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EX-32.1 - EXHIBIT 32.1 - VONAGE HOLDINGS CORPa10-qq318exhibit321certifi.htm
EX-31.2 - EXHIBIT 31.2 - VONAGE HOLDINGS CORPa10-qq318exhibit312certifi.htm
EX-31.1 - EXHIBIT 31.1 - VONAGE HOLDINGS CORPa10-qq318exhibit311certifi.htm
EX-10.4 - EXHIBIT 10.4 - VONAGE HOLDINGS CORPa10-qq3exhibit104implement.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 September 30, 2018
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 every Interactive Data File required to be submitted 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 such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated 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  
  
 
 
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
October 31, 2018
Common Stock, par value $0.001
 
239,580,512
 
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) 
(Unaudited) 
 
September 30,
2018
 
December 31,
2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
25,735

 
$
31,360

Accounts receivable, net of allowance of $2,480 and $2,258, respectively
57,060

 
44,159

Inventory, net of allowance of $198 and $108, respectively
1,420

 
2,971

Deferred customer acquisition costs, current portion
10,669

 

Prepaid expenses
21,344

 
23,763

Other current assets
5,363

 
7,522

Total current assets
121,591

 
109,775

Property and equipment, net of accumulated depreciation of $97,962 and $87,792, respectively
42,754

 
46,754

Goodwill
389,490

 
373,764

Software, net of accumulated amortization of $100,251 and $93,858, respectively
17,828

 
22,252

Deferred customer acquisition costs
34,821

 

Restricted cash
1,984

 
1,967

Intangible assets, net of accumulated amortization of $151,029 and $124,573, respectively
158,939

 
173,270

Deferred tax assets
114,757

 
110,892

Other assets
27,546

 
20,007

Total assets
$
909,710

 
$
858,681

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
26,256

 
$
29,766

Accrued expenses
99,232

 
85,706

Deferred revenue, current portion
27,509

 
30,255

Current portion of notes payable
10,000

 
18,750

Total current liabilities
162,997

 
164,477

Indebtedness under revolving credit facility
114,000

 
141,000

Notes payable, net of debt related costs and current portion
86,672

 
72,765

Other liabilities
8,147

 
7,541

Total liabilities
371,816

 
385,783

Commitments and Contingencies (Note 7)

 

Stockholders’ Equity:
 
 
 
Common stock, par value $0.001 per share; 596,950 shares authorized at September 30,
2018 and December 31, 2017; 309,462 and 298,174 shares issued at September 30, 2018
and December 31, 2017, respectively; 239,523 and 230,939 shares outstanding at
September 30, 2018 and December 31, 2017, respectively
310

 
298

Additional paid-in capital
1,405,991

 
1,375,391

Accumulated deficit
(605,042
)
 
(672,561
)
Treasury stock, at cost, 69,939 shares at September 30, 2018 and 67,235 shares at
December 31, 2017
(274,336
)
 
(244,239
)
Accumulated other comprehensive income
10,971

 
14,009

Total stockholders’ equity
537,894

 
472,898

Total liabilities and stockholders’ equity
$
909,710

 
$
858,681

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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Total revenues
$
261,531

 
$
253,083

 
$
774,979

 
$
748,266

 
 
 
 
 
 
 
 
Operating Expenses:
 
 
 
 
 
 
 
Cost of revenues (exclusive of depreciation and amortization)
104,351

 
102,938

 
315,122

 
301,688

Sales and marketing
74,380

 
73,576

 
229,201

 
235,245

Engineering and development
14,309

 
6,956

 
35,504

 
21,996

General and administrative
37,620

 
26,811

 
97,376

 
98,411

Depreciation and amortization
16,024

 
18,179

 
51,886

 
54,520

Total operating expenses
246,684

 
228,460

 
729,089

 
711,860

Income from operations
14,847

 
24,623

 
45,890

 
36,406

Other Income (Expense):
 
 
 
 
 
 
 
Interest expense
(3,036
)
 
(3,821
)
 
(9,294
)
 
(11,385
)
Other income (expense), net
347

 
468

 
431

 
943

Total other income (expense), net
(2,689
)
 
(3,353
)
 
(8,863
)
 
(10,442
)
Income before income taxes
12,158

 
21,270

 
37,027

 
25,964

Income tax (expense) benefit
(2,570
)
 
(10,668
)
 
5,644

 
(4,624
)
Net income
$
9,588

 
$
10,602

 
$
42,671

 
$
21,340

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic
$
0.04

 
$
0.05

 
$
0.18

 
$
0.10

Diluted
$
0.04

 
$
0.04

 
$
0.17

 
$
0.09

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
239,303

 
227,943

 
236,775

 
223,956

Diluted
249,516

 
242,720

 
248,780

 
242,552




See accompanying notes to condensed consolidated financial statements.

4

 

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

  
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Net income
$
9,588

 
$
10,602

 
$
42,671

 
$
21,340

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustment, net of tax (benefit) expense of ($2,346), $822, ($3,702), and $3,258, respectively
1,525

 
6,390

 
(4,576
)
 
23,622

Unrealized gain on available-for-sale securities, net of tax expense of $0, $0, $0, and $0, respectively

 

 

 
1

Unrealized gain on derivatives, net of tax benefit of $745, $0, $354, and $0, respectively
530

 
197

 
1,538

 
197

Total other comprehensive income (loss)
2,055

 
6,587

 
(3,038
)
 
23,820

Comprehensive income
$
11,643

 
$
17,189

 
$
39,633

 
$
45,160




See accompanying notes to condensed consolidated financial statements.

5

 

VONAGE HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) 
 
Nine Months Ended
 
September 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
42,671

 
$
21,340

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
24,412

 
25,930

Amortization of intangibles
27,306

 
28,458

Deferred income taxes
(9,506
)
 
2,475

Amortization of deferred customer acquisition costs
7,002

 

Allowance for doubtful accounts and obsolete inventory
1,643

 
901

Amortization of debt issuance costs
764

 
300

Gain on sale of business

 
(1,377
)
Loss on disposal of fixed assets
168

 
132

Loss on extinguishment of debt
14

 

Share-based expense
24,495

 
28,997

Changes in derivatives
(65
)
 

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
(15,085
)
 
(3,970
)
Inventory
1,274

 
1,156

Prepaid expenses and other current assets
6,416

 
4,653

Deferred customer acquisition costs
(18,008
)
 

Accounts payable and accrued expenses
6,898

 
(31,002
)
Deferred revenue
(2,704
)
 
(1,477
)
Other assets and liabilities
(3,232
)
 
4,084

Net cash provided by operating activities
94,463

 
80,600

Cash flows from investing activities:
 
 
 
Capital expenditures
(10,687
)
 
(15,790
)
Maturities and sales of marketable securities

 
602

Acquisition and development of software assets
(6,198
)
 
(9,438
)
Acquisition of business, net of cash acquired
(32,299
)
 

Proceeds from sale of business

 
1,000

Net cash used in investing activities
(49,184
)
 
(23,626
)
Cash flows from financing activities:
 
 
 
Principal payments on capital lease obligations and other financing obligations
(119
)
 
(5,701
)
Payments on notes and revolving credit facility
(293,688
)
 
(56,063
)
Proceeds received from issuance of revolving credit facility and term note
272,000

 
15,000

Payment of debt issuance costs
(3,376
)
 

Common stock repurchases

 
(9,542
)
Employee taxes paid on withholding shares
(31,064
)
 
(14,927
)
Proceeds from exercise of stock options
6,117

 
14,476

Net cash used in financing activities
(50,130
)
 
(56,757
)
Effect of exchange rate changes on cash
(757
)
 
550

Net (decrease) increase in cash, cash equivalents, and restricted cash
(5,608
)
 
767

Cash, cash equivalents, and restricted cash, beginning of period
33,327

 
30,929

Cash, cash equivalents, and restricted cash, end of period
$
27,719

 
$
31,696

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the periods for:
 
 
 
Interest
$
8,454

 
$
10,147

Income taxes
$
5,669

 
$
5,395

Non-cash investing activities:
 
 
 
Capital expenditures included in accounts payable and accrued liabilities
$
1,840

 
$
2,231


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
 
Total
Balance at December 31, 2017
230,939

 
$
298

 
$
1,375,391

 
$
(672,561
)
 
$
(244,239
)
 
$
14,009

 
$
472,898

Cumulative effect adjustment upon
  the adoption of Topic 606
 
 
 
 


 
24,848

 
 
 
 
 
24,848

Stock option exercises
11,288

 
12

 
6,105

 
 
 
 
 
 
 
6,117

Share-based expense
 
 
 
 
24,495

 
 
 
 
 
 
 
24,495

Employee taxes paid on withholding
  shares
(2,704
)
 
 
 
 
 
 
 
(30,097
)
 
 
 
(30,097
)
Foreign currency translation
  adjustment
 
 
 
 
 
 
 
 
 
 
(4,576
)
 
(4,576
)
Unrealized gain on derivatives
 
 
 
 
 
 
 
 
 
 
1,538

 
1,538

Net income
 
 
 
 
 
 
42,671

 
 
 
 
 
42,671

Balance at September 30, 2018
239,523

 
$
310

 
$
1,405,991

 
$
(605,042
)
 
$
(274,336
)
 
$
10,971

 
$
537,894




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.    Nature of Business
Nature of Operations
Vonage Holdings Corp. (“Vonage”, “Company”, “we”, “our”, “us”) is incorporated as a Delaware corporation. At Vonage, we are redefining business communications. We are embracing technology to transform how businesses communicate to create better business outcomes. Our cloud communications platform enables businesses of all sizes to collaborate more productively and engage their customers more efficiently across any device. All of our cloud communications solutions are designed to allow businesses to be more productive by integrating communications with all their existing business productivity tools and our programmable solutions allow customers to engage with their customers via embedded voice, chat, or messaging to create seamless and contextual communications that makes doing business easier for end customers.
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, or SIP, based Voice over Internet Protocol, or VoIP, network. We also offer Communications Platform as a Service, or CPaaS, solutions designed to enhance the way businesses communicate with their customers by embedding communications into apps, websites and business processes. 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.
We provide a robust suite of feature-rich residential communication solutions that allow consumers to connect their home phones and mobile phones on one number and we offer attractive international long distance rates that help create a loyal base of satisfied customers.
Customers in the United States represented 79% and 84% of our consolidated revenues for the three months ended September 30, 2018 and 2017 and 80% and 86% for the nine months ended September 30, 2018 and 2017, respectively, with the balance in Canada, the United Kingdom, China, Singapore, Netherlands, and many other 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 Company's financial position, results of operations, comprehensive income, cash flows, and stockholders’ equity for the periods presented. The results for the three and nine months ended September 30, 2018 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, 2017 filed with the Securities and Exchange Commission on February 27, 2018.
Use of Estimates
Our condensed consolidated financial statements and notes thereof 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 periods to conform to classifications used in the current year periods. The reclassifications did not affect results of 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 2, Summary of Significant Accounting Policies to our Annual Report on Form 10-K for the year ended December 31, 2017.
Cost of Revenues
Cost of revenues excludes depreciation and amortization expense of $6,386 and $6,852 for the three months ended September 30, 2018 and 2017 and $19,046 and $20,497 for the nine months ended September 30, 2018 and 2017, respectively. In addition, costs of goods sold included in cost of revenues during the three months ended September 30, 2018 and 2017 were $6,386 and $6,306 and during the nine months ended September 30, 2018 and 2017 were $18,854 and $19,786, respectively.
Advertising Costs
We incurred advertising costs which are included in sales and marketing of $12,883 and $11,423 for the three months ended September 30, 2018 and 2017 and $41,805 and $43,760 for the nine months ended September 30, 2018 and 2017, respectively.
Engineering and Development Expenses
Engineering and development expenses predominantly include personnel and related costs for developers responsible for research and development of new products.
Fair Value of Financial Instruments
The Company records certain of its financial assets at fair value on a recurring basis as described below. Certain of the Company's other financial instruments, which include 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 September 30, 2018 and December 31, 2017. We believe the fair value of our debt at September 30, 2018 and December 31, 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 obligations for a similar debt instrument and are classified as Level 3 within the fair value hierarchy. 
We account for financial assets using a framework that establishes a hierarchy that ranks the quality and reliability of the inputs, or assumptions, we use in the determination of fair value, and we classify financial assets and liabilities carried at fair value in one of the following three categories:
Level 1 - quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets and liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
Level 2 - observable prices that are based on inputs not quoted on active markets but corroborated by market data; and
Level 3 - unobservable inputs when there is little or no market data available, thereby requiring an entity to develop its own assumptions. The fair value hierarchy gives the lowest priority to Level 3 inputs.
The following table presents the assets that are measured and recognized at fair value on a recurring basis classified under the appropriate level of the fair value hierarchy as of September 30, 2018 and December 31, 2017:
 
September 30,
2018
 
December 31, 2017
Level 2 Measurements
 
 
 
Interest rate swaps (1)
$
2,805

 
$
1,285


(1) Included in other assets on our condensed consolidated balance sheets.

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
 
September 30,
2018
 
December 31, 2017
Cash and cash equivalents
$
25,735

 
$
31,360

 
 
 
 
Cash collateralized letter of credit - lease deposits
1,513

 
1,563

Cash reserves
471

 
404

Restricted cash
1,984

 
1,967

 
 
 
 
Cash, cash equivalents, and restricted cash
$
27,719

 
$
33,327


Intangible assets, net
 
September 30,
2018
 
December 31, 2017
Customer relationships
$
108,224

 
$
122,393

Developed technology
47,574

 
46,004

Patents and patent licenses
2,893

 
4,030

Trade names
25

 
352

Non-compete agreements
223

 
491

Intangible assets, net
$
158,939

 
$
173,270


Accrued expenses
 
September 30,
2018
 
December 31, 2017
Compensation and related taxes and temporary labor
$
28,331

 
$
30,059

Marketing
11,592

 
10,759

Taxes and fees
16,982

 
13,353

Acquisition related consideration accounted for as compensation

 
2,534

Telecommunications
20,686

 
16,068

Other accruals
7,200

 
7,078

Customer credits
2,800

 
2,310

Professional fees
10,313

 
1,618

Inventory
1,328

 
1,927

Accrued expenses
$
99,232

 
$
85,706

Recent Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("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. The adoption of ASU 2017-04 will not have a material impact 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 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 their leasing arrangements. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, using a modified retrospective transition method at the beginning of the earliest period presented in the financial statements. Early adoption is permitted for all entities. The adoption of this ASU will increase our assets and liabilities for real estate and equipment operating leases for which we are the lessee and increase our lease disclosures. In July 2018, FASB issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements,” and ASU 2018-10, “Codification Improvements to Topic 842, Leases”, both of which affect narrow aspects of the guidance issued in ASU 2016-02. In addition, ASU 2018-11 provides an additional (and optional) transition method upon adoption of ASU 2016-02 to initially apply the new lease standard at the adoption date by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption in lieu of the comparative reporting initially required under ASU 2016-02. We have substantially completed our review of contracts in the scope of Topic 842 and are currently evaluating the financial impact of the guidance on our financial statements. While this review is still in the process, the Company expects the adoption of Topic 842 will have a material impact on its balance sheet. Additionally, the Company plans to utilize the transition method provided by ASU 2018-11 and will recognize the cumulative effect of the adoption in retained earnings as of January 1, 2019.
The following standards were adopted by the Company during the current period:
In August 2018, FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force)”. Under this ASU, a customer in a cloud computing arrangement that is a service contract would look to existing guidance for internal-use software under ASC 350-40 to determine whether implementation costs incurred under such arrangement may be capitalized and subsequently amortized over the periods covered under any applicable renewal options that are reasonably certain to be exercised. In addition, the guidance in this ASU also require the entity to present the expense related to the capitalized implementation costs in the same line item in the statement of income as the fees associated with the hosting element (service) of the arrangement and classify payments for capitalized implementation costs in the statement of cash flows in the same manner as payments made for fees associated with the hosting element. The entity is also required to present the capitalized implementation costs in the statement of financial position in the same line item that a prepayment for the fees of the associated hosting arrangement would be presented. The amendments in this ASU are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption of the amendments in this ASU is permitted, including adoption in any interim period. The amendments in this ASU should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company early adopted this ASU on a retrospective basis and began capitalizing implementation costs associated with cloud computing arrangements entered into that are service contracts. The adoption of this ASU did not have a material impact on our condensed consolidated financial statements and related disclosures.
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. We adopted this ASU on January 1, 2018 and the adoption of this ASU did not have a material impact 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. We adopted this ASU on January 1, 2018 and the adoption of this ASU did not have a material impact on our condensed consolidated financial statements and related disclosures.
In May 2014, FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)". This ASU, as amended, provided comprehensive guidance on the recognition of revenue from contracts with customers arising from the transfer of goods and services, guidance on accounting for certain contract costs and new disclosures. 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. On January 1, 2018, we adopted this ASU. Refer to Note 3. Revenue Recognition for related disclosures required upon adoption.

11


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


In August 2017, FASB issued ASU 2017-12, "Derivatives and Hedging". The ASU improves the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements and simplifies the application of the hedge accounting guidance in current generally accepted accounting principles ("GAAP"). It also amends the disclosures requirements by requiring a tabular disclosure related to the effect on the incomes statement of fair value and cash flow hedges and eliminating the ineffective portion of the change in fair value of hedging instrument disclosures. This ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted in any interim period after issuance and is applied to hedging relationships existing on the date of adoption. We adopted ASU 2017-12 during the third quarter of 2018 and the adoption did not have a material impact on our condensed consolidated financial statements and related disclosures.
Note 3.  Revenue Recognition
On January 1, 2018, the Company adopted the guidance of ASC Topic 606, Revenue from Contracts with Customers using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Our results for reporting periods beginning after January 1, 2018 are presented in accordance with the provisions under Topic 606 but any prior period amounts have not been adjusted and continue to be reported in accordance with our revenue recognition policy as further described in Note 2, Summary of Significant Accounting Policies to our Annual Report on Form 10-K for the year ended December 31, 2017. In connection with our adoption of Topic 606, we recognized a net increase to opening retained earnings of $24,848, net of tax, as of January 1, 2018 related to commissions paid associated with the acquisition of business customers and associated deferred tax liability.
Upon our adoption of Topic 606, we measure revenue based upon consideration specified by contracts with our customers. Revenue is recognized when our performance obligation under the contract is satisfied by transferring control over the product or service to the customer. We derive our revenues for our Consumer and Business segments primarily from the sale of our communication services and customer equipment as further described below. The majority of the Company's contracts with customers have a single performance obligation for service revenues. We recognize revenue with customers when control transfers, which occurs upon delivery of a service or product. For our Business segment, the typical life of a customer for service is six years. The adoption of Topic 606 did not result in a change in the timing of how the Company recognizes revenue.
Service Revenues
Substantially all of our revenues are service revenues, which are derived from monthly subscription fees under usage based or pay-per-use type billing arrangements, and contract-based services plans. For consumer customers in the United States, we offer domestic and international rate plans, including a variety of residential plans and mobile plans. For business customers, we offer small and medium business, mid-market, and enterprise customers several service plans with different pricing structures and contractual requirements ranging in duration from month-to-month to three years. In addition, we provide managed equipment to business customers for a monthly fee. Customers also have the opportunity to purchase premium features for additional fees. We also derive service revenues from per minute fees for international calls if not covered under a plan, including calls made via applications for mobile devices and other stand-alone products, and for any calling minutes in excess of a customer's monthly plan limits. For a portion of our customers, monthly subscription fees are automatically charged to customers' credit cards, debit cards or electronic check payments ("ECP"), in advance and are recognized over the following month as service is provided.
Service revenue also includes supplying messaging (SMS and Voice) services to customers as part of our CPaaS offerings. Revenue is recognized in the period when messages are sent by the customer. We also transact with providers or bulk SMS aggregators and sell services to these customers who then onsell to their customers. Since the aggregator is our customer, revenue is recognized on a gross basis with related costs included in cost of revenues.
In the United States, we charge regulatory, compliance, E-911 and intellectual property-related fees on a monthly basis to defray costs and to cover taxes that we are charged by the suppliers of telecommunications services. These charges, along with the remittance to the relevant government entity, are recorded on a net basis. In addition, we charge customers Federal Universal Service Fund ("USF") fees from customers to recover our obligation to contribute to the fund, as allowed by the Federal Communications Commission ("FCC"). We recognize USF revenue on a gross basis and record the related fees in cost of revenues.
Customer Equipment and Shipping Revenues
Revenues are generated from sales of customer equipment directly to customers for replacement devices, or for upgrading their device at the time of customer sign-up for which we charge an additional fee. In addition, customer equipment and shipping revenues include revenues from the sale of VoIP telephones in order to access our small and medium business services. Customer equipment and shipping revenues also include the fees that customers are charged for shipping their customer equipment to them.

12


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


Disaggregation of Revenue
The following table details our revenue from customers disaggregated by primary geographical market, source of revenue, and timing of revenue recognition. The table also includes a reconciliation of the disaggregated revenue for our Business and Consumer segments.
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018
 
September 30, 2018
 
Business
 
Consumer
 
Total
 
Business
 
Consumer
 
Total
Primary geographical markets
 
 
 
 
 
 
 
 
 
 
 
United States
$
107,446

 
$
99,061

 
$
206,507

 
$
311,562

 
$
309,056

 
$
620,618

Canada
919

 
5,781

 
6,700

 
2,293

 
18,275

 
$
20,568

United Kingdom
6,505

 
3,054

 
9,559

 
20,315

 
9,503

 
$
29,818

Other Countries (1)
38,765

 

 
38,765

 
103,975

 

 
$
103,975

 
153,635

 
107,896

 
261,531

 
438,145

 
336,834

 
774,979

Major Sources of Revenue
 
 
 
 
 
 
 
 
 
 
 
Service revenues
$
133,709

 
$
97,093

 
$
230,802

 
$
377,703

 
$
301,954

 
$
679,657

Access and product revenues
12,427

 
92

 
12,519

 
37,674

 
472

 
38,146

USF revenues
7,499

 
10,711

 
18,210

 
22,768

 
34,408

 
57,176

 
153,635

 
107,896

 
261,531

 
438,145

 
336,834

 
774,979

(1) No individual other international country represented greater than 10% of total revenue during the periods presented.
In addition, the Company recognizes service revenues from its customers through subscription services provided or through usage or pay-per-use type arrangements. During the three months ended September 30, 2018, the Company recognized $149,091 related to subscription services, $63,857 related to usage, and $48,583 related to other revenues such as USF, other regulatory fees, and credits. During the nine months ended September 30, 2018, the Company recognized $452,257 related to subscription services, $175,764 related to usage, and $146,958 related to other revenues such as USF, other regulatory fees, and credits.
Contract Assets and Liabilities
The following table provides information about receivables and contract liabilities from contracts with customers:
 
September 30, 2018
Receivables (1)
$
57,060

Contract liabilities (2)
27,509

(1) Amounts included in accounts receivables on our condensed consolidated balance sheet.
(2) Amounts included in deferred revenues and other liabilities on our condensed consolidated balance sheet.
Our deferred revenue represents the advance consideration received from customers for subscription services and is predominantly recognized over the following month as transfer of control occurs. During the three and nine months ended September 30, 2018, the Company recognized revenue of $105,494 and $332,480, respectively, related to its contract liabilities. We expect to recognize $27,509 into revenue over the next twelve months related to our deferred revenue as of September 30, 2018.

13


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


Contract Acquisition Costs
We have various commission programs for which eligible employees and third parties may earn commission on sales of services and products to customers. We expect that these commission fees are recoverable and, therefore, we have capitalized $45,490 (net of accumulated amortization) and $34,484 as contract costs as of September 30, 2018 and January 1, 2018, respectively, included within deferred customer acquisitions costs, current and deferred customer acquisition costs on our condensed consolidated balance sheet. In addition, we established a deferred tax liability associated with the transition asset of $9,636. Capitalized commission fees are amortized to sales and marketing expense over estimated customer life, which is six years for Business customers. During the three and nine months ended September 30, 2018, the amounts amortized to sales and marketing were $2,579 and $7,002, respectively, and there were no impairment losses recognized in relation to the costs capitalized. In addition, the Company expenses sales commissions for commission plans related to customer arrangements deemed less than a year and for residuals and renewals.
Note 4.    Earnings Per Share
The following table sets forth the computation for basic and diluted earnings per share for the three and nine months ended September 30, 2018 and 2017:
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2018
 
2017
 
2018
 
2017
Numerator
 
 
 
 
 
 
 
 
Net income
 
$
9,588

 
$
10,602

 
$
42,671

 
$
21,340

Denominator
 
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
239,303

 
227,943

 
236,775

 
223,956

Dilutive effect of stock options and restricted stock units
 
10,213

 
14,777

 
12,005

 
18,596

Diluted weighted average common shares outstanding
 
249,516

 
242,720

 
248,780

 
242,552

Basic earnings per share
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
0.04

 
$
0.05

 
$
0.18

 
$
0.10

Diluted earnings per share
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
0.04

 
$
0.04

 
$
0.17

 
$
0.09



For the three and nine months ended September 30, 2018 and 2017, the following were excluded from the calculation of diluted earnings per common share because of their anti-dilutive effects: 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2018
 
2017
 
2018
 
2017
Restricted stock units
 
3,368

 
4,938

 
2,200

 
2,458

Stock options
 
1,637

 
5,362

 
1,013

 
4,023

 
 
5,005

 
10,300

 
3,213

 
6,481



14


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 7, Long-Term Debt and Revolving Credit Facility to our Annual Report on Form 10-K for the year ended December 31, 2017.
A schedule of long-term note and revolving credit facility at September 30, 2018 and December 31, 2017 is as follows:
 
September 30,
2018
 
December 31,
2017
2.00-2.75 Term note - due 2023, net of debt related costs
$
86,672

 
$

2.00-2.75 Revolving credit facility - due 2023
114,000

 

2.50-3.25% Term note - due 2020, net of debt related costs

 
72,765

2.50-3.25% Revolving credit facility - due 2020

 
141,000

Total Long-term note and revolving credit facility
$
200,672

 
$
213,765


2018 Term Note and Revolving Credit Facility

On July 31, 2018, the Company replaced its 2016 Credit Facility previously consisting of a $125 million term loan and a $325 million revolving credit facility with the 2018 Credit Facility consisting of a $100 million senior secured term loan and a $500 million revolving credit facility. The co-borrowers under the 2018 Credit Facility are the Company and Vonage America Inc., the Company’s wholly owned subsidiary. Obligations under the 2018 Credit Facility are guaranteed, fully and unconditionally, by the Company’s other United States subsidiaries and are secured by substantially all of the assets of each borrower and each guarantor.
The company used $232,000 of the proceeds available under our 2018 Credit Facility plus cash on hand to retire all of the debt outstanding under our 2016 Credit Facility and to cover transaction fees and expenses. Total transaction fees and expense incurred were $3,376, of which $474 was allocated to the term note and $2,813 was allocated to the revolving credit facility which will be amortized over the term of 2018 Credit Facility. The remaining $89 of transaction fees were expensed during the three months ended September 30, 2018. The Company recognized a loss on extinguishment of debt of $14 which primarily consisted of the write off of previously deferred financing costs offset by the realization of a portion of gains associated with the interest rate swaps included in accumulated other comprehensive income. Remaining proceeds available from the undrawn revolving credit facility under our 2018 Credit Facility will be used for general corporate purposes and to fund potential additional acquisitions.

2018 Credit Facility Terms
The following description summarizes the material terms of the 2018 Credit Facility:
The loans under the 2018 Credit Facility mature on July 31, 2023. Principal amounts under the 2018 Credit Facility are repayable in quarterly installments of $2.5 million for the term loan. The unused portion of the Company's revolving credit facility incurs a 0.30% per annum commitment fee.
Outstanding amounts under the 2018 Credit Facility, at the Company's option, will bear interest at:
LIBOR (applicable to one-, two-, three-, six-, or twelve-month periods) plus an applicable margin equal to 2.00% up to 2.75% per annum payable on the last day of each relevant interest period or, if the interest period is longer than three months, each day that is three months after the first day of the interest period, or
the base rate determined by reference to the highest of (a) the rate of interest last quoted by the Wall Street Journal as the “Prime Rate” in the U.S., (b) the federal funds effective rate from time to time plus 0.50%, and (c) the adjusted LIBO rate applicable to one month interest periods plus 1.00%, plus an applicable margin equal to 1.00% up to 1.75% per annum payable on the last business day of each March, June, September, and December and the maturity date of the 2018 Credit Facility.

15


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


During the nine months ended September 30, 2018, we made mandatory repayments of $2.5 million under the 2018 term note and made discretionary repayments of $18 million under the 2018 revolving credit facility. In addition, the effective interest rate was 4.50% as of September 30, 2018.

2016 Term Note and Revolving Credit Facility
On June 3, 2016, the company 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. During the nine months ended September 30, 2018, we made mandatory repayments of $9.4 million under the term note and made discretionary repayments of $35.0 million under the revolving credit facility and borrowed $40.0 million under the revolving credit facility, of which $32.9 million was used in connection with the acquisition of TokBox on August 1, 2018.
Interest Rate Swaps
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 became effective on July 31, 2017 and will expire on 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 are accounted for as cash flow hedges in accordance with ASC 815, Derivatives and Hedging.
In connection with the $14 debt extinguishment, the Company reclassified $271 from accumulated other comprehensive income to earnings. The remaining $2,654 gain accumulated in other comprehensive income will be amortized over the term of the 2018 Credit Facility. The cash flows on the 2018 Credit Facility have been designated and qualify as a cash flow hedge of forecasted interest coupon payments.
As of September 30, 2018, the fair market value of the swaps was $2,805, which is included in other assets on our condensed consolidated balance sheet. The following table summarizes the effects of ASC 815 on the Company's accumulated OCI balance attributable to cash flow derivatives:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
Accumulated OCI beginning balance
 
$
1,973

 
$

 
$
965

 
$

Reclassified from accumulated OCI to income:
 
 
 
 
 
 
 
 
Due to reclassification of previously deferred gain
 
(336
)
 

 
(336
)
 

Change in fair value of cash flow hedge accounting contracts, net of tax
 
866

 
197

 
1,874

 
197

Accumulated OCI ending balance, net of tax benefit of $34 and $0, respectively
 
$
2,503

 
$
197

 
$
2,503

 
$
197

Gains expected to be reclassified from accumulated OCI during the next 12 months
 
$
531

 
$

 
$
531

 
$


16


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


Note 6.    Common Stock
As of September 30, 2018 and December 31, 2017, the Company had 596,950 shares of common stock authorized and had 8,386 shares available for grants under our share-based compensation programs as of September 30, 2018. For a detailed description of our share-based compensation programs refer to Note 10, Employee Stock Benefit Plans in our Annual Report on Form 10-K for the year ended December 31, 2017.
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.
We repurchased the following shares of common stock with cash resources under the 2014 $100.0 million repurchase program during the nine months ended September 30, 2018 and 2017:
  
 
Nine Months Ended
 
 
September 30,
 
 
2018
 
2017
Shares of common stock repurchased
 

 
1,599

Value of common stock repurchased
 
$

 
$
9,510

There were no repurchases for the three and nine months ended September 30, 2018 and the three months ended September 30, 2017.
As of September 30, 2018, $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.

17


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


Litigation
IP Matters
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. In a parallel Arizona district court litigation involving RPost, certain of the asserted patent claims were invalidated on June 7, 2016, which decision was affirmed by the Federal Circuit, with the Supreme Court denying certiorari on December 11, 2017. On September 5, 2018, 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.
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. A fourth joint status report was filed with the District Court on September 26, 2017. A fifth joint status report was filed with the District Court on December 26, 2017. Counsel for Vonage spoke with counsel for plaintiffs in mid-February 2018, seeking voluntary dismissal. Plaintiff's counsel advised they intended to seek public injunctive relief. The parties are reviewing their respective positions. The parties continue to file quarterly joint status reports pending plaintiffs decision on next steps.
Regulation
Telephony services are subject to a broad spectrum of state, federal and foreign 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.

18


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


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 Federal Communications Commission, or 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, or 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. In December 2017, the FCC issued a decision reversing its prior position on net neutrality. The decision allows for paid prioritization. Numerous public interest groups and some companies are currently or expected to challenge the order in court. It is also anticipated that Congress may introduce legislation to overrule the FCC's decision and reinstate net neutrality. Nonetheless, on June 4, 2018, the old Net Neutrality rules were repealed. Various states are enacting their own laws to require net neutrality within their state.
Federal - Rural Call Completion Issues
On February 7, 2013, the FCC released a 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 reviewed and evaluated the FCC's proposed changes and provided input to The Voice on the Net, or VON, Coalition, an organization that works to advance regulatory policies for IP-enabled communications. Comments to the Rural Call Completion Second Report and Order and Third Further Notice of Proposed Rulemaking were adopted by the FCC on April 17, 2018. Comments were due on June 4, 2018 and replies were due on June 19, 2018. On April 24, the FCC Wireline Competition Bureau granted a waiver of the rural call completion reporting requirements, including a temporary waiver with respect to the report on May 1, 2018. On August 15, 2018 the FCC established a registry for intermediate providers to register before offering to transmit voice calls. The intermediate providers have to register within 30 days from publication in the Federal Register. Vonage can use contractual restrictions to flow down requirements for the call paths. On August 1, 2018, the NTCA filed a petition for reconsideration, which the VON Coalition opposed.
Federal - NPRM - Number Slamming
On July 13, 2017, the FCC adopted a NPRM regarding ways to protect consumers from number "slamming" and "cramming" without impeding competition or impairing the ability of consumers to switch providers. Vonage is monitoring this NPRM. On June 7, 2018, the FCC adopted new consumer protections against slamming and cramming. The amended rules reinforce the FCC's ability to take action against slammers and crammers and to deter carriers from slamming and cramming. Specifically, the FCC codified a ban on material misrepresentations on sales calls and unauthorized charges on telephone bills, and improved the effectiveness of the existing third-party verification process. At the same time, the FCC declined to adopt additional measures that may unduly hinder consumers' ability to switch providers.

19


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


Federal - NPRM Toll Free Assignment Modernization
On September 26, 2017, the FCC issued a NPRM regarding the modernization of toll free number assignment. The FCC proposes amending its rules to allow for the use of an auction to assign certain toll free numbers - such as vanity and repeater numbers - in order to better promote the equitable and efficient use of numbers (especially as afforded by the opening of the 833 toll free code). The FCC issued a Report and Order on September 27, 2018 providing for (a) a public auction for rights to use numbers in the new 833 toll free code, (b) an experiment on using competitive bidding to most effectively determine how to effectively assign toll free numbers, (c) assigning SOMOS as the Administrator/Auctioneer for the 833 code, (d) finding use of competitive bidding orderly and efficient (as opposed to prior FIFO approach), (e) eliminating requirement that only responsible organizations can participate, and (f) use of a Vickery single round auction, whereby the winner only has to pay the second highest bid. Vonage continues to monitor activity with respect to this NPRM.
Federal - NOI - Enterprise Communications Systems Access to 911/Kari’s Law/Ray Baum’s Law
On September 26, 2017, the FCC adopted a Notice of Inquiry, or NOI, with respect to 911 access, routing and location in Enterprise Communication Systems. Vonage continues to monitor activity related to this NOI. On September 26, 2018 the FCC issued a Notice of Proposed Rulemaking to address issues around 911 Emergency Calling. Kari’s Law will require multi-line telephone systems to allow users to dial 911 directly without a “9” or other prefix, and configure multi-line telephone systems to provide a notification that (a) a 911 call has been placed, (b) a valid call back number has been provided, and (c) identifies the callers’ location. Ray Baum’s law requires the FCC to consider adopting rules that require a dispatchable location. The NPRM requests interested parties to comment on the technical feasibility and other issues related to these two laws.
Federal - Access to Telecommunication Equipment and Services by Persons with Disabilities
At its open meeting on for October 24, 2017, the FCC applied its wireline hearing aid compatibility rules/standards to handsets that provide advanced communication services, which includes interconnected and non-interconnected VoIP. The rules include certain coupling and volume control requirements that would allow the handsets to work better for persons with hearing aids. There are also testing and certification requirements, which typically apply to the handset manufacturer. The FCC also adopted a requirement for volume control in wireless handsets. The new rules have a two-year phase in for new phones and do not require the modification to existing handsets. On April 5, 2018 the FCC’s Consumer and Governmental Affairs Bureau issued a public notice seeking comment on the accessibility of communications technologies for the 2018 Biennial Report required by the Twenty First Century Communications and Video Accessibility Act. The report must be filed with Congress on or before October 8, 2018. The Bureau sought comments by April 26, 2018. On August 5. 2018, the FCC invited comments (a) on level of accessibility and usability of covered products and services, (b) barriers to accessibility, and (c) impact of record keeping requirements and enforcement measures have had on development and deployment of new technologies. On August 9, 2018, the FCC issued a notice seeking public comments, which were due August 23, 2018. Vonage will continue to monitor activity.
Federal - Rules and Policies Regarding Caller ID Services
At its open meeting on October 24, 2017, the FCC issued a report and order regarding amendments to the FCC's rules to exempt threatening calls from current Caller ID blocking roles so that, among other changes, law enforcement and security personnel have timely access to information they need to aid their investigations. The order exempts threatening calls from the CPN privacy rules.
Federal - Number Portability NPRM and NOI
At its open meeting on October 24, 2017, the FCC released a NPRM that would allow carriers flexibility in conducting number portability database queries to promote nationwide number portability and eliminate the dialing party requirement as it applies to interexchange service. The NOI seeks comments on industry number portability models and how number administration might be improved for more efficient technical, operational, administrative and legal processes. In early July 2018 the FCC adopted a report and order that made technical rule changes to lay the groundwork for nationwide number portability. The Report and Order expands existing forbearance from dialing parity requirements beyond incumbent LECS such that the forbearance is widely applicable. It further revises the N-1 call routing requirements by allowing upstream carriers to query the number portability database rather than only permitting the N-1, or second to last carrier, to do so. This may positively impact Vonage when it goes into effect in September 2019, as it essentially changes N-1 rule to be a default in the absence of other agreements. Vonage is working with the VON Coalition and is monitoring this NPRM and NOI.

20


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


Federal - Second Further Notice of Proposed Rulemaking - Unwanted calls to reassigned telephone numbers
On March 23, 2018, the FCC issued its Second NPRM seeking comments on ways to address unwanted calls to reassigned telephone numbers. The FCC is seeking comment on, among other issues, (1) the specific information that callers need from a reassigned numbers database, and (2) the best way to make that information available to callers that want it. The rules are intended to benefit consumers by reducing unwanted calls intended for another consumer while helping callers avoid the costs of calling the wrong consumer, including potential violations of the TCPA. Vonage will continue to monitor this rulemaking through the VON Coalition.
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, or 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. 
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. In September 2017 amicus briefs were filed in support of the Minnesota PUC's appeal of the Charter decision by AARP, the AARP Foundation, Professor Barbara Cherry, the National Association of Regulatory Utility Commissioners and the national Association of State Consumer Advocates and the Mid-Minnesota Legal Aid. In September 2018, an appeal was filed from the US District Court- Minneapolis’ decision that VoIP is an “Information Service “ under the Telecommunications Act and that therefore state regulation of Charter’s VoIP services was preempted by federal law. NARUC and others have argued that the decision (a) undermines the Federal USF subsidy program which can be accessed only by providers of “telecom services”, which a 2014 10th circuit decision equates with interconnected VoIP service, (b) classified “information services” in a way that directly undermines the local telephone competition that was the central thrust of the 1996 Telecommunication Act by treating carriers competing to provide local telephone service differently, and (c) the information services classification is illogical and inconsistent with the plain text of the statute. Vonage will continue to monitor this action.
On August 14, 2017, the Arizona Corporation Commission issued an opinion and order with respect to amendments to the Arizona Universal Services Fund. The rulemaking allows for, among other things, the collection of additional USF surcharges in Arizona to fund the E-rate Broadband Special Construction Project Matching Fund Program. The Arizona Corporation Commission held hearings on September 12 and 13, 2017. Vonage will continue to monitor this rulemaking to determine its effect upon its business activities within Arizona.
We expect that state public utility commissions and state legislators will continue their attempts to apply state telecommunications regulations to nomadic VoIP service.

21


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


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 established reserves of $1,868 and $1,147 as of September 30, 2018 and December 31, 2017, respectively, as our best estimate of the potential tax exposure for any retroactive assessment.
UK OFCOM Investigation
On April 3, 2018, the UK Office of Communications ("OFCOM") launched an investigation to determine Vonage Limited’s compliance with General Condition 3.1 and Section 105A of the Communications Act 2003, which cover obligations of communication providers to take necessary measures to, among other things, maintain network availability and access to emergency services. In cases where violations are found, OFCOM has the authority to issue monetary penalties in accordance with its Guidelines and limitations imposed by statute. In April 2018, Vonage submitted its responses to OFCOM’s first request for information, and in May 2018, Vonage submitted its responses to OFCOM’s second request for information. On October 18, 2018, representatives from Vonage met with OFCOM for the purpose of receiving an update from the OFCOM case team on the status of the case. Vonage was informed that the fact-gathering phase was coming to a close, and that a final information request would be forthcoming. Subsequently, on October 19, 2018, that request was received from OFCOM, and Vonage submitted its response shortly thereafter. OFCOM is reviewing the submitted information.

 
Note 8. Acquisitions and Dispositions

Acquisition of TokBox
On August 1, 2018, the Company announced that it had acquired 100% of the issued and outstanding shares of Telefonica Digital, Inc. (“TDI”), a subsidiary of Telefonica, S.A., and TDI’s subsidiaries, TokBox, Inc. (“TokBox”) and TokBox Australia Pty Limited, for a purchase price of $32,906 paid in cash. San Francisco-based TokBox develops and operates the OpenTok Platform and is the industry leader in the WebRTC programmable video segment of the cloud communications market which will compliment the Company's existing portfolio of programmable communications.

22


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


The acquisition was recorded as a business combination under ASC 805, with identifiable assets acquired and liabilities assumed provisionally recorded at their estimated fair value on the acquisition date. The initial accounting for the business combination is not complete because the evaluation necessary to assess the fair value of certain net assets acquired is still in process. The provisional amounts are subject to revision until the evaluations are completed to the extent that additional information is obtained about the facts and circumstances that existed as of the acquisition date. The allocation of the purchase price may be modified up to one year from the date of the acquisition as more information is obtained about the fair value of assets acquired and liabilities assumed. The purchase price of $32,906 was provisionally allocated as follows:
 
August 1, 2018
Assets
 
Cash and cash equivalents
$
557

Current assets
2,205

Property, plant and equipment
124

Goodwill
20,499

Intangible assets
15,602

Restricted cash
50

Total assets acquired
39,037

 
 
Liabilities
 
Accounts payable
371

Accrued expenses
5,760

Total liabilities assumed
6,131

Net assets acquired
$
32,906

The Company recorded goodwill of $20,499 which is attributable to the Business segment and is deductible for tax purposes. The factors that resulted in goodwill arising from the acquisition include the revenues expected to be achieved by incorporating a video feature in the Company's API platform along with a skilled workforce proficient in API development. The Company also recorded intangible assets of $15,602 comprised of customer relationships of $5,020 and developed technology of $10,582 with weighted average remaining amortization period of 7 years and 5 years, respectively. In addition, the Company incurred and expensed acquisition related transaction costs included in general and administrative expense related to the acquisition of TokBox of $4,672 and $4,954 for the three and nine months ended September 30, 2018.
Supplemental Pro Forma Information
Since the acquisition date, TokBox contributed $1,626 in revenue and $3,620 in net losses. The following supplemental pro forma information represents the results of operations as if Vonage had acquired TokBox on January 1, 2017.
 
 
Nine Months Ended
 
 
September 30,
 
 
2018
 
2017
Revenue
 
$
780,846

 
$
758,245

Net income
 
27,601

 
5,524

Net income per share - basic
 
$
0.12

 
$
0.02

Net income per share - diluted
 
$
0.11

 
$
0.02


23


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


The pro forma information has been adjusted to include the pro-forma impact of amortization of intangible assets based on the preliminary purchase price allocations. The pro forma data has also been adjusted to eliminate non-recurring transaction costs as well as the related tax impact of pro forma adjustments. There were no transactions between Vonage and TokBox. The pro forma results are presented for illustrative purposes only and do not reflect the realization of potential cost savings or any related integration costs.
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, 2017
 
$
373,764

Increase in goodwill related to acquisition of TokBox
 
20,499

Foreign currency translation adjustment
 
(4,773
)
Balance at September 30, 2018
 
$
389,490


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, an additional $0.5 million of contingent consideration received during the third quarter of 2017 and the potential for up to $2.5 million further consideration 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 historically been included within the Business segment. As a result of the sale, we recorded a gain $1,377 for the nine months ended September 30, 2017, within other income. This disposal did not represent a strategic shift in operations and, therefore, did not qualify for presentation as discontinued operations.



24


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


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.
Business
For our Business customers, we provide innovative, cloud-based UCaaS solutions, comprised of integrated voice, text, video, data, collaboration, and mobile applications over our flexible, scalable SIP based VoIP network. Through Nexmo, the Vonage API Platform, we also offer 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 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/4G, 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,
Access and product revenues. Product revenues include equipment sold to customers, shipping and handling, professional services, and broadband access. Beginning January 1, 2018, we also included revenues associated with providing access services to Business customers. We have adjusted the three and nine months ended September 30, 2017 to include these revenues in access and product revenues which were previously included in service revenues.
USF revenues. USF revenues represent fees passed on to customers to offset required contributions to the USF.
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.
Access and 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. As noted above, beginning January 1, 2018, we also included costs associated with providing access services to Business customers. We have adjusted the three and nine months ended September 30, 2017 to include these costs in access and product revenues which were previously included in service cost of revenues.
USF cost of revenues. USF cost of revenues represents contributions to the Federal USF and related fees.

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 nine months ended September 30, 2018 were as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018
 
September 30, 2018
 
Business
 
Consumer
 
Total
 
Business
 
Consumer
 
Total
Revenues
 
 
 
 
 
 
 
 
 
 
 
Service revenues
$
133,709

 
$
97,093

 
$
230,802

 
$
377,703

 
$
301,954

 
$
679,657

Access and product revenues (1)
12,427

 
92

 
12,519

 
37,674

 
472

 
38,146

Service, access and product revenues
146,136

 
97,185

 
243,321

 
415,377

 
302,426

 
717,803

USF revenues
7,499

 
10,711

 
18,210

 
22,768

 
34,408

 
57,176

Total revenues
153,635

 
107,896

 
261,531

 
438,145

 
336,834

 
774,979

 
 
 
 
 
 
 
 
 
 
 
 
Cost of revenues
 
 
 
 
 
 
 
 
 
 
 
Service cost of revenues (2)
59,600

 
10,661

 
70,261

 
172,917

 
37,050

 
209,967

Access and product cost of revenues (1)
14,887

 
993

 
15,880

 
43,291

 
4,657

 
47,948

Service, access and product cost of revenues
74,487

 
11,654

 
86,141

 
216,208

 
41,707

 
257,915

USF cost of revenues
7,499

 
10,711

 
18,210

 
22,773

 
34,434

 
57,207

Total cost of revenues
81,986

 
22,365

 
104,351

 
238,981

 
76,141

 
315,122

 
 
 
 
 
 
 
 
 
 
 
 
Segment gross margin
 
 
 
 
 
 
 
 
 
 
 
Service margin
74,109

 
86,432

 
160,541

 
204,786

 
264,904

 
469,690

Access and product margin
(2,460
)
 
(901
)
 
(3,361
)
 
(5,617
)
 
(4,185
)
 
(9,802
)
Gross margin ex-USF (Service, access and product margin)
71,649

 
85,531

 
157,180

 
199,169

 
260,719

 
459,888

USF margin

 

 

 
(5
)
 
(26
)
 
(31
)
Segment gross margin
$
71,649

 
$
85,531

 
$
157,180

 
$
199,164

 
$
260,693

 
$
459,857

 
 
 
 
 
 
 
 
 
 
 
 
Segment gross margin %
 
 
 
 
 
 
 
 
 
 
 
Service margin %
55.4
%
 
89.0
%
 
69.6
%
 
54.2
%
 
87.7
%
 
69.1
%
Gross margin ex-USF (Service, access and product margin %)
49.0
%
 
88.0
%
 
64.6
%
 
47.9
%
 
86.2
%
 
64.1
%
Segment gross margin %
46.6
%
 
79.3
%
 
60.1
%
 
45.5
%
 
77.4
%
 
59.3
%
(1) Includes customer premise equipment, access, and shipping and handling.
(2) Excludes depreciation and amortization of $5,141 and $1,245 for the three months ended September 30, 2018 and $15,092 and $3,954 for the nine months ended September 30, 2018, respectively.

26


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 nine months ended September 30, 2017 were as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 30, 2017
 
Business
 
Consumer
 
Total
 
Business
 
Consumer
 
Total
Revenues
 
 
 
 
 
 
 
 
 
 
 
Service revenues
$
108,819

 
$
111,913

 
$
220,732

 
$
303,814

 
$
346,666

 
$
650,480

Access and product revenues (1)
13,749

 
94

 
13,843

 
41,622

 
498

 
42,120

Service, access and product revenues
122,568

 
112,007

 
234,575

 
345,436

 
347,164

 
692,600

USF revenues
6,738

 
11,770

 
18,508

 
19,386

 
36,280

 
55,666

Total revenues
129,306

 
123,777

 
253,083

 
364,822

 
383,444

 
748,266

 
 
 
 
 
 
 
 
 
 
 
 
Cost of revenues
 
 
 
 
 
 
 
 
 
 
 
Service cost of revenues (2)
49,078

 
19,434

 
68,512

 
134,041

 
62,969

 
197,010

Access and product cost of revenues (1)
14,401

 
1,517

 
15,918

 
43,537

 
5,475

 
49,012

Service, access and product cost of revenues
63,479

 
20,951

 
84,430

 
177,578

 
68,444

 
246,022

USF cost of revenues
6,738

 
11,770

 
18,508

 
19,386

 
36,280

 
55,666

Total cost of revenues
70,217

 
32,721

 
102,938

 
196,964

 
104,724

 
301,688

 
 
 
 
 
 
 
 
 
 
 
 
Segment gross margin
 
 
 
 
 
 
 
 
 
 
 
Service margin
59,741

 
92,479

 
152,220

 
169,773

 
283,697

 
453,470

Access and product margin
(652
)
 
(1,423
)
 
(2,075
)
 
(1,915
)
 
(4,977
)
 
(6,892
)
Gross margin ex-USF (Service, access and product margin)
59,089

 
91,056

 
150,145

 
167,858

 
278,720

 
446,578

USF margin

 

 

 

 

 

Segment gross margin
$
59,089

 
$
91,056

 
$
150,145

 
$
167,858

 
$
278,720

 
$
446,578

 
 
 
 
 
 
 
 
 
 
 
 
Segment gross margin %
 
 
 
 
 
 
 
 
 
 
 
Service margin %
54.9
%
 
82.6
%
 
69.0
%
 
55.9
%
 
81.8
%
 
69.7
%
Gross margin ex-USF (Service, access and product margin %)
48.2
%
 
81.3
%
 
64.0
%
 
48.6
%
 
80.3
%
 
64.5
%
Segment gross margin %
45.7
%
 
73.6
%
 
59.3
%
 
46.0
%
 
72.7
%
 
59.7
%
(1) Includes customer premise equipment, access, and shipping and handling.
(2) Excludes depreciation and amortization of $5,053 and $1,799 for the three months ended September 30, 2017 and $14,931 and $5,566 for the nine months ended September 30, 2017, respectively.

27


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 income taxes is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Total reportable gross margin
$
157,180

 
$
150,145

 
$
459,857

 
$
446,578

Sales and marketing
74,380

 
73,576

 
229,201

 
235,245

Engineering and development
14,309

 
6,956

 
35,504

 
21,996

General and administrative
37,620

 
26,811

 
97,376

 
98,411

Depreciation and amortization
16,024

 
18,179

 
51,886

 
54,520

Income from operations
14,847

 
24,623

 
45,890

 
36,406

 
 
 
 
 
 
 
 
Interest expense
(3,036
)
 
(3,821
)
 
(9,294
)
 
(11,385
)
Other income (expense), net
347

 
468

 
431

 
943

Income before income taxes
$
12,158

 
$
21,270

 
$
37,027

 
$
25,964

Information about our operations by geographic location is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
  
2018
 
2017
 
2018
 
2017
  
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
United States
$
206,507

 
$
212,346

 
$
620,618

 
$
639,852

Canada
6,700

 
6,877

 
20,568

 
23,324

United Kingdom
9,559

 
7,175

 
29,818

 
19,446

Other Countries (1)
38,765

 
26,685

 
103,975

 
65,644

 
$
261,531

 
$
253,083

 
$
774,979

 
$
748,266

(1) No individual other international country represented greater than 10% of total revenue during the periods presented.
  
September 30, 2018
 
December 31, 2017
Long-lived assets:
 
 
 
United States
$
607,618

 
$
615,432

United Kingdom
265

 
365

Israel
1,128

 
243

 
$
609,011

 
$
616,040

 

28


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


Note 10. Income Taxes

The income tax (expense) benefit consisted of the following:
 
 
Three Months Ended
Nine Months Ended
 
 
September 30,
September 30,
 
 
2018
 
2017
 
2018
 
2017
Income before income taxes
 
$
12,158

 
$
21,270

 
$
37,027

 
$
25,964

Income tax (expense) benefit
 
(2,570
)
 
(10,668
)
 
5,644

 
(4,624
)
Effective tax rate
 
21.1
%
 
50.2
%
 
(15.2
)%
 
17.8
%
We recognize income tax equal to pre-tax income multiplied by our annual effective income tax rate. In addition, adjustments are recorded for discrete period items and changes to our state effective tax rate which can cause the rate to fluctuate from quarter to quarter.
For the three and nine months ended September 30, 2018, our effective tax rate was different than the statutory rate due to a forecasted permanent adjustment of $5,312 as a result of the officer compensation limitation under IRC §162(m) and $5,597 for both periods related to the new Global Intangible Low-Taxed Income ("GILTI") tax rules that were enacted as part of tax reform in December 2017. In addition, the Company recorded a discrete period tax benefit of $1,912 and $19,228, respectively, which were recognized related to excess tax benefits on equity compensation for the three and nine months ended September 30, 2018.
For the three and nine months ended September 30, 2017, our effective tax rate was different than the statutory rate due to a discrete period tax benefits of $9,539 and $1,433, respectively which were recognized related to excess tax benefits on equity compensation recognized primarily in the first quarter of 2017 as well as an adjustment to our deferred asset related to stock compensation.
On December 22, 2017, the United States enacted the Tax Cuts and Jobs Act ("TCJA") which reformed tax policy in the United States with the primary impact resulting in reducing the corporate tax rate from 35% to 21% beginning January 1, 2018. This resulted in an expense of $69,378 recognized by the Company during the year ended December 31, 2017 attributable to the re-measurement of the Company's deferred tax assets as of December 31, 2017. Due to the timing of the enactment and the complexity involved in applying the provisions of the TCJA, the Company has made reasonable estimates of the effects and recorded provisional amounts in our financial statements as of December 31, 2017.
During the nine months ended September 30, 2018, we reviewed further information and interpreted the TCJA utilizing additional guidance issued by the U.S. Treasury Department, the Internal Revenue Service and other regulatory bodies. We have made no adjustments to the provisional amounts recorded related to the re-measurement of the deferred tax asset as well as the conclusion regarding the applicability of repatriation tax. The Company will continue to analyze the effects of the TCJA on the Company’s operations and will record any adjustments associated with the enactment of the legislature during the measurement period as provided by SAB 118.
Uncertain Tax Positions
The Company had an uncertain tax position of $1,086 as of December 31, 2017. As a result of acceptance by the Internal Revenue Service of requested accounting method change relating to the reporting of tenant incentive allowance income, this uncertain tax position has been removed. As of September 30, 2018, the Company has recorded an uncertain tax position in the amount of $272 due to the uncertainty regarding the rate used by TokBox when calculating its transfer pricing costs to its affiliated entities. The Company recognizes interest and penalties related to uncertain tax positions in income taxes. The Company did not have any interest or penalties related to this uncertain tax position during the three and nine months ended September 30, 2018 and September 30, 2017.
Net Operating Loss Carry Forwards ("NOLs")
As of September 30, 2018, we had cumulative domestic Federal NOLs of $565,730 and cumulative state NOLs of approximately $146,254, expiring at various times through 2037. In addition, we had NOLs for United Kingdom tax purposes of $50,142 with no expiration date.



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



Note 11. Subsequent Events

On October 31, 2018, the Company acquired 100% of the issued and outstanding shares of NewVoiceMedia Limited (“NewVoiceMedia”), a cloud Contact Center-as-a-Service (CCaaS) provider, for a purchase price of $350 million paid in cash. NewVoiceMedia is a private limited company organized under the laws of England & Wales.
Due to the closing of the acquisition subsequent to the period end, the Company is currently in the process of determining the fair value of assets acquired and liabilities assumed necessary to develop the purchase price allocation. As such, disclosure of the purchase price allocation and supplemental pro forma information is not practicable. As of September 30, 2018, the Company has incurred and expensed acquisition related transaction costs included in general and administrative expense related to the acquisition of NewVoiceMedia of approximately $4,832.









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Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion together with our condensed consolidated financial statements and the related notes included elsewhere in this Form 10-Q and our audited financial statements included in our Annual Report on Form 10-K. This discussion contains forward-looking statements. These forward-looking statements are based on information available at the time the statements are made and/or management’s belief as of that time with respect to future events and involve risks and uncertainties that could cause actual results and outcomes to be materially different. Important factors that could cause such differences include but are not limited to: the competition we face; the expansion of competition in the cloud communications market; our ability to adapt to rapid changes in the cloud communications market; the nascent state of the cloud communications for business market; our ability to retain customers and attract new customers cost effectively; the risk associated with developing and maintaining effective internal sales teams and effective distribution channels; risks related to the acquisition or integration of businesses we have acquired; security breaches and other compromises of information security; risks associated with sales of our services to medium-sized and enterprise customers; our reliance on third party hardware and software; our dependence on third party facilities, equipment, systems and services; system disruptions or flaws in our technology and systems; our ability to scale our business and grow efficiently; our dependence on third party vendors; the impact of fluctuations in economic conditions, particularly on our small and medium business customers; our ability to comply with data privacy and related regulatory matters; our ability to obtain or maintain relevant intellectual property licenses; failure to protect our trademarks and internally developed software; fraudulent use of our name or services; intellectual property and other litigation that have been and may be brought against us; reliance on third parties for our 911 services; uncertainties relating to regulation of business services; risks associated with legislative, regulatory or judicial actions regarding our business products; risks associated with operating abroad; risks associated with the taxation of our business; risks associated with a material weakness in our internal controls; governmental regulation and taxes in our international operations; liability under anti-corruption laws or from governmental export controls or economic sanctions; our dependence on our customers' broadband connections; restrictions in our debt agreements that may limit our operating flexibility; foreign currency exchange risk; our ability to obtain additional financing if required; any reinstatement of holdbacks by our credit card processors; our history of net losses and ability to achieve consistent profitability in the future; our ability to fully realize the benefits of our net operating loss carry-forwards if an ownership change occurs; certain provisions of our charter documents/ and other factors that are set forth in the “Risk Factors” in our Annual Report on Form 10-K and in our Quarterly Reports on Form 10-Q. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, and therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to the date this Form 10-Q is filed with the Securities and Exchange Commission.
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. All trademarks are the property of their owners.
Overview and Strategy
At Vonage, we are redefining business communications. True to our roots as a technology disruptor, we are embracing technology to transform how businesses communicate to create better business outcomes. Our cloud communications platform enables businesses of all sizes to collaborate more productively and engage their customers more efficiently across any device. Vonage customers can choose among two separate delivery models to suit their specific communication needs: They can purchase Vonage Business with a Software as a Service, or SaaS, model for a complete and configured unified communications solution or they can purchase Nexmo's "the Vonage API Platform" with a Platform as a Service, or PaaS, model and consume our cloud communication in programmable modules, delivered via application programming interfaces, or APIs. We also provide a robust suite of feature-rich residential communication solutions.

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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 based Voice over Internet Protocol, or VoIP, network. We also offer Communications Platform as a Service, or CPaaS, solutions designed to enhance the way businesses communicate with their customers by embedding communications into apps, websites and business processes. 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. We have a robust set of product families tailored to serve the full range of the business value chain, from the 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, and Clio. With our ability to integrate these cloud-based, workplace tools, Vonage integrates the entire business communications value chain - from employee communications that maximize productivity to the direct engagement with customers that CPaaS provides. When combined with our MPLS network, as well as voice services over customers' broadband networks via our SmartWan solution, we create a differentiated offering.
Our Business strategy is to support the full range of business customers, using two product families: Vonage Business Cloud, based on our proprietary call processing platform that is purpose-built for SMB and mid-market customers; and Vonage Enterprise, based on Broadsoft’s call processing platform in combination with other Vonage cloud based solutions, which serves larger customers, from mid-market businesses through large enterprises. We also organized our sales force to address the full business market. We believe operating two platforms at scale enables us to deliver the right products and solutions to address the needs of diverse customers while maximizing our subscriber economics, regardless of segment served. Revenues are generated primarily through the sale of subscriptions for our UCaaS services. Our revenue generation efforts are focused on customer acquisition and retention as well as providing additional services to existing customers as they grow and scale.
Our diverse customer base spans a wide variety of industries, including manufacturing, automotive, legal, information technology, financial services, construction, real estate, engineering, healthcare, and non-profit.
Vonage Business Cloud. Vonage Business Cloud customers subscribe to our cloud-based communication services, delivered through our proprietary platform that is purpose-built for SMB and mid-market customers. Vonage Business Cloud provides a cost-effective, scalable, feature-rich solution, delivered over-the-top of a customer’s broadband, typically month-to-month without a commitment and is sold primarily through our direct telesales and online channels, and is increasingly sold through our channel partners and field sales teams. We believe the strength of the Vonage brand directly contributes to a lower-cost customer acquisition model and provides attractive subscriber economics.
Vonage Enterprise. Our Vonage Enterprise offerings are tailor-made for the large mid-market and enterprise segments. Vonage Enterprise is a feature-rich/fully managed solution that utilizes Broadsoft Inc.’s ("Broadsoft") enterprise-grade call processing platform, in combination with other cloud services like advanced contact center, video conferencing and speak2dial, and can be provided with high-level quality of service ("QoS"), which is generally delivered over our national MPLS network, with 21 network Points of Presence (POPs) across the country. Vonage can also provide QoS-level quality over-the-top of the customer’s broadband through our Smart-WAN router solution. Customers value our proprietary provisioning and feature-management tool, named Zeus, which enables the rapid deployment of solutions directly by Vonage while giving full visibility to our channel partners and our customers. Further differentiating Vonage is our robust service delivery team comprised of team members specializing in project management, voice and data provisioning, and line number porting. This team is intensely focused on providing an outstanding customer experience, and is rapidly becoming a competitive differentiator.
Our Vonage Enterprise offering is sold primarily through our channel partner, and our field and enterprise sales teams, and generally requires a three-year contract. We are a preferred provider for many of the largest master agents in the country, harnessing a network of over 20,000 sub agents selling both Vonage Enterprise and Vonage Business Cloud. We believe we have one of the largest multi-channel distribution sales platforms in our industry to serve the full range of business customers. We plan to capitalize on the growing adoption of cloud-based communications and collaboration solutions by continuing to expand our salesforce, expand into new markets, and enhance our relationships with existing customers to provide additional functionality and overall business value that can be achieved with our UCaaS platform.

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Nexmo, the Vonage API Platform. We are a global leader in the CPaaS segment of the cloud communications market, providing innovative communication 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