then discuss the fourth quarter and updated full year 2021 guidance. Beginning on Slide 8, we had another quarter of solid execution, accelerating revenue and improving profitability. Each of our product areas, including API, UC, and CC delivered on our commitments while we continue to improve on the Rule of 40. Turning to Slide 9. Consolidated revenue increased 13% to $358 million, driven by a 23% increase in Vonage Communications Platform revenue to $288 million. VCP revenue now represents 80% of consolidated revenue, up from 74% in the third quarter of the prior year. Consolidated third quarter adjusted EBITDA of $51 million was up $9 million or 22% year-over-year due to higher revenue and improving operating structure within VCP. Moving to the Vonage Communication Platform on Slide 10. VCP service revenue increased 25% to $274 million, ahead of our expectations driven by broad-based demand across our entire portfolio. VCP revenue churn was 0.6% in the third quarter, an improvement of 60 basis points from a year ago, driven by improvements across all products. Monthly service revenue per customer increased 25% to $657 from $527 over the prior year quarter. VCP gross margin in the third quarter was 45%, down year-over-year due to the higher growth in our API products, particularly messaging. As we continue to strategically pursue new customer opportunities to drive product adoption across the VCP platform. VCP adjusted EBITDA was $5 million, representing a $19 million year-over-year improvement. Moving to Slide 11. API revenue was $155 million in the third quarter, up 43% driven by continued growth across all product areas and geographies. We saw particular strength in our e-commerce, financial and travel verticals as customers continue to adopt new products and expand usage across the portfolio. Unified Communications & Contact Center service revenue was $119 million in the third quarter, up 8% year-over-year. Let's move to Slide 12. VCP operating expenses totaled $165 million and accounted for 57% of total VCP revenue, an improvement of 18 points year-over-year. This improvement is due to the business optimization and alignment efforts we took last year to rebalance the business. VCP sales and marketing expenses were $83 million or 29% of total VCP revenue. As we continue to make investments in sales head count and targeted demand generation. VCP engineering and development expenses were $17 million or 6% of total VCP revenue. VCP E&D expenses plus capitalized software totaled $28 million or 10% of VCP service revenue. VCP general and administrative expenses were $42 million or 15% of total VCP revenue, down approximately $11 million due to restructuring charges in the prior year quarter. Turning to Slide 13. Consumer segment revenue was $70 million in the third quarter, a 15% decrease from the prior year. Consumer adjusted EBITDA was $46 million in the third quarter, down from $56 million in the prior year. Moving to Slide 14, we ended the third quarter with $447 million of net debt, down $28 million from last quarter and $90 million from the prior year. As of September 30, net debt was less than 2.3 times last 12 months adjusted EBITDA. Moving to guidance on Slide 15. For the fourth quarter, we expect VCP revenue in the range of $293 million to $301 million. We expect VCP service revenue growth in the 22% to 25% range. Embedded in this guidance are the following assumptions. In API, we expect fourth quarter year-over-year revenue growth to be in the 34% to 40% range. With regard to Unified Communications and Contact Center, we expect service revenue growth in the high single digits. We expect fourth quarter VCP adjusted EBITDA to be in the range of $4 million to $8 million. Within Consumer, we expect revenue in the $65 million range and adjusted EBITDA of approximately $42 million. On a consolidated basis, we expect total revenue of $358 million to $366 million and adjusted EBITDA in the $46 million to $50 million range. For the full year 2021, we are raising our revenue and adjusted EBITDA guidance to reflect our strong third quarter performance and higher fourth quarter expectations. We expect VCP revenue to be in the range of $1.113 billion to $1.121 billion. VCP service revenue is expected to be in the range of $1.55 billion to $1.63 billion, representing growth in the 23% to 24% range. We expect API revenue growth for the full year to be in the 40% range. And we expect full year UC, CC service revenue growth in the mid to high single-digit. We expect VCP adjusted EBITDA to be in the $8 million to $12 million range. For the full year, we expect our VCP rule of 40 results to be in the mid-20s, up from our original guidance of low 20s, driven by stronger than expected growth across our API and UC, CC product portfolio. For consumer, we expect full year revenue of approximately $288 million and adjusted EBITDA in the $186 million range. We expect total consolidated revenue to be in the range of $1.400 billion to $1.409 billion and adjusted EBITDA in the $194 million to $198 million range. With that, I’ll turn the call over to the operator to start the Q&A.

Operator, Operator

Thank you. Our first question is from Mike Latimore with Northland Capital Markets. Please proceed.

Mike Latimore, Analyst

Great. Thanks. Yes, congratulations. Excellent results there. I guess just a question on the gross margin on VCP. I know messaging is growing rapidly and there’s huge demand there. How should we think about gross margin longer-term? Where does that sort of stabilize in VCP?

Rory Read, CEO

Thanks, Mike. Hey Mike, I’ll get started and I’ll pass it over to Steve. From my perspective, what we’re seeing is this secular change in the way communications are used across pretty much every industry, and we’re seeing robust demand across our portfolio. I think the team is executing particularly well, and we’re seeing that demand across all product areas. So I like that a lot. We’re not seeing a lot in terms of pricing pressure. We’re seeing really robust demand across all product areas. And as we continue to innovate, I think we’re seeing that innovation drive more demand and definitely value for the customer. So I think that’s an important factor in terms of it. You highlighted mix, we’ve definitely seen some strong robust demand across messaging, but again, we see it across every product area. So I’m pleased with where we’re at. We’re confident we're going to execute well in 4Q and finish the year strong. But Steve, do you want to give a little bit of a feel for how we view gross margins across the VCP platform?

Steve Lasher, CFO

Sure. Thanks, Rory. And Mike, thanks for the question. As Rory stated, when we take a look at gross margin, we think it’s going to stay in that mid-40% area. For us, it’s about the scale. As you know, we are always looking to improve on gross margin. Right now, we are seeing opportunities for capturing new clients and having them scale across our platform. So right now, as we set our mission, we’re happy to trade off a point or so of margin for two points on that top line. As we continue to make progress on our rule of 40, you’re starting to see. We’ve really done a nice job, and the team’s done a lot of hard work to continue to deliver on our rule of 40 and we’re making great progress. As we continue to look towards the future, that mid-40s range, we’re comfortable with it, especially as we think about the mission going forward.

Mike Latimore, Analyst

Yes, makes sense. And then on the API business, broad-based demand, it sounds like. Were there any geographic regions that either outperformed or underperformed your expectations?

Rory Read, CEO

No, Mike, we saw strength across the board. You look at the dollar-based net expansion from the standpoint of a 129%, we like to run that in the 120% to 130% range. We saw demand from our existing customers for existing APIs, and we saw some good expansion in terms of new and multiple APIs. New customer growth was strong. Again, we saw it expand in pretty much every geography and almost every vertical. There’s a lot of demand out there. Whether the world is opening up from the pandemic or however it’s changing, what we’re seeing is the secular change in how consumers want to interact with companies, and these companies need to implement these compostable APIs to create these multi-modal communication interactions that create a kind of 360-degree relationship. I think that’s pretty powerful. We’re seeing it across all industries and customer sizes, big, medium, and small across the board, nice API demand from existing and new customers.

Mike Latimore, Analyst

Okay. Thank you. Congratulations.

Rory Read, CEO

Thanks, Mike.

Operator, Operator

Our next question is from Meta Marshall with Morgan Stanley. Please proceed.

Dave Nwokonko, Analyst

Hi, this is Dave Nwokonko on for Meta Marshall. So you touched on the rule of 40 a little while ago. Just as you progress towards that, do you think that’s driven more by additional OpEx leverage, or will that primarily be driven by growth?

Rory Read, CEO

Yes. So Dave, I mentioned that when we did the Investor Day in the spring this year, our first Investor Day in 20 years, and we won’t wait 20 years for the next one. We look forward to it in the first half of next year again. We kind of gave this a three-year view of our transformation. We expected at the beginning of the year to kind of have a rule of 40 in the high teens and exit the year near the 20. As the year has progressed, we’ve seen strength in terms of the top line, the robust demand for all products. UCC is now approaching double-digit growth and we’ll see that by early 2022. We see it in terms of all APIs, including messaging, and we see it across all of our other APIs. Our rule of 40 went to 27, up from 13 a year ago; that’s a big improvement. We thought we’d see mid-20s in the rule of 40 next year. So, we’re significantly ahead of schedule. It’s never exactly a straight line on that, but we’re definitely seeing momentum in terms of demand and velocity across all geographies, all customer sizes, and this demand for the product is there. So we’re focused on improving our execution on the financials on the bottom line and how positive we thought we would do that in the second half, and we did it a little bit earlier. That’s accelerating, and we expect to continue to throw off more profitability as we move forward. But as Steve said, we’re always going to invest that profitability once we’re in that minus 1% to plus 3% kind of range. We want to invest that into future growth. What’s going to drive and continue to drive the rule of 40 is effective fiscal management with a focus on investing where the customer is going. You’re going to see the growth rate as one of the key drivers of a rule of 40 as we look out over the next two years.

Dave Nwokonko, Analyst

Great. Thanks. And just one follow-up, I was wondering if you could share the FX impact on VCP growth.

Rory Read, CEO

Sure. Steve, you’ve got that.

Steve Lasher, CFO

Yes. When we take a look at FX, it was relatively flat. From our perspective, it is relatively flat. From a VCP service revenue, as reported was 25%, constant currency was 25%.

Rory Read, CEO

So Dave, we saw no impact on that front.

Dave Nwokonko, Analyst

Yes. Thank you. Thanks for the questions and congrats on the quarter.

Rory Read, CEO

Thank you, Dave.

Operator, Operator

Our next question is from Will Power with Baird. Please proceed.

Will Power, Analyst

Okay, great. I guess I echo my congratulations. Great to see the revenue and operating efficiency improvements. Maybe a question on Jumper.ai; that seems like a pretty interesting acquisition and fit for you all. So I guess I’d love to better understand potential impacts that to Q4 and even into 2022 revenue and maybe even on the cost side. And maybe just any other background color on, any integration process, how quickly you can get up and running with that.

Rory Read, CEO

Hey, Will, I love that question. From the standpoint of how we see this market evolving over the next three, five, seven years, we’re going to see this multimodal communications transformation across every industry, every workflow, every geography, every customer size. What we’re seeing is this movement from transactional notifications, kind of flat interaction through these composable APIs, whether it’s videos or messaging or our voice, what’s going to fundamentally occur is it’s going to move from this concept of notification and transactional communication to 360-degree engagements, full conversations ongoing. This is going to be one of the key engagement levers for every industry and every customer. Unfortunately, the pandemic has accelerated that because now all age groups are accepting of this kind of activity. Because of the cloud, mobility, and powerful handsets in everyone’s hand, plus 5G networks with improved latency and bandwidth, we’re seeing that. Jumper.ai, what it does for us is it, it moves. It’s a leader in the conversational commerce space. Look at the customers, I mean, L’Oréal, Burger King, Kiehl's, Dove, Ben & Jerry's, they’re setting a trend there. We believe this is only going to accelerate, is this 360-degree kind of engagement in the metaverse expands and explodes. We think we’re at the beginning of it, but the Jumper team brings technology innovation and customers; that’s going to enable us to be a leader in this space. We have other things that we’re continuing to look at in this space. This is a secular change and that’s why we came to Vonage: to participate in this movement from notification to true engagement. It’s going to change the world. In terms of how we integrate, I had the opportunity to integrate Dell and EMC, the largest tech deal in history. Jumper is going to come in, they’re going to fit right in; they have a great culture, and we’ll spend time with that team. They’re energized about how we can open up the opportunity. We think this is an important capability for us in 2022 and 2023. We’ve always called 2022 and 2023 the year of the product, and you’re going to see us continue to build on that.

Will Power, Analyst

Okay. No, that’s great. Is there anything from a granular standpoint to call out with respect to initial revenue or cost impacts?

Rory Read, CEO

Well, Steve you can comment if you like. But I’d say, I’m not seeing anything significant. On the OpEx side, we’re very financially well structured. We’ve been managing well. You could see the $19 million improvement year-to-year on the bottom line. We’ve structured that all into our outlooks in our forecast. I think it’s going to help us in terms of the velocity of the business because I think it’s a differentiated capability. I don’t think with differentiate capability, it’s also going to help us get into even higher margin, messaging, higher margin APIs. But Steve any comment for Will?

Steve Lasher, CFO

Yes. Will, thanks for the question. When we look at it, look over time, we will see some synergies from Jumper.ai that’s going to allow us to improve our operating margin and that’s going to come over time. It goes back to as Rory mentioned, as transactions move to conversations, that’s going to allow us to improve. But as far as where we are right now, you’re not going to see any significant change to where we are. It’s really about us embedding Jumper into the platform and moving forward and the evolution of transactions to conversations.

Will Power, Analyst

Okay. Great. Thank you.

Operator, Operator

Our next question is from Samad Samana with Jefferies. Please proceed.

Mason Marion, Analyst

Hi. This is Mason Marion on for Samad. Thanks for taking our questions. So I want to go back to API. You mentioned in your prepared remarks that messaging is particularly strong. Going forward, how are you thinking about growth between messaging, voice, and video, and what the main drivers will be?

Rory Read, CEO

Sure. Thanks, Mason. I think from the standpoint of API messaging and this continued trend toward moving notifications to conversation and adding value-added capabilities like the Jumper.ai offering in this conversational commerce is going to continue to drive robust demand in messaging. We see that in the pipelines; we see that in the trend. We’re going to continue to participate in that. You’re going to see Barry and his team doing an outstanding job working across our go-to-market to really understand where the opportunities are to open up TAM and improve even our margin participation with higher value offerings. Our innovation engine is moving more rapidly. So we like the robust demand. That’s a good thing. We see it out into the future based on the pipeline. From the standpoint of the other APIs, like the intelligent messaging APIs, we think this area will ultimately grow faster in terms of percentage base. Some of those will work off some relatively smaller numbers, but there we’ve got to focus on what functionality we need to introduce that will open it up. We’re going to focus on vertical differentiation in our go-to-market team, so we can see the use cases where they’re applied and we’re going to bring expertise. I think it’s a very interesting time. You’ve got this convergence of the cloud, mobility, and 5G networks. This is opening up demand, and we’re seeing robust demand across the board.

Mason Marion, Analyst

Okay. Great. Thank you. And then going over to the UCC business, growth is accelerating right on track. Can you guys talk about your channel partner efforts, and how the channel partners are responding to the changes you’ve made? Can you talk about your direct sales efforts down market and how your new go-to-market motion is resonating there?

Rory Read, CEO

Yes. I’ll make a couple of comments here. The UCC base I’ve been so impressed with our team. We kind of laid out with Rodolpho, Reggie, and others, this kind of concept of really pivoting and turning that business around. We began that work in 2020. We could see it in terms of the pipeline, in terms of bookings, install—it's a waterfall. You can really see it. We’ve seen year-over-year improvements, sequential improvements, and that business is right on track. We’ve called it earlier on these calls that we would return to double-digit growth. The cloud components, Vonage VBC and BCC are already in that mid-double-digit growth. We’re optimistic we’re going to continue to build. Remember Mason, there’s 0.5 billion, let me say that again, 0.5 billion seats that need to move to the cloud—less than 10% of it, maybe right around 10% have moved. This is a huge opportunity, and it’s across all customer segments. We’re doing a nice job in re-energizing micro and small with the work that Joy’s marketing team is working with. The go-to-market has improved in that space. I think—and then the strength that we continue to see in the mid-enterprise. You asked about the channel. I spent the past four weeks meeting with every major channel partner one-on-one, and I’ve spoken at many of their events over the past two months. I believe in the channel. I believe in the channel’s multiple applying capabilities for reach and customer impact. We’ve received feedback that we’re on the right track. They like the portal; they like the tool. They like our ability to work with them to create a great outcome for the customer. We’ve seen the pipeline and the key deals in the channel continue to accelerate. I think where they are is, we’re building real trust with them. They have seen some start and stops with Vonage in the past in the channel. We’re committed. We believe in the channel. We believe in our partners. We’re going to continue to accelerate our investment to build that capability out. We see it in the results. The feedback has been good. The trust is building, and we’re going to continue to follow through on that over the next three, four, eight, or 12 quarters to continue to create that great relationship. I think they want us to win. I really do, and I think they are helping us. So, good feedback so far. But there’s more work to do, and we’re going to do it.

Mason Marion, Analyst

Thank you.

Operator, Operator

Our next question is from Tim Horan with Oppenheimer. Please proceed.

Tim Horan, Analyst

Thanks guys. Your largest API competitor, you kind of grew faster than for, I think the first time I can remember. I’ve always been curious why you haven’t been kind of growing faster than them for the last couple of years, because you have such small market share versus them. My question is, if you look at your top 20, 30 API users globally, are you starting to gain share there with those customers? Do you have the product quality now? Because your points seem to be quite a bit below them, and do you think you’re basically set up at this point to really gain a lot more share from them with the larger customers out there? Thanks.

Rory Read, CEO

Yes. Thanks, Tim. I think one of the things we wanted to do is, during the first phase of the transformation, is to really get the house in order. We did that in the second half of 2020. It’s like restoring a sports car. We’ve taken it out of the garage and we took it out on the track to see what it could do. The feedback is good; the product quality has improved. Knock on wood, we’ll continue to focus on that. We’re adding new features and functions. I highlighted a few like video express in this most recent quarter, last quarter, the HIPAA compliance, and the SOX compliance. These are opening up new TAM for us. We’re getting to the point where we’re getting this business in a good balance. We have fiscal responsibility; we have very good operational discipline and structure, and there’s demand out there. That demand is robust, and for us, we can improve the value we’re getting for our products by adding these new features and functions like Jumper.ai and the conversational commerce or adding the HIPAA compliance messaging to ensure that medical and privacy standards are covered. There’s competitors out there sure. But our focus is we understand them, but we’re really spending our time with our customers, and our customers are telling us we’re on the right track. We’re definitely increasing our footprint with them. We’re expanding across other APIs, but we have more work to do, and we’re going to do it. So, we like the progress we’re on in our three-year transformation. We are ahead of schedule, but the demand is there, and people are reacting to the improvements we’re making. So Tim, we’re going to continue to do what we’re doing, listen to our customers, put customers first, deliver the innovations that create value, and we’re going to go after this market.

Tim Horan, Analyst

But I guess specifically, are the larger API customers looking at dual sourcing at this point, or are you starting to gain some traction with them? Do you think there’s a lot more potential only because it seems like no SG&A and R&D costs with those customers? I would think they want a dual source.

Rory Read, CEO

Yes, Tim, I think you’re spot on. We’re definitely scaling our OpEx now. We’re getting the business in balance so that we can add in particular areas, like you suggested in some of the larger relationships, and we’re winning new routes. We’re expanding our footprint with them. They definitely are reacting. We’re going to go across the entire planet and go after the competition. Customers are reacting. So, you’re spot on that. I definitely think there’s an opportunity, and we’re going to be the aggressor.

Operator, Operator

Our next question is from Drew Glaeser with JPMorgan. Please proceed.

Drew Glaeser, Analyst

Hey guys, congrats on a great quarter. You mentioned this briefly in the prepared remarks, but how are the COVID impacted industries like travel and hospitality performing at this point? Are there any specific verticals that are leading the way in the API business or the UC, CC side?

Rory Read, CEO

Hey, Drew, how are you? Good to speak with you. I’d say in terms of our portfolio, and we’ve commented a couple of times in the past, I think it’s a competitive advantage— the diversity of it, both geographically and vertically wise. We’re definitely seeing improvement in travel and hospitality as COVID kind of moderates. We’re also seeing activity in logistics. We're seeing it in crypto platforms, and we're seeing it in social and payment sectors. There is no question that there is demand out there, and we see it in terms of e-commerce, financial, and logistics. The hospitality area and travel have absolutely picked up, but there's still more room for them to go. They’re going to add a lot more in terms of capacity, and we'll continue to participate in that. I feel that we have a nice combination, so we're not just tied to pre-COVID kind of industry. We're participating across the board. Drew, I think it really is less to do about COVID and more about this change in how customers want to interact. That’s why we went after Jumper AI and that’s why we’re building that technology. This is truly going to move in the direction of engagement in the metaverse for the next five, seven, or 10 years. You had a second question, Drew. What was the second part?

Drew Glaeser, Analyst

So, I think that covered the first one, but I do have another quick question. So you talked about building trust with the channel. I was wondering if you could expand upon what exactly you're doing to incentivize those channel partners?

Rory Read, CEO

Sure, Drew. One of the things that we did when I first got here is reach out to the channel partners, their leadership, and communicated our commitment and focus. Then when we launched the whole Vonage Accelerate and the whole concept of getting that to move faster in the channel, we backed that up with actions, better tooling, better documentation, and better incentives. Our teams have invested to expand our footprint with feet on the street to allow us to deliver that. It’s a series of steps, and within the most recent six to eight weeks, I followed up with all of them with my team to understand what the feedback was. I’ve spoken at a lot of their kickoffs and events. The feedback is positive; they like the investment of the portal, they like the tooling, and the ability to do faster pricing. We need to do it even faster, but the feedback was good and spent time. I’m trying to reinforce that we say that we’re going to do it, we do it, and we follow up. We’ll get feedback and we continue to improve. Their feedback was good; as I said, we’re on track and seeing it in terms of the pipeline and in terms of velocity. We’re not at the knee of the curve yet. I think there's more to do here, and you can hear it in their voice because they’re looking and they’re believing that we’re executing and committed— which we are, and we’re going to build on that activity. Why the channel? They have such reach and are trusted advisers to so many players in the space, particularly in UC/CC, and we will create that combination of Vonage, that channel partner, and that end customer—that's expertise. That's a trusted adviser. That’s better together. Their feedback has been good and we’ll continue to build on our track record. Action will build trust.

Drew Glaeser, Analyst

Yes. Got it. Thank you. That's very helpful.

Operator, Operator

Our next question is from George Sutton with Craig-Hallum. Please proceed.

George Sutton, Analyst

Thank you. Rory, as a long-term follower, I would say this turnaround has been fun to watch, and I think your use of data to create some predictability is really creating renewed confidence in the story. So I think it's great. I had a quick question on Salesforce.com and your ability to go to market with them on the CCaaS side; I know that's been an increased effort for you and certainly an area of enthusiasm for us? And then secondarily, just the issue of the day, Microsoft voice being added to their CCaaS platform. Any thoughts around that relative to your opportunity going through the Microsoft channel? Thank you.

Rory Read, CEO

Thanks, George. Hey, I'll pitch it to Steve for a quick comment on the data because one of the things that we've really focused on over the past 18 months is to give us instrumentation. We invested in our BI structure and analytics capability. Steve, maybe a couple of sentences on the focus; all reports up into you. How are you feeling about our instrumentation and analytics in terms of providing that data to really focus on where the opportunities are?

Steve Lasher, CFO

Sure. Thanks, Rory. And George, thanks for the question. When we take a look at how we're trying to really get underneath the diagnostics to where we compete best and where it gives us the best opportunity to win. Our business analytics, insights, and data, all roll up to me to have one source of the truth. We’re really able to leverage that information especially when we look at the opportunities of the pipeline, how they’re flowing through, and really getting into the details around what allows us to win. Quite frankly, the relationship with Salesforce continues to reveal strong opportunities in the pipeline, and the win rates continue to be really strong. As we continue to win, they pull us into more integration opportunities. That’s really what it’s about —more opportunities swings as we get a chance to engage. We see that continuing.

Rory Read, CEO

Yes. And I'll just add a little about Salesforce; the top-to-top communications are strong. The service cloud voice represents an interesting opportunity. We’re clearly a leadership partner in this. I believe we have significantly more wins than anyone else in this space and that pipeline is trending well. So there's a lot of interest in that top-to-top conversation and we're building it through the team, Jay and Brie who runs our engage partner activity. We’re committed to this and we’re going to build that out. So good traction so far. We will add more feature and function. I do think the Jumper.ai capability, again, will help us in the UCC space as well. So that's an interesting combination. In terms of Microsoft's conversation, it's a 0.5 billion seats out there. I've dealt, competed, and worked with Microsoft for 38 years of my career. I’ve heard so many times that they were going to do this or take over that. There's a huge opportunity out there —they're just starting. We have some great products, solid channel relationships, and there's a 0.5 billion seats. We have a real opportunity to participate in a significant way. We take every competitor seriously, but our focus is on our customer and the opportunity; that’s a big opportunity and we’re going to go get it. Thanks, George.

George Sutton, Analyst

Thank you.

Operator, Operator

Our next question is from Ryan MacWilliams with Barclays. Please proceed.

Ryan MacWilliams, Analyst

Thanks for taking the question. Rory, good to hear about your hands-on and consistent approach to the channel. I know they love that. So with net debt now at like 2.3 times and down almost the full turn from last year, how should we think about M&A here? I know you probably feel pretty good about your hand, but how should we think about anything transformational on the horizon? Thanks.

Rory Read, CEO

Thanks, Ryan. Great to have you back in the fold; always enjoy it. Steve, do you want to share your thoughts on how we improved our net debt? It’s impressive fiscal management, including how we're managing accounts receivable, but what are your thoughts?

Steve Lasher, CFO

Sure. And Ryan, thanks for the question. We've seen strong progress in collections and again, it's really just been the team continuing to go after it, and we’ve done a really nice job with collections and being able to pay down the debt. It shows the operations are running smoothly. There's always work to do. We'll continue to drive and expand on that. We feel pretty good about where we are. From a terms perspective, we're not extending or changing any new terms, so we feel good about that. Moving forward, we’ll continue to pay down the debt as we move forward. When we think about what that allows us to do, it allows us to optimize for M&A, and as you asked the question, Rory runs a robust process around acquisitions, looking for strategic plays in the marketplace. We feel we’re in a pretty good place in terms of the VCP business, getting to profitability, and continuing to utilize cash from consumer. We’re looking through the marketplace focused on key areas that will allow us to build on that top line but advance the strategy and mission that we're on. Jumper.ai is one of the first that you’ll see coming through the pipeline, which we feel really embeds in the technology and helps advance the platform.

Rory Read, CEO

The Board and management are consistently exploring ways to create value for our team members, customers, and shareholders. We are always seeking improvements, and this is a continuous effort. We have a thorough process in place that evaluates over 70 potential interesting assets. While we cast a wide net, our focus remains on enhancing our capabilities through new technologies and skills that provide value. The Jumper.ai acquisition is a strong asset in this regard. We will continue to seek opportunities in the market. We also consider transformational changes. Our company has a long-standing history of collaborating with the Board on such initiatives. Rest assured, we are actively searching every day for ways to enhance value for our shareholders, team members, and customers. Thank you, Ryan.

Ryan MacWilliams, Analyst

Thanks. Just one more on the API side; you mentioned in your prepared remarks and we picked up in our checks that some of your larger UC CC deals included API revenues or API use cases alongside that. Do you think channel partners are becoming more comfortable selling API solutions on top of traditional Contact Center solutions? Are you seeing more cross-sell there? Thanks.

Rory Read, CEO

Yes, it’s a great question, Ryan. The amount of discussion about API in my channel checks that I did over the past eight weeks has definitely increased from the previous two cycles that I've done. I do it about every quarter and a half to get a feel for where that is; the channel is definitely interested in adding it. They see it as future-proofing the opportunity again; I think that’s why this platform concept is a good one. I think whether it's the channel or our UC customer, we’re at the beginning of that kind of integration. But I can tell you in every customer call we make in the UC CC space, the API section where we share our capabilities is probably one of the most well-attended and the best interactions, as their interested in talking because APIs and composable APIs are going to dominate the planet for the next three, five, seven, or 10 years. We’re going to see more of it. It’s still early, but you’re right to feel that, and we are seeing it.

Ryan MacWilliams, Analyst

Thanks guys.

Operator, Operator

Our next question is from Andrew King with Colliers. Please proceed.

Andrew King, Analyst

Hey, thanks for taking my question. Really nice to see the UC CC group accelerating lines of plant laid out at the Analyst Day. Give us an idea how much of that acceleration is being driven by bundled versus standalone contact center.

Rory Read, CEO

Sure. Thanks, Andrew. Yes, the momentum in that space we've laid out; I think the team's done a very nice job of understanding where the products fit. We still see the dominant volume in the pipeline and the closed deals being one or the other, UC or CC, but we’re clearly seeing more and more each quarter, particularly in the larger size deals. Our biggest deals have a combined structure, and that combination is just a natural capability. What we see is a customer engages us on one tower; then once they get into it, they're like, 'Oh, this makes a lot of sense; let’s do both.' I highlighted a couple of those phenomena in the prepared remarks. So we like that, and that business is on track to get to double digits—the cloud components are already there. Thanks, Andrew.

Andrew King, Analyst

Great. If I could just sneak one more quick one in here. There's a pretty meaningful step-up in engineering development this quarter. Could you just talk about what caused that and where you see that going forward, especially with the acquisition of Jumper.ai?

Rory Read, CEO

Yes, I like Steve to comment, but it’s basically a one-time kind of item on some of the accounting. We’re definitely investing and growing that. You’ll see in 2022 and well, 2022 for sure the plans down, but for sure, you will see it in 2023 as well. We’re going to increase and have increased our development footprint; this is a software communications cloud business. The future is around product and innovation. This is just a one-time kind of blip based on some one-time items, but it’s really up to the right. Steve, any further thoughts?

Steve Lasher, CFO

No, I think you hit on it, Rory. We will continue to invest in our engineering and development, and it is a focus for us; we’ll continue to make investments as we move forward.

Rory Read, CEO

Great. Thank you.

Operator, Operator

Our final question is from Steve Enders with KeyBanc Capital Markets. Please proceed.

Unidentified Analyst, Analyst

Hi, this is George on for Steve. Congrats on the quarter. Just one quick one for me. Anything to call out from VCP carrier fees on the messaging side. That's it and congrats again.

Rory Read, CEO

And Steve, do you want to add any comment there? I have some quick thoughts.

Steve Lasher, CFO

Yes, no again, so George, thanks for the question. From a carrier fees perspective, there’s no change as we continue to move through the quarter. Obviously, we'll stay closer as it goes, but as far as impacting any of our guide, we feel confident in what the team's been able to deliver and then going forward when we take a look at the growth from a VCP on a go-forward basis, continuing to see API at that midpoint of about a 37% growth, we're seeing that continue in UC, CC in that high single digits. It's all baked in as we continue to expand on the Rule of 40 as we talk about looking forward and baking in some of these fees. It's really all about our progression. I think the go-forward for us looks great.

Rory Read, CEO

Yes. Thanks, George. Hey, appreciate everyone's time. We definitely look forward to updating you on our progress in 4Q. We've got work to do, so we're going to get to it. Pass it back to you, Sherry.

Operator, Operator

Thank you. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.