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EX-32.1 - EXHIBIT 32.1 - VONAGE HOLDINGS CORPa10-qq217exhibit321certifi.htm
EX-31.2 - EXHIBIT 31.2 - VONAGE HOLDINGS CORPa10-qq217exhibit312certifi.htm
EX-31.1 - EXHIBIT 31.1 - VONAGE HOLDINGS CORPa10-qq217exhibit311certifi.htm
EX-10.1 - EXHIBIT 10.1 - VONAGE HOLDINGS CORPa10-qq217exhibit101jrtrans.htm
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
Form 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2017
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From __________  to __________                    
Commission File Number 001-32887 
VONAGE HOLDINGS CORP.
(Exact name of registrant as specified in its charter)
 
Delaware
 
11-3547680
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
 
 
23 Main Street,
Holmdel, NJ
 
07733
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (732) 528-2600
(Former name, former address and former fiscal year, if changed since last report): Not Applicable
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x  No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
x
  
Accelerated filer
o
 
 
 
 
 
Non-accelerated filer
o  
  
(Do not check if a smaller reporting company)
 
Smaller reporting company
o
 
Emerging growth company
o
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o  No  x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
Outstanding at
July 31, 2017
Common Stock, par value $0.001
 
227,345,315
 
shares


 

VONAGE HOLDINGS CORP.
INDEX
 
Part 1 - Financial Information
 
 
 
 
 
 
Page
Item 1.
Condensed Consolidated Financial Statements and Notes
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 

Financial Information Presentation
For the financial information discussed in this Quarterly Report on Form 10-Q, other than per share and per line amounts, dollar amounts are presented in thousands, except where noted.

2

 

PART 1 - FINANCIAL INFORMATION
ITEM 1 - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES
VONAGE HOLDINGS CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value) 

 
June 30,
2017
 
December 31,
2016
Assets
(unaudited)
 
(revised) (1)
Current assets:
 
 
 
Cash and cash equivalents
$
26,825

 
$
29,078

Marketable securities

 
601

Accounts receivable, net of allowance of $3,112 and $2,093, respectively
36,185

 
36,688

Inventory, net of allowance of $137 and $117, respectively
3,503

 
4,116

Deferred customer acquisition costs, current
1,486

 
2,610

Prepaid expenses
25,833

 
26,041

Other current assets
2,278

 
3,147

Total current assets
96,110

 
102,281

Property and equipment, net of accumulated depreciation of $138,644 and $129,166, respectively
44,688

 
48,415

Goodwill
366,806

 
360,363

Software, net of accumulated amortization of $92,361 and $87,626, respectively
23,867

 
21,971

Restricted cash
1,802

 
1,851

Intangible assets, net of accumulated amortization of $107,914 and $88,419, respectively
188,076

 
199,256

Deferred tax assets
204,286

 
184,210

Other assets
15,761

 
17,319

Total assets
$
941,396

 
$
935,666

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
23,045

 
$
30,751

Accrued expenses
84,170

 
109,195

Deferred revenue, current portion
31,157

 
32,442

Current maturities of capital lease obligations
1,021

 
3,288

Current portion of notes payable
18,750

 
18,750

Total current liabilities
158,143

 
194,426

Indebtedness under revolving credit facility
214,000

 
209,000

Notes payable, net of debt related costs and current portion
81,953

 
91,124

Capital lease obligations, net of current maturities
46

 
140

Other liabilities
5,084

 
4,435

Total liabilities
459,226

 
499,125

 
 
 
 
Commitments and Contingencies (Note 7)

 

 
 
 
 
Stockholders’ Equity
 
 
 
Common stock, par value $0.001 per share; 596,950 shares authorized at June 30, 2017
and December 31, 2016; 294,386 and 282,319 shares issued at June 30, 2017 and
December 31, 2016, respectively; 227,287 and 219,001 shares outstanding at
June 30, 2017 and December 31, 2016, respectively
294

 
282

Additional paid-in capital
1,349,356

 
1,310,847

Accumulated deficit
(627,890
)
 
(641,869
)
Treasury stock, at cost, 67,099 shares at June 30, 2017 and 63,318 shares at
December 31, 2016
(243,229
)
 
(219,125
)
Accumulated other comprehensive loss
3,639

 
(13,594
)
Total stockholders’ equity
482,170

 
436,541

Total liabilities and stockholders’ equity
$
941,396

 
$
935,666


(1) see Note 3. Correction of Prior Period Financial Statements

See accompanying notes to condensed consolidated financial statements.

3

 

VONAGE HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
 

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
 
 
 
(revised) (1)
 
 
 
(revised) (1)
Total revenues
$
251,836

 
$
233,675

 
$
495,183

 
$
460,499

 
 
 
 
 
 
 
 
Operating Expenses:
 
 
 
 
 
 
 
Cost of service (exclusive of depreciation and amortization)
97,674

 
76,078

 
185,270

 
145,228

Cost of goods sold
6,187

 
8,352

 
13,480

 
17,418

Sales and marketing
79,738

 
83,344

 
161,669

 
162,945

Engineering and development
6,670

 
7,243

 
15,040

 
14,077

General and administrative
36,514

 
35,053

 
71,600

 
61,723

Depreciation and amortization
18,394

 
18,218

 
36,341

 
35,197

Total operating expenses
245,177

 
228,288

 
483,400

 
436,588

Income from operations
6,659

 
5,387

 
11,783

 
23,911

Other Income (Expense):
 
 
 
 
 
 
 
Interest income
4

 
25

 
9

 
46

Interest expense
(3,861
)
 
(3,057
)
 
(7,564
)
 
(5,503
)
Other income (expense), net
686

 
104

 
466

 
258

Total other income (expense), net
(3,171
)
 
(2,928
)
 
(7,089
)
 
(5,199
)
Income before income taxes
3,488

 
2,459

 
4,694

 
18,712

Income tax benefit (expense)
1,337

 
(2,241
)
 
6,044

 
(10,563
)
Net income
$
4,825

 
$
218

 
$
10,738

 
$
8,149

Earnings per common share:
 
 
 
 
 
 
 
Basic
$
0.02

 
$

 
$
0.05

 
$
0.04

Diluted
$
0.02

 
$

 
$
0.04

 
$
0.04

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
223,492

 
213,558

 
221,930

 
213,800

Diluted
239,938

 
222,700

 
239,923

 
223,978


(1) see Note 3. Correction of Prior Period Financial Statements

See accompanying notes to condensed consolidated financial statements.

4

 

VONAGE HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 

  
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
 
 
 
(revised) (1)
 
 
 
(revised) (1)
Net income
$
4,825

 
$
218

 
$
10,738

 
$
8,149

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustment
14,185

 
(1,691
)
 
17,232

 
(1,713
)
Unrealized gain on available-for-sale securities
(20
)
 
4

 
1

 
26

Total other comprehensive income (loss)
14,165

 
(1,687
)
 
17,233

 
(1,687
)
Comprehensive income (loss)
$
18,990

 
$
(1,469
)
 
$
27,971

 
$
6,462


(1) see Note 3. Correction of Prior Period Financial Statements

See accompanying notes to condensed consolidated financial statements.

5

 

VONAGE HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) 
 
Six Months Ended
 
June 30,
 
2017
 
2016 (1)
Cash flows from operating activities:
 
 
 
Net income
$
10,738

 
$
8,149

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation, amortization and impairment charges
17,381

 
18,579

Amortization of intangibles
18,826

 
16,618

Deferred income taxes
(8,111
)
 
8,897

Allowance for doubtful accounts
452

 
597

Allowance for obsolete inventory
293

 
352

Amortization of debt issuance costs
204

 
517

Gain on sale of business
(928
)
 

Loss on disposal of fixed assets
134

 

Share-based expense
20,891

 
16,670

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
1,280

 
(7,176
)
Inventory
353

 
906

Prepaid expenses and other current assets
1,173

 
(2,587
)
Deferred customer acquisition costs
1,129

 
913

Accounts payable
(8,124
)
 
5,095

Accrued expenses
(23,787
)
 
(23,311
)
Deferred revenue
(1,506
)
 
(1,534
)
Other assets and liabilities
2,295

 
(158
)
Net cash provided by operating activities
32,693

 
42,527

Cash flows from investing activities:
 
 
 
Capital expenditures
(8,995
)
 
(15,948
)
Purchase of marketable securities

 
(5,664
)
Maturities and sales of marketable securities
602

 
7,524

Acquisition and development of software assets
(6,884
)
 
(5,655
)
Acquisition of businesses, net of cash acquired

 
(163,042
)
Proceeds from sale of business
1,000

 

Net cash used in investing activities
(14,277
)
 
(182,785
)
Cash flows from financing activities:
 
 
 
Principal payments on capital lease obligations and other financing obligations
(4,861
)
 
(6,329
)
Principal payments on notes and revolving credit facility
(19,375
)
 
(33,437
)
Proceeds received from draw down of revolving credit facility and issuance of notes payable
15,000

 
181,250

Debt related costs

 
(1,316
)
Common stock repurchases
(9,542
)
 
(32,902
)
Employee taxes paid on withholding shares
(14,562
)
 
(3,966
)
Proceeds from exercise of stock options
11,962

 
3,023

Net cash (used)/provided by financing activities
(21,378
)
 
106,323

Effect of exchange rate changes on cash
660

 
(109
)
Net decrease in cash, cash equivalents, and restricted cash
(2,302
)
 
(34,044
)
Cash, cash equivalents, and restricted cash, beginning of period
30,929

 
60,313

Cash, cash equivalents, and restricted cash, end of period
$
28,627

 
$
26,269

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the periods for:
 
 
 
Interest
$
6,722

 
$
4,833

Income taxes
$
3,554

 
$
3,163

Non-cash investing and financing activities:
 
 
 
Capital expenditures included in accounts payable and accrued liabilities
$
3,492

 
$
4,918

Issuance of common stock in connection with acquisition of business
$

 
$
31,591

Contingent consideration in connection with acquisition of business
$

 
$
16,472

Assumption of options in connection with acquisition of business
$

 
$
4,779


(1) See Note 2. Summary of Significant Accounting Policies for reclassification due to the adoptions of new Accounting Standard Updates and Note 3. Correction of Prior Period Financial Statements

See accompanying notes to condensed consolidated financial statements.

6

 

VONAGE HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(In thousands)
(Unaudited)
 
 
Shares
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Deficit
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Balance at December 31, 2016 (Revised) (1)
219,001

 
$
282

 
$
1,310,847

 
$
(641,869
)
 
$
(219,125
)
 
$
(13,594
)
 
$
436,541

Cumulative effect adjustment upon the adoption of ASU 2016-09
 
 
 
 
5,668

 
3,241

 
 
 
 
 
8,909

Stock option exercises
12,068

 
12

 
11,950

 
 
 
 
 
 
 
11,962

Share-based expense
 
 
 
 
20,891

 
 
 
 
 
 
 
20,891

Employee taxes paid on withholding shares
(2,183
)
 
 
 
 
 
 
 
(14,562
)
 
 
 
(14,562
)
Common stock repurchases
(1,599
)
 
 
 
 
 
 
 
(9,542
)
 
 
 
(9,542
)
Foreign currency translation adjustment
 
 
 
 
 
 
 
 
 
 
17,232

 
17,232

Unrealized loss on available-for-sale securities
 
 
 
 
 
 
 
 
 
 
1

 
1

Net income
 
 
 
 
 
 
10,738

 
 
 
 
 
10,738

Balance at June 30, 2017
227,287

 
$
294

 
$
1,349,356

 
$
(627,890
)
 
$
(243,229
)
 
$
3,639

 
$
482,170


(1) see Note 3. Correction of Prior Period Financial Statements

See accompanying notes to condensed consolidated financial statements.


7


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)



Note 1.    Basis of Presentation
Nature of Operations
Vonage Holdings Corp. (“Vonage”, “Company”, “we”, “our”, “us”) is incorporated as a Delaware corporation. We are a leading provider of cloud communications services for business. We transform the way people work and businesses operate through a portfolio of cloud-based communications solutions that enable internal collaboration among employees, while also keeping companies closely connected with their customers, across any mode of communication, on any device.
Through our Nexmo subsidiary which was acquired on June 3, 2016, we are a global leader in the Communications-Platform-as-a-Service ("CPaaS") segment of the cloud communications market, providing innovative communication application program interfaces ("APIs") for text messaging and voice communications, allowing developers and enterprises to embed contextual communications into mobile apps, websites and business workflows via text, social media, chat apps and voice. With just few lines of code, developers can send and receive text messages and build programmable voice applications. Nexmo, the Vonage API Platform can scale from one API call to billions. The platform makes it easy for any of our developers to access communication services via software and APIs. Through Nexmo we have a global network of interconnected carriers delivering our API-based communications platform, enabling businesses to communicate with their customers reliably and with ease, no matter where in the world they are located. The addition of our Nexmo products to our business offering allows our customers to address their full communications needs, from employee to employee communications through business to customer communications.
We also provide a robust suite of feature-rich residential communication solutions.
Customers in the United States represented 85% and 93% of our consolidated revenues for the three months ended June 30, 2017 and 2016 and 86% and 94% for the six months ended June 30, 2017 and 2016, respectively, with the balance in Canada, the United Kingdom, and other countries. Nexmo Inc. ("Nexmo") has operations in the United States, United Kingdom, Hong Kong, and Singapore, and provides CPaaS solutions to our customers located in many countries around the world.
Unaudited Interim Financial Information
The accompanying unaudited interim condensed consolidated financial statements and information have been prepared in accordance with accounting principles generally accepted in the United States and in accordance with the SEC's regulations for interim financial information and with the instructions for Form 10-Q. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, these financial statements contain all normal and recurring adjustments considered necessary to present fairly the financial position, results of operations, cash flows, and statement of stockholders’ equity for the periods presented. The results for the three and six months ended June 30, 2017 are not necessarily indicative of the results to be expected for the full year.
These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission on February 28, 2017.
Use of Estimates
Our condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the amounts reported and disclosed in the condensed consolidated financial statements and the accompanying notes. Actual results could differ materially from these estimates.
Reclassifications
Reclassifications have been made to our condensed consolidated financial statements for the prior year period to conform to classification used in the current year period. The reclassifications did not affect results from operations or net assets.

8


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Note 2.    Summary of Significant Accounting Policies
This footnote should be read in conjunction with the complete description of our significant accounting policies under Note 1, Basis of Presentation and Significant Accounting Policies to our Annual Report on Form 10-K for the year ended December 31, 2016.
Cost of Services
Cost of services excludes depreciation and amortization expense of $6,863 and $6,985 for the three months ended June 30, 2017 and 2016 and $13,645 and $13,818 for the six months ended June 30, 2017 and 2016, respectively.
Advertising Costs
We incurred advertising costs included in sales and marketing of $14,994 and $20,079 for the three months ended June 30, 2017 and 2016 and $32,337 and $36,958 for the six months ended June 30, 2017 and 2016, respectively.
Engineering and Development Expenses
Engineering and development expenses primarily include personnel and related costs for developers responsible for new products, and software engineers maintaining and enhancing existing products. Research and development costs related to new product development included in engineering and development were $5,349 and $5,402 for the three months ended June 30, 2017 and 2016 and $11,695 and $10,310 for the six months ended June 30, 2017 and 2016, respectively.
Restructuring Activities
During the three months ended June 30, 2017, we recognized $4 million of costs associated with restructuring activities included in general and administrative expense and is primarily comprised of costs associated with severance and other employee related costs. As of June 30, 2017, the accrued severance of $4 million is expected to be paid during the third quarter of 2017.
Fair Value of Financial Instruments
The Company records certain of its financial assets at fair value on a recurring basis. The Company's financial instruments, which includes cash and cash equivalents, accounts receivable and accounts payable, approximate fair value because of their short-term maturities. The carrying amounts of our capital leases approximate fair value of these obligations based upon management’s best estimates of interest rates that would be available for similar debt obligations at June 30, 2017 and December 31, 2016. We believe the fair value of our debt at June 30, 2017 was approximately the same as its carrying amount as market conditions, including available interest rates, credit spread relative to our credit rating, and illiquidity, remain relatively unchanged from the issuance date of our debt on June 3, 2016 for a similar debt instrument. 
As of June 30, 2017, we did not have any assets or liabilities that are measured and recognized at fair value on a recurring basis. The following table presents the assets and liabilities that are measured and recognized at fair value on a recurring basis classified under the appropriate level of the fair value hierarchy as of December 31, 2016:
 
December 31, 2016
Level 1 Assets
 
Money market fund (1)
$
300

Level 2 Assets
 
Available-for-sale securities (2)
$
601


(1) Included in cash and cash equivalents on our condensed consolidated balance sheet.
(2) Included in marketable securities on our condensed consolidated balance sheet.


9


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Supplemental Balance Sheet Information

Cash, cash equivalents and restricted cash
 
June 30,
2017
 
December 31, 2016
Cash and cash equivalents
$
26,825

 
$
29,078

 
 
 
 
Cash collateralized letter of credit-lease deposits
$
1,580

 
$
1,578

Cash reserves
222

 
273

Restricted cash
$
1,802

 
$
1,851

 
 
 
 
Cash, cash equivalents, and restricted cash
$
28,627

 
$
30,929


Intangible assets, net
 
June 30,
2017
 
December 31, 2016
Customer relationships
129,635

 
133,774

Developed technology
51,882

 
57,245

Patents and patent licenses
4,789

 
5,547

Trade names
698

 
1,033

Non-compete agreements
1,072

 
1,657

Intangible assets, net
$
188,076

 
$
199,256


Accrued expenses
 
June 30,
2017
 
December 31, 2016
Compensation and related taxes and temporary labor
$
28,294

 
$
35,308

Marketing
11,911

 
11,979

Taxes and fees
14,380

 
18,976

Acquisition related consideration accounted for as compensation
1,733

 
6,608

Telecommunications
16,019

 
14,724

Settlement

 
5,000

Other accruals
8,333

 
12,846

Customer credits
1,200

 
2,074

Professional fees
2,300

 
1,680

Accrued expenses
 

$
84,170

 
$
109,195

Recent Accounting Pronouncements
In January 2017, FASB issued ASU 2017-04, "Intangibles - Goodwill and Other". The ASU simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. This ASU is effective for an annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019 on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We are currently evaluating the impact of adopting ASU 2017-04 on our condensed consolidated financial statements and related disclosures.

10


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


In May 2014, FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)" which was further amended through various updates issued by the FASB thereafter. The amendments of Topic 606 clarify the principles for recognizing revenue and provide a common revenue standard for U.S. GAAP and International Financial Reporting Standards, or IFRS, and to improve financial reporting. The core principle of these standards are that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Topic 606 also amends the current guidance for the recognition of costs to obtain and fulfill contracts with customers requiring that all incremental costs of obtaining and direct costs of fulfilling contracts with customers such as commissions be deferred and recognized over the expected customer life. In August 2015, an ASU was issued by the FASB which deferred the effective date to annual and interim periods beginning on or after December 15, 2017. We will adopt the requirements of the new standard in the first quarter of 2018 and anticipate using the modified retrospective transition method under which the standard will be applied only to the most current period presented and the cumulative effect of applying the standard will be recognized at the date of initial application.
We are in the process of evaluating the impact of the standard with respect to the terms of our revenue arrangements and expect our review to be substantially completed during the third quarter of 2017. We expect the timing of recognition of our sales commissions will also be impacted as a substantial portion of these costs which are currently expensed will be capitalized under the revised standard and amortized over the period of benefit.
In October 2016, FASB issued ASU 2016-16, "Income Taxes". This ASU improves the accounting for income tax consequences of intra-entity transfers of assets other than inventory. This ASU is effective for fiscal years beginning after December 15, 2017 on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Early adoption is permitted as of the beginning of an annual reporting period for which financial statements have not been issued or made available for issuance. We are currently evaluating the impact of adopting ASU 2016-16 on our condensed consolidated financial statements and related disclosures.
In August 2016, FASB issued ASU 2016-15, "Statement of Cash Flows". This ASU addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This ASU is effective for fiscal years beginning after December 15, 2017 on a retrospective basis. Early adoption is permitted, including adoption in an interim period. The adoption of ASU 2016-15 will not have a material impact on our condensed consolidated financial statements and related disclosures.
In February 2016, FASB issued ASU 2016-02, "Leases". This ASU increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted for all entities. The adoption of this ASU will increase assets and liabilities for operating leases. We will adopt these ASUs when effective. We are currently evaluating the effect of adopting ASU 2016-02 on our condensed consolidated financial statements and related disclosures.
In January 2016, FASB issued ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities". This ASU provide guidance concerning certain matters involving the recognition, measurement, and disclosure of financial assets and financial liabilities. The guidance does not alter the basic framework for classifying debt instruments held as financial assets. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is not permitted, with some exceptions. The adoption of ASU 2016-01 will not have a material impact on our condensed consolidated financial statements and related disclosures.


11


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


The following standards were adopted by the Company during the current year:
In November 2016, FASB issued ASU 2016-18, "Statement of Cash Flows". This ASU requires that a statement of cash flows explains the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. We adopted this ASU in the first quarter of 2017 and applied the retrospective transition method for each period presented. For the six months ended June 30, 2016, $690 and $10 were reclassified from investing activity and effect of exchange rate changes on cash, respectively, and $51, $2,587 and $1,938 were adjusted to acquisition of business, net of cash acquired, cash, cash equivalents, and restricted cash, beginning of the period and end of the period balances, respectively.
In March 2016, FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting". This ASU is issued as part of its Simplification Initiative. The areas for simplification in this ASU involve several aspects of the accounting for share- based payment transactions, including the income tax consequences, recognition of share-based expense, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted for any entity in any interim or annual period. We adopted this ASU in the first quarter of 2017. We elected to account for forfeitures when they occur versus our prior practice of estimating the number of awards that are expected to vest. The election of this new ASU resulted in a one-time adjustment in 2017 to accumulated deficit and to additional paid-in-capital of $5,668 and the corresponding benefit to our accumulated deficit and deferred tax asset of $2,285 related to the reversal of forfeiture rate as of December 31, 2016. In addition, a benefit to our accumulated deficit and deferred tax asset of $6,624 was recorded for excess tax benefits on equity compensation as of December 31, 2016. We also classified cash paid by us when directly withholding shares for tax-withholding purposes as a financing activity. As a result, $3,966 was reclassified from operating activity to financing activity for the six months ended June 30, 2016.
In July 2015, FASB issued ASU 2015-11, "Simplifying the Measurement of Inventory". This ASU applies to inventory that is measured using first-in, first-out ("FIFO") or average cost. Under the updated guidance, an entity should measure inventory that is within scope at the lower of cost and net realizable value, which is the estimated selling prices in the ordinary course of business, less reasonably predicable costs of completion, disposal and transportation. Subsequent measurement is unchanged for inventory that is measured using last-in, first-out ("LIFO") or the retail inventory. This ASU is effective for annual and interim periods beginning after December 15, 2016, and should be applied prospectively with early adoption on permitted at the beginning of an interim and annual reporting period. We adopted ASU 2015-11 in the first quarter of 2017 and the adoption of this ASU did not have a material impact on our condensed consolidated financial statements and related disclosures.

12


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Note 3.  Correction of Prior Period Financial Statements
In connection with the preparation of our condensed consolidated financial statements for the quarter ended March 31, 2017, and our remediation efforts related to the material weakness in our internal control over financial reporting related to our controls over the preparation of the annual tax provision, we identified an error as of December 31, 2016 in our recognition of a deferred tax asset related to contingent consideration with vesting requirements paid in connection with the acquisition of Nexmo. Based in part upon the vesting requirements of contingent consideration, we recorded the consideration as compensation expense in general and administrative expense in our consolidated statements of operations. However, for tax purposes the contingent consideration should have been recorded as merger consideration and not deductible compensation. The correction of this error requires the reversal of the deferred tax asset on the consolidated balance sheets and related tax benefits of $4,756 as of December 31, 2016. In accordance with Staff Accounting Bulletin (“SAB”) No. 99, Materiality, and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, we evaluated the error and determined that the related impact was not material to our results of operations or financial position for any prior annual or interim period, but that correcting the $4,756 cumulative impact of the error would be material to our results of operations for the three months ended March 31, 2017. Accordingly, we have corrected the consolidated balance sheets as of December 31, 2016 and will correct this error in all prior periods presented by revising the appropriate condensed consolidated financial statements. This error had no impact on the three months ended March 31, 2016. The impact to the consolidated balance sheet as of December 31, 2016 and the consolidated statements of income for the three and six months ended June 30, 2016, the three and nine months ended September 30, 2016, and the three months and year ended December 31, 2016 is as follows:

Consolidated Balance Sheets
 
 
 
 
 
 
 
 
As of December 31, 2016
 
 
As Reported
 
Adjustment
 
As Revised
 
 
 
 
 
 
 
Deferred tax assets, non-current
 
$
188,966

 
$
4,756

 
$
184,210

Total assets
 
940,422

 
4,756

 
935,666

Accumulated deficit
 
(637,113
)
 
4,756

 
(641,869
)
Total stockholders' equity
 
441,297

 
4,756

 
436,541

Total liabilities and stockholders' equity
 
940,422

 
4,756

 
935,666


13


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Condensed Consolidated Statements of Income
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30, 2016
 
June 30, 2016
 
 
As Reported
 
Adjustment
 
As Revised
 
As Reported
 
Adjustment
 
As Revised
 
 
 
 
 
 
 
 
 
 
 
 
 
Income tax expense
 
$
(1,562
)
 
$
679

 
$
(2,241
)
 
$
(9,884
)
 
$
679

 
$
(10,563
)
Net income
 
897

 
679

 
218

 
8,828

 
679

 
8,149

Net income per common share:
 
 
 
 
 
 
 
 
 
 
 
 
   Basic
 
$

 
$

 
$

 
$
0.04

 
$

 
$
0.04

   Diluted
 
$

 
$

 
$

 
$
0.04

 
$

 
$
0.04

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2016
 
September 30, 2016
 
 
As Reported
 
Adjustment
 
As Revised
 
As Reported
 
Adjustment
 
As Revised
 
 
 
 
 
 
 
 
 
 
 
 
 
Income tax expense
 
$
(1,501
)
 
$
2,038

 
$
(3,539
)
 
$
(11,385
)
 
$
2,717

 
$
(14,102
)
Net income
 
9,078

 
2,038

 
7,040

 
17,906

 
2,717

 
15,189

Net income per common share:
 
 
 
 
 
 
 
 
 
 
 
 
   Basic
 
$
0.04

 
$
0.01

 
$
0.03

 
$
0.08

 
$
0.01

 
$
0.07

   Diluted
 
$
0.04

 
$
0.01

 
$
0.03

 
$
0.08

 
$
0.01

 
$
0.07

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
Year Ended
 
 
December 31, 2016
 
December 31, 2016
 
 
As Reported
 
Adjustment
 
As Revised
 
As Reported
 
Adjustment
 
As Revised
 
 
 
 
 
 
 
 
 
 
 
 
 
Income tax expense
 
$
(1,553
)
 
$
2,039

 
$
(3,592
)
 
$
(12,938
)
 
$
4,756

 
$
(17,694
)
Net income
 
1

 
2,039

 
(2,038
)
 
17,907

 
4,756

 
13,151

Net income per common share:
 
 
 
 
 
 
 
 
 
 
 
 
   Basic
 
$

 
$
0.01

 
$
(0.01
)
 
$
0.08

 
$
0.02

 
$
0.06

   Diluted
 
$

 
$
0.01

 
$
(0.01
)
 
$
0.08

 
$
0.02

 
$
0.06



14


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Note 4.    Earnings Per Share
The following table sets forth the computation for basic and diluted earnings per share for the three and six months ended June 30, 2017 and 2016:
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2017
 
2016
 
2017
 
2016
Numerator
 
 
 
(revised) (1)
 
 
 
(revised) (1)
Net income
 
$
4,825

 
$
218

 
$
10,738

 
$
8,149

Denominator
 
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
223,492

 
213,558

 
221,930

 
213,800

Dilutive effect of stock options and restricted stock units
 
16,446

 
9,142

 
17,993

 
10,178

Diluted weighted average common shares outstanding
 
239,938

 
222,700

 
239,923

 
223,978

Basic earnings per share
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
0.02

 
$

 
$
0.05

 
$
0.04

Diluted earnings per share
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
0.02

 
$

 
$
0.04

 
$
0.04


(1) see Note 3. Correction of Prior Period Financial Statements

For the three and six months ended June 30, 2017 and 2016, the following were excluded from the calculation of diluted earnings per common share because of their anti-dilutive effects: 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2017
 
2016
 
2017
 
2016
Restricted stock units
 
4,540

 
12,851

 
3,344

 
12,012

Stock options
 
4,605

 
14,597

 
4,254

 
14,400

 
 
9,145

 
27,448

 
7,598

 
26,412



15


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Note 5.    Long-Term Note and Revolving Credit Facility
This footnote should be read in conjunction with the complete description of our financing arrangements under Note 6, Long-Term Debt and Revolving Credit Facility to our Annual Report on Form 10-K for the year ended December 31, 2016.
A schedule of long-term note and revolving credit facility at June 30, 2017 and December 31, 2016 is as follows:
 
June 30,
2017
 
December 31,
2016
2.50-3.25% Term note - due 2020, net of debt related costs
$
81,953

 
$
91,124

2.50-3.25% Revolving credit facility - due 2020
214,000

 
209,000

Total Long-term note and revolving credit facility
$
295,953

 
$
300,124


2016 Financing
On June 3, 2016, we entered into Amendment No. 1 to the Amended and Restated Credit Agreement (the “2016 Credit Facility”) consisting of a $125.0 million term note and a $325.0 million revolving credit facility. The co-borrowers under the 2016 Credit Facility are the Company and Vonage America Inc., the Company’s wholly owned subsidiary. Obligations under the 2016 Credit Facility are guaranteed, fully and unconditionally, by the Company’s other United States material subsidiaries and are secured by substantially all of the assets of each borrower and each guarantor.
We used $197.8 million of the net available proceeds of the 2016 Credit Facility to retire all of the debt under our 2015 Credit Facility. We used $179.0 million from our 2016 Credit Facility in connection with the acquisition of Nexmo on June 3, 2016. Remaining proceeds from the term note and the undrawn revolving credit facility under the 2016 Credit Facility will be used for general corporate purposes. During the six months ended June 30, 2017, we made mandatory repayments of $9.4 million under the term note and $10.0 million under the revolving credit facility, respectively, and borrowed $15.0 million under the revolving credit facility. In addition, the effective interest rate was 4.25% as of June 30, 2017.

Interest Rate Swap
On July 14, 2017, we executed on three interest rate swap agreements in order to hedge the variability of expected future cash interest payments related to the 2016 Credit Facility. The swaps have an aggregate notional amount of $150 million and are effective on July 31, 2017 through June 3, 2020 concurrent with the term of the 2016 Credit Facility. Under the swaps our interest rate is fixed at 4.7%. The interest rate swaps will be accounted for as cash flow hedges in accordance with ASC 815, Derivatives and Hedging.
Note 6.    Common Stock
As of June 30, 2017 and December 31, 2016, the Company had 596,950 shares of common stock authorized and had 11,369 shares available for grants under our share-based compensation programs as of June 30, 2017. For a detailed description of our share-based compensation programs refer to Note 9, Employee Benefit Plans in our Annual Report on Form 10-K for the year ended December 31, 2016.
Common Stock Repurchases
On December 9, 2014, Vonage's Board of Directors authorized a program for the Company to repurchase up to $100.0 million of its outstanding common stock (the "2014 $100.0 million repurchase program"). Repurchases under the 2014 $100.0 million repurchase program are expected to be made over a four-year period ending on December 31, 2018.

16


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


We repurchased the following shares of common stock with cash resources under the 2014 $100.0 million repurchase program during the three and six months ended June 30, 2017 and 2016:
  
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
Shares of common stock repurchased

 
5,747

 
1,599

 
7,400

Value of common stock repurchased
$

 
$
24,754

 
$
9,510

 
$
32,762

As of June 30, 2017, $42,533 remained of our 2014 $100.0 million repurchase program. The repurchase program expires on December 31, 2018 but may be suspended or discontinued at any time without notice.
In any period under the 2014 $100.0 million repurchase program, cash used in financing activities related to common stock repurchases may differ from the comparable change in stockholders' equity, reflecting timing differences between the recognition of share repurchase transactions and their settlement for cash.
Note 7.    Commitments and Contingencies
From time to time, in addition to those identified below, we are subject to legal proceedings, claims, investigations, and proceedings in the ordinary course of business, including claims of alleged infringement of third-party patents and other intellectual property rights, commercial, employment, and other matters. From time to time we receive letters or other communications from third parties inviting us to obtain patent licenses that might be relevant to our business or alleging that our services infringe upon third party patents or other intellectual property. In accordance with generally accepted accounting principles, we make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss or range of loss can be reasonably estimated. These provisions, if any, are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. We believe that we have valid defenses with respect to the legal matters pending against us and are vigorously defending these matters. Given the uncertainty surrounding litigation and our inability to assess the likelihood of a favorable or unfavorable outcome in the matters noted below and our inability to reasonably estimate the amount of loss or range of loss, it is possible that the resolution of one or more of these matters could have a material adverse effect on our condensed consolidated financial position, cash flows or results of operations.
Litigation
IP Matters
Bear Creek Technologies, Inc. On June 26, 2017, the litigations brought by Bear Creek Technologies, Inc. against Vonage Holdings Corp. and certain of its subsidiaries were dismissed with prejudice pursuant to stipulation, with no settlement paid by the Company.
RPost Holdings, Inc. On August 24, 2012, RPost Holdings, Inc., RPost Communications Limited, and RMail Limited (collectively, “RPost”) filed a lawsuit against StrongMail Systems, Inc. (“StrongMail”) in the United States District Court for the Eastern District of Texas alleging that StrongMail’s products and services, including its electronic mail marketing services, are covered by United States Patent Nos. 8,224,913, 8,209,389, 8,161,104, 7,966,372, and 6,182,219. On February 11, 2013, RPost filed an amended complaint, adding 27 new defendants, including Vonage America Inc. RPost’s amended complaint alleges willful infringement of the RPost patents by Vonage and each of the other new defendants because they are customers of StrongMail. StrongMail has agreed to fully defend and indemnify Vonage in this lawsuit. Vonage answered the complaint on May 7, 2013. On September 17, 2015, the Court ordered the consolidation for pre-trial purposes of this case with other cases by RPost. The lead case has been administratively closed and stayed since January 30, 2014 due to multiple pending actions by third parties regarding ownership of the patents at issue. On June 1, 2017, the parties in the consolidated actions filed a joint notice regarding status of the co-pending actions. Plaintiffs requested that the stay be lifted, while defendants maintain that the stay should remain in place.

17


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


AIP Acquisition LLC. On January 3, 2014, AIP Acquisition LLC (“AIP”), filed a lawsuit against Vonage Holdings Corp., Vonage America, Inc., and Vonage Marketing LLC in the U.S. District Court for the District of Delaware alleging that Vonage’s products and services are covered by United States Patent No. 7,269,247. Vonage filed an answer and counterclaims on February 25, 2014. AIP filed an amended complaint on March 18, 2014, which Vonage answered on April 4, 2014. On April 8, 2014, the Court stayed the case pending final resolution of non-party Level 3’s inter partes review request of United States Patent No. 7,724,879, which is a continuation of the ‘247 patent. On October 8, 2014, the Patent Office issued a Final Written Decision, finding all challenged claims of the ‘879 patent to be invalid. On November 10, 2015, the Federal Circuit rejected AIP’s appeal and affirmed the Patent Office’s rejection of the ‘879 patent.
Cisco petitioned for inter partes review of the ‘247 patent on November 25, 2014, which was granted on May 20, 2015. On May 18, 2016, the Patent Office issued a Final Written Decision, finding all challenged claims of the ‘247 patent to be invalid. AIP appealed to the Federal Circuit, filing its opening brief on December 15, 2016. On December 20, 2016, the Patent Office filed a notice of intervention in the appellate proceedings. Briefing on the appeal is complete, with oral argument to be scheduled.
Commercial Litigation
Merkin & Smith, et al.  On September 27, 2013, Arthur Merkin and James Smith filed a putative class action lawsuit against Vonage America, Inc. in the Superior Court of the State of California, County of Los Angeles, alleging that Vonage violated California’s Unfair Competition Law by charging its customers fictitious 911 taxes and fees. On October 30, 2013, Vonage filed a notice removing the case to the United States District Court for the Central District of California. On November 26, 2013, Vonage filed its Answer to the Complaint. On December 4, 2013, Vonage filed a Motion to Compel Arbitration, which the Court denied on February 4, 2014. On March 5, 2014, Vonage appealed that decision to the United States Court of Appeals for the Ninth Circuit. On March 26, 2014, the district court proceedings were stayed pending the appeal. On February 29, 2016, the Ninth Circuit reversed the district court’s ruling and remanded with instructions to grant the motion to compel arbitration. On March 22, 2016, Merkin and Smith filed a petition for rehearing. On May 4, 2016, the Ninth Circuit withdrew its February 29, 2016 decision and issued a new order reversing the district court’s order and remanded with instructions to compel arbitration. The Ninth Circuit also declared as moot the petition for rehearing. On June 27, 2016, the lower court stayed the case pending arbitration. A joint status report was filed with the District Court on December 23, 2016. A second joint status report was filed with the District Court on March 23, 2017. A third joint status report was filed with the District Court on June 27, 2017.
Regulation
Telephony services are subject to a broad spectrum of state and federal regulations. Because of the uncertainty over whether Voice over Internet Protocol (“VoIP”) should be treated as a telecommunications or information service, we have been involved in a substantial amount of state and federal regulatory activity. Implementation and interpretation of the existing laws and regulations is ongoing and is subject to litigation by various federal and state agencies and courts. Due to the uncertainty over the regulatory classification of VoIP service, there can be no assurance that we will not be subject to new regulations or existing regulations under new interpretations, and that such change would not introduce material additional costs to our business.
Federal - Net Neutrality
Clear and enforceable net neutrality rules make it more difficult for broadband Internet service providers to block or discriminate against Vonage service. In addition, explicitly applying net neutrality rules to wireless broadband Internet service providers could create greater opportunities for VoIP applications that run on wireless broadband Internet service. In December 2010, the FCC adopted net neutrality rules that applied strong net neutrality rules to wired broadband Internet service providers and limited rules to wireless broadband Internet service providers. On January 14, 2014, the D.C. Circuit Court of Appeals vacated a significant portion of the 2010 rules. On May 15, 2014, the FCC issued a Notice of Proposed Rulemaking (NPRM) proposing new net neutrality rules. After public response to the NPRM, the FCC adopted new neutrality rules on February 26, 2015. These rules prohibit broadband Internet service providers from: (1) blocking or throttling lawful content applications, or services; (2) imposing paid prioritization arrangements; and (3) unreasonably interfering or unreasonably disadvantaging consumers or edge providers. In addition, broadband Internet service providers are required to make certain disclosures regarding their network management practices, network performance, and commercial terms. These net neutrality rules apply the same requirements to wired and wireless broadband Internet service providers. Several parties filed appeals which are pending at the D.C. Circuit Court of Appeals. Oral arguments at the D.C. Circuit Court of Appeals were held on December 4, 2015. On June 14, 2016, the D.C. Circuit of Appeals denied the appeals. Several parties filed a petition for rehearing en banc on July 29, 2016, which was denied on May 1, 2017.

18


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Federal - Rural Call Completion Issues
On February 7, 2013, the FCC released a Notice of Proposed Rulemaking (NPRM) on rural call completion issues. The NPRM proposed new detailed reporting requirements to gauge rural call completion performance. Rural carriers have argued that VoIP provider call completion performance to rural areas is generally poor. On October 28, 2013, the FCC adopted an order on rural call completion imposing new reporting obligations and restricting certain call signaling practices. The call signaling rules went into effect on January 31, 2014.  We filed for extensions of the rules, which the FCC granted, and as of April 17, 2014, we were compliant with the FCC call signaling rules.  The effective date for the reporting requirements was April 1, 2015. We could be subject to an FCC enforcement action in the future in the event the FCC took the position that our rural call completion performance is inadequate or we were not compliant with the FCC’s order. On June 22, 2017, the FCC issued a Second Further Notice of Proposed Rulemaking. The FCC has proposed changes to the FCC's rules that allegedly would more effectively address rural call completion problems while reducing burdens on covered providers. Vonage is reviewing and evaluating the FCC's proposed changes.
State Telecommunications Regulation
In general, the focus of interconnected VoIP telecommunications regulation is at the federal level. On November 12, 2004, the FCC issued a declaratory ruling providing that our service is subject to federal regulation and preempted the Minnesota Public Utilities Commission (“MPUC”) from imposing certain of its regulations on us. The FCC's decision was based on its conclusion that our service is interstate in nature and cannot be separated into interstate and intrastate components. On March 21, 2007, the United States Court of Appeals for the 8th Circuit affirmed the FCC's declaratory ruling preempting state regulation of our service.
While this ruling does not exempt us from all state oversight of our service, it effectively prevents state telecommunications regulators from imposing certain burdensome and inconsistent market entry requirements and certain other state utility rules and regulations on our service. State regulators continue to probe the limits of federal preemption in their attempts to apply state telecommunications regulation to interconnected VoIP service. On July 16, 2009, the Nebraska Public Service Commission and the Kansas Corporation Commission filed a petition with the FCC seeking a declaratory ruling or, alternatively, adoption of a rule declaring that state authorities may apply universal service funding requirements to nomadic VoIP providers. We participated in the FCC proceedings on the petition. On November 5, 2010, the FCC issued a declaratory ruling that allowed states to assess state USF on nomadic VoIP providers on a going forward basis provided that the states comply with certain conditions to ensure that imposing state USF does not conflict with federal law or policy. More recently on July 28, 2015, the MPUC found that it has authority to regulate Charter’s fixed, interconnected VoIP service. Charter challenged the MPUC’s order at the U.S. District Court for Minnesota. This challenge is currently pending. We expect that state public utility commissions and state legislators will continue their attempts to apply state telecommunications regulations to nomadic VoIP service.
State and Municipal Taxes
In accordance with generally accepted accounting principles, we make a provision for a liability for taxes when it is both probable that a liability has been incurred and the amount of the liability or range of liability can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. For a period of time, we did not collect or remit state or municipal taxes (such as sales, excise, utility, use, and ad valorem taxes), fees or surcharges (“Taxes”) on the charges to our customers for our services, except that we historically complied with the New Jersey sales tax. We have received inquiries or demands from a number of state and municipal taxing and 911 agencies seeking payment of Taxes that are applied to or collected from customers of providers of traditional public switched telephone network services. Although we have consistently maintained that these Taxes do not apply to our service for a variety of reasons depending on the statute or rule that establishes such obligations, we are now collecting and remitting sales taxes in certain of those states including a number of states that have changed their statutes to expressly include VoIP. In addition, many states address how VoIP providers should contribute to support public safety agencies, and in those states we remit fees to the appropriate state agencies. We could also be contacted by state or municipal taxing and 911 agencies regarding Taxes that do explicitly apply to VoIP and these agencies could seek retroactive payment of Taxes. As such, we have reserves of $653 and $1,763 as of June 30, 2017 and December 31, 2016, respectively, as our best estimate of the potential tax exposure for any retroactive assessment. We believe the maximum estimated exposures for retroactive assessments are approximately $2,000 and $2,600 as of June 30, 2017 and December 31, 2016, respectively.


19


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Note 8. Acquisitions and Dispositions

Sale of Hosted Infrastructure Product Line

On May 31, 2017, we completed the sale of our Hosted Infrastructure product line for up to $4.0 million consideration comprised of $1.0 million received upon closing and the potential for an additional $0.5 million to be paid six months from closing and up to $2.5 million based on the achievement of financial objectives for net sales during the 18 months following closing. The results of our Hosted Infrastructure product line have been included within our business segment. As a result of the sale, we recorded a gain of $928 within other income for the three months ended June 30, 2017. This disposal did not represent a strategic shift in operations and, therefore, did not qualify for presentation as discontinued operations.
Acquisition of Nexmo
Nexmo is a global leader in the Communications-Platform-as-a-Service (“CPaaS”) segment of the cloud communications market. Nexmo provides innovative communication application program interfaces (“APIs”) for text messaging and voice communications, allowing developers and enterprises to embed contextual communications into mobile apps, websites and business workflows via text, social media, chat apps and voice.
Pursuant to the Agreement and Plan of Merger dated May 5, 2016, by and among the Company, Neptune Acquisition Corp., a Delaware corporation and newly formed indirect, wholly owned subsidiary of Vonage (“Merger Sub”), Nexmo, a Delaware corporation, and Shareholder Representative Services LLC, a Colorado limited liability company, as representative of the security holders of Nexmo, on June 3, 2016, Merger Sub, on the terms and subject to the conditions thereof, merged with and into Nexmo, and Nexmo became a wholly owned indirect subsidiary of Vonage.
On June 2, 2016, Vonage, Merger Sub, Nexmo and the Representative entered into Amendment No. 1 to the Merger Agreement (the “Amendment”). The Amendment amended the Merger Agreement to, among other things, (1) increase the purchase price payable to the Nexmo security holders by the amount of unrestricted cash and cash equivalents of Nexmo in lieu of the declaration of a dividend or other distribution of such unrestricted cash and cash equivalents to the Nexmo security holders, (2) clarify the treatment of enterprise management incentive options issued by Nexmo to certain of its employees located in the United Kingdom, and (3) add certain technical provisions with respect to deposits made to the escrow agent and the exchange agent in connection with the closing of the transactions contemplated by the Merger Agreement.
Under the agreement, Nexmo shareholders received consideration of $231,122, with an additional earn-out opportunity (the "contingent consideration") of up to $20,000 contingent upon Nexmo achieving certain performance targets. Of the consideration, $194,684 (net of cash acquired of $16,094) was paid at close, consisting of $163,093 of cash (net of $16,094 of cash acquired) and 6,823 in shares of Vonage common stock valued at $31,591. The remaining $36,438 of the $231,122 purchase price is in the form of restricted cash, restricted stock and options held by Nexmo management and employees (the "Employee Payout Amount"), subject to vesting requirements over time and to be amortized to compensation expense quarterly until vested. We financed the transaction with $179,000 from our 2016 Credit Facility. The purchase price was subject to adjustments pursuant to the merger agreement for closing cash and working capital of Nexmo, reductions for indebtedness and transaction expenses of Nexmo that remained unpaid as of closing, and escrow fund deposits. The aggregate consideration will be allocated among Nexmo equity holders.
The consideration was allocated to acquisition cost as follows:
Cash paid at closing (inclusive of cash acquired of $16,094)
$
179,186

Stock paid at closing
31,591

Contingent consideration (described below)
16,472

Employee Payout Amount (described below)
4,779

Acquisition Cost
$
232,028


20


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


In addition, Nexmo shareholders were eligible to earn a Variable Payout Amount of up to $20,000, subject to the achievement of certain performance targets during the 12 month period following the closing of the transaction. The contingent consideration payable to the holders of Nexmo stock is determined based on (i) the achievement of certain revenue targets for the calendar year 2016, and (ii) Nexmo’s revenues received from its top customers following the closing. The contingent consideration may be in the form of cash, a number of shares of Vonage common stock or a combination thereof, at our sole discretion. We estimated using probability weighting that the value of the contingent consideration is $17,840 at the acquisition date and included that amount in acquisition cost at the net present value amount of $16,472. As of December 31, 2016, Nexmo did not achieve the performance targets necessary to earn the Variable Payout Amount but the parties agreed to a $5,000 settlement that the parties were paid in the first quarter of 2017. The $5,000 settlement was reflected in accrued expenses within the condensed consolidated balance sheets and in general and administrative expenses in the condensed consolidated statements of income during the year ended December 31, 2016.
In addition, Nexmo management and employees were eligible to earn an Employee Payout Amount of $36,438 attributable to restricted cash, restricted stock and assumed options, of which $4,779 is included in acquisition cost as service had been provided pre-acquisition and $31,659 will be recorded as post-acquisition expense assuming all amounts vest, of which $31,087 will be recorded as compensation expense and $572 will be recorded as interest expense as continued employment is a condition of receiving consideration.
Pursuant to the merger agreement, $20,372 of the cash consideration and $5,081 of the stock consideration were placed in escrow for unknown liabilities that may have existed as of the acquisition date.
For the three months ended June 30, 2017 and June 30, 2016, we incurred approximately $10 and $5,059, respectively, in acquisition related transaction costs, which were recorded in general and administrative expense in the accompanying condensed consolidated statements of income. For the full year 2016, we incurred approximately $5.5 million in acquisition related transaction costs.
The acquisition was accounted for using the acquisition method of accounting under which assets and liabilities of Nexmo were recorded at their respective fair values including an amount for goodwill representing the difference between the acquisition consideration and the fair value of the identifiable net assets. We do not expect any portion of this goodwill to be deductible for tax purposes. The goodwill attributable to the acquisition has been recorded as a non-current asset and is not amortized, but is subject to an annual review for impairment. The factors that contributed to goodwill include synergies that are specific to our consolidated business, the acquisition of a talented workforce that provides us with expertise in the small and medium business markets, as well as other intangible assets that do not qualify for separate recognition.
The acquisition price was allocated to the tangible and identified intangible assets acquired and liabilities assumed as of the closing date. The fair values assigned to identifiable intangible assets assumed were based on management’s current estimates and assumptions. The accounting for the Nexmo acquisition was completed during the three months ended June 30, 2017, at which point the fair values became final. The table below summarizes the provisional amounts recognized for assets acquired and liabilities assumed as of December 31, 2016 as well as adjustments made through the three months ended June 30, 2017, when the allocation became final. Measurement period adjustments primarily reflect the tax impact of the acquisition date fair values.

21


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


The purchase price was allocated as follows:
 
Acquisition Date Fair Value as of December 31, 2016
 
Measurement period adjustments
 
Revised Acquisition Date Fair Value
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
16,094

 
$

 
$
16,094

Accounts receivable
8,764

 

 
8,764

Prepaid expenses and other current assets
3,507

 

 
3,507

Total current assets
28,365

 

 
28,365

Property and equipment
757

 

 
757

Software, net
242

 

 
242

Intangible assets
101,770

 

 
101,770

Restricted cash
51

 

 
51

Total assets acquired
131,185

 

 
131,185

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Accounts payable
1,841

 

 
1,841

Accrued expenses
9,299

 

 
9,299

Deferred revenue, current portion
1,735

 

 
1,735

Total current liabilities
12,875

 

 
12,875

Deferred tax liabilities, net, non-current
29,355

 
(5,482
)
 
23,873

Total liabilities assumed
42,230

 
(5,482
)
 
36,748

 
 
 
 
 
 
Net identifiable assets acquired
88,955

 
5,482

 
94,437

Goodwill
143,073

 
(5,482
)
 
137,591

Total purchase price
$
232,028

 
$

 
$
232,028

Identifiable intangible assets recognized in connection with the acquisition included:
  
Amount

Customer relationships
$
85,900

Developed technologies
13,768

Non-compete agreements
972

Trade names
1,130

 
$
101,770


22


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Goodwill
The following table provides a summary of the changes in the carrying amounts of goodwill which is attributable to our business segment:
Balance at December 31, 2016
 
$
360,363

Decrease in goodwill related acquisition of Nexmo
 
(5,482
)
Currency translation adjustments
 
11,925

Balance at June 30, 2017
 
$
366,806

Pro forma financial information
The following unaudited supplemental pro forma information presents the combined historical results of operations of Vonage and Nexmo for the six months ended June 30, 2016, as if the acquisition had been completed at the beginning of 2016.
 
 
Six Months Ended
 
 
June 30,
 
 
2016
Revenues
 
$
494,094

Net income
 
$
5,887

Earnings per common share - basic
 
$
0.03

Earnings per common share - diluted
 
$
0.03

The pro forma financial information includes certain adjustments to reflect expenses in the appropriate pro forma periods as though the companies were combined as of the beginning of 2016 and includes the pro-forma impact of amortization of identifiable intangibles assets and interest expense on borrowings under our revolving line of credit utilized to, in part, finance the acquisition. The pro forma data was also adjusted to eliminate non-recurring transaction costs incurred by us as well as the related tax impact. The pro forma results are not necessarily indicative of the results that we would have achieved had the transaction actually occurred on January 1, 2016 and does not purport to be indicative of future financial operating results nor does it reflect any operating efficiencies and cost savings that may be realized from the integration of the acquisition.

Note 9. Industry Segment and Geographic Information
ASC 280 "Segment Reporting" establishes reporting standards for an enterprise's business segments and related disclosures about its products, services, geographic areas and major customers. Under ASC 280, the method for determining what information to report is based upon the way management organizes the operating segments within the Company for making operating decisions and assessing financial performance. Our chief operating decision-maker reviews revenue and gross margin information for each of our reportable segments, but does not review operating expenses on a segment by segment basis. In addition, with the exception of goodwill and intangible assets, we do not identify or allocate our assets by the reportable segments.

23


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Business
For our Business customers, we provide innovative, cloud-based Unified Communications as a Service, or UCaaS, solutions, comprised of integrated voice, text, video, data, collaboration, and mobile applications over our flexible, scalable Session Initiation Protocol (SIP) based Voice over Internet Protocol, or VoIP, network. Through Nexmo, the Vonage API Platform, we also offer Communications Platform as a Service, or CPaaS, solutions designed to enhance the way businesses communicate with their customers embedding communications into apps, websites and business processes. Together we have a robust set of product families tailored to serve the full range of the business value chain, from the small and medium business, or SMB, market, through mid-market and enterprise markets. We provide customers with multiple deployment options, designed to provide the reliability and quality of service they demand. We provide customers the ability to integrate our cloud communications platform with many cloud-based productivity and CRM solutions, including Google’s G Suite, Zendesk, Salesforce’s Sales Cloud, Oracle, Clio, and other CRM solutions. In combination, our products and services permit our business customers to communicate with their customers and employees through any cloud-connected device, in any place, at any time without the often costly investment required with on-site equipment.
Consumer
For our Consumer customers, we enable users to access and utilize our UCaaS services and features, via a single “identity,” either a number or user name, regardless of how they are connected to the Internet, including over 3G, LTE, Cable, or DSL broadband networks. This technology enables us to offer our Consumer customers attractively priced voice and messaging services and other features around the world on a variety of devices.
For our segments we categorize revenues as follows:
Services revenues. Services revenues consists primarily of revenue attributable to our communication services for Consumer and Software Defined Wide Area Network, or SD-WAN, UCaaS and CPaaS services for Business,
Product revenues. Product revenues includes equipment sold to customers, shipping and handling, professional services, and broadband access.
USF revenues. USF revenues represent contributions to the Federal Universal Service Fund (“USF”) and related fees.
For our segments we categorize cost of revenues as follows:
Services cost of revenues. Services cost of revenues consists of costs associated with network operations and technical support personnel, communication origination, and termination services provided by third party carriers and excludes depreciation and amortization.
Product cost of revenues. Product cost of revenues includes equipment sold to customers, shipping and handling, professional services, cost of certain products including equipment or services that we give customers as promotions, and broadband access.
USF cost of revenues. USF cost of revenues represents contributions to the Federal Universal Service Fund (“USF”) and related fees.

24


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Information about our segment results for the three and six months ended June 30, 2017 were as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2017
 
June 30, 2017
 
Business
 
Consumer
 
Total
 
Business
 
Consumer
 
Total
Revenues
 
 
 
 
 
 
 
 
 
 
 
Service revenues
$
103,825

 
$
115,636

 
$
219,461

 
$
196,116

 
$
234,753

 
$
430,869

Product revenues (1)
13,392

 
201

 
13,593

 
26,752

 
404

 
27,156

Service and product revenues
117,217

 
115,837

 
233,054

 
222,868

 
235,157

 
458,025

USF revenues
6,497

 
12,285

 
18,782

 
12,648

 
24,510

 
37,158

Total revenues
123,714

 
128,122

 
251,836

 
235,516

 
259,667

 
495,183

 
 
 
 
 
 
 
 
 
 
 
 
Cost of revenues
 
 
 
 
 
 
 
 
 
 
 
Service cost of revenues (2)
49,246

 
21,435

 
70,681

 
88,441

 
43,535

 
131,976

Product cost of revenues (1)
12,456

 
1,942

 
14,398

 
25,658

 
3,958

 
29,616

Service and product cost of revenues
61,702

 
23,377

 
85,079

 
114,099

 
47,493

 
161,592

USF cost of revenues
6,497

 
12,285

 
18,782

 
12,648

 
24,510

 
37,158

Total cost of revenues
68,199

 
35,662

 
103,861

 
126,747

 
72,003

 
198,750

 
 
 
 
 
 
 
 
 
 
 
 
Gross margin
 
 
 
 
 
 
 
 
 
 
 
Service margin
54,579

 
94,201

 
148,780

 
107,675

 
191,218

 
298,893

Product margin
936

 
(1,741
)
 
(805
)
 
1,094

 
(3,554
)
 
(2,460
)
Gross margin ex-USF (Service and product margin)
55,515

 
92,460

 
147,975

 
108,769

 
187,664

 
296,433

USF margin

 

 

 

 

 

Gross margin
$
55,515

 
$
92,460

 
$
147,975

 
$
108,769

 
$
187,664

 
$
296,433

 
 
 
 
 
 
 
 
 
 
 
 
Gross margin %
 
 
 
 
 
 
 
 
 
 
 
Service margin %
52.6
%
 
81.5
%
 
67.8
%
 
54.9
%
 
81.5
%
 
69.4
%
Gross margin ex-USF (Service and product margin %)
47.4
%
 
79.8
%
 
63.5
%
 
48.8
%
 
79.8
%
 
64.7
%
Gross margin %
44.9
%
 
72.2
%
 
58.8
%
 
46.2
%
 
72.3
%
 
59.9
%
(1) Includes customer premise equipment, access, professional services, and shipping and handling.
(2) Excludes depreciation and amortization of $5,003 and $1,860 for the three months ended June 30, 2017 and $9,878 and $3,767 for the six months ended June 30, 2017, respectively.

25


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


Information about our segment results for the three and six months ended June 30, 2016 were as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2016
 
June 30, 2016
 
Business
 
Consumer
 
Total
 
Business
 
Consumer
 
Total
Revenues
 
 
 
 
 
 
 
 
 
 
 
Service revenues
$
67,079

 
$
133,462

 
$
200,541

 
$
123,552

 
$
271,234

 
$
394,786

Product revenues (1)
13,265

 
160

 
13,425

 
26,177

 
307

 
26,484

Service and product revenues
80,344

 
133,622

 
213,966

 
149,729

 
271,541

 
421,270

USF revenues
5,368

 
14,341

 
19,709

 
9,803

 
29,426

 
39,229

Total revenues
85,712

 
147,963

 
233,675

 
159,532

 
300,967

 
460,499

 
 
 
 
 
 
 
 
 
 
 
 
Cost of revenues
 
 
 
 
 
 
 
 
 
 
 
Service cost of revenues (2)
22,527

 
25,727

 
48,254

 
37,930

 
52,247

 
90,177

Product cost of revenues (1)
12,902

 
3,564

 
16,466

 
25,364

 
7,865

 
33,229

Service and product cost of revenues
35,429

 
29,291

 
64,720

 
63,294

 
60,112

 
123,406

USF cost of revenues
5,369

 
14,341

 
19,710

 
9,814

 
29,426

 
39,240

Total cost of revenues
40,798

 
43,632

 
84,430

 
73,108

 
89,538

 
162,646

 
 
 
 
 
 
 
 
 
 
 
 
Gross margin
 
 
 
 
 
 
 
 
 
 
 
Service margin
44,552

 
107,735

 
152,287

 
85,622

 
218,987

 
304,609

Product margin
363

 
(3,404
)
 
(3,041
)
 
813

 
(7,558
)
 
(6,745
)
Gross margin ex-USF (Service and product margin)
44,915

 
104,331

 
149,246

 
86,435

 
211,429

 
297,864

USF margin
(1
)
 

 
(1
)
 
(11
)
 

 
(11
)
Gross margin
$
44,914

 
$
104,331

 
$
149,245

 
$
86,424

 
$
211,429

 
$
297,853

 
 
 
 
 
 
 
 
 
 
 
 
Gross margin %
 
 
 
 
 
 
 
 
 
 
 
Service margin %
66.4
%
 
80.7
%
 
75.9
%
 
69.3
%
 
80.7
%
 
77.2
%
Gross margin ex-USF (Service and product margin %)
55.9
%
 
78.1
%
 
69.8
%
 
57.7
%
 
77.9
%
 
70.7
%
Gross margin %
52.4
%
 
70.5
%
 
63.9
%
 
54.2
%
 
70.2
%
 
64.7
%
(1) Includes customer premise equipment, access, professional services, and shipping and handling.
(2) Excludes depreciation and amortization of $4,473 and $2,512 for the three months ended June 30, 2016 and $8,792 and $5,026 for six months ended June 30, 2016, respectively

26


VONAGE HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(Unaudited)


A reconciliation of the total of the reportable segments' gross margin to consolidated income before provision for income taxes is as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
Total reportable gross margin
$
147,975

 
$
149,245

 
$
296,433

 
$
297,853

Sales and marketing
79,738

 
83,344

 
161,669

 
162,945

Engineering and development
6,670

 
7,243

 
15,040

 
14,077

General and administrative
36,514

 
35,053

 
71,600

 
61,723

Depreciation and amortization
18,394

 
18,218

 
36,341

 
35,197

Income from operations
6,659

 
5,387

 
11,783

 
23,911

 
 
 
 
 
 
 
 
Interest income
4

 
25

 
9

 
46

Interest expense
(3,861
)
 
(3,057
)
 
(7,564
)
 
(5,503
)
Other income (expense), net
686

 
104

 
466

 
258