Ooma Inc (OOMA) 2017 Q2 法說會逐字稿

Good day, everyone, and welcome to the Ooma second-quarter fiscal 2017 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Erin Rheaume, Investor Relations. Please go ahead, ma'am.

Thank you. This is Erin Rheaume, Ooma Investor Relations, and I am pleased to welcome you to Ooma's conference call to discuss its second-quarter fiscal 2017 earnings results. With me on the call today is Ooma's CEO, Eric Stang, and CFO, Ravi Narula. After the market close today, Ooma issued a press release through PR Newswire. The release is also available on the Company's website at Ooma.com. This call is being webcast live on the Investor Relations page of the Ooma website and will be available for a period of one year.

During the course of today's presentation, our executives will make forward-looking statements within the meaning of the federal securities laws. Forward-looking statements generally relate to future events or future financial or operating performance. Forward-looking statements in this presentation include, but are not limited to, statements related to our business and financial performance and expectations and guidance for future periods, our expectations regarding our strategic product initiatives, and the related benefits and our expectations regarding the market. Our expectations and beliefs regarding these matters may not materialize, and actual results in financial periods are subject to risks and uncertainties that could cause actual results to differ materially from those projected.

These risks include those set forth in the press release that we issued earlier today, as well as those more fully described in our filings with the Securities and Exchange Commission. The forward-looking statements in this presentation are based on information available to us as of the date hereof, and we disclaim any obligation to update any forward-looking statements except required by law.

Please note other than revenue or as otherwise specifically stated, the financial measures to be discussed on this call will be on a non-GAAP basis. The non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. A discussion of present non-GAAP financial measures and a reconciliation of non-GAAP financial measures discussed in this call on the most recently comparable GAAP financial measures are included in our earnings press release that is available on our website.

Let me now turn the call over to Eric Stang, Ooma's CEO.

Thank you, Erin. Hello, and welcome to Ooma's FY 2017 Q2 earnings call. I'm very pleased to talk with you today and to share our strong results and outlook for the future.

Q2 was another strong quarter for Ooma. Total revenue increased to $25.5 million and our core user base reached 869,000. Subscription services revenue grew 28% year-over-year.

In Q2, our subscription service gross margins expanded 4 percentage points year-over-year to 68%. With this margin expansion, we believe we are on track to reach our goal of positive EBITDA within the next three quarters.

The strongest area of growth in Q2 was Ooma Office subscription services, which increased more than 80% over Q2 last year. We believe this level of growth is outpacing our major cloud business phone service competitors. All in all, our strong Q2 performance demonstrates the power of our business model and our competitive advantage over other solutions for small-business home and mobile users.

Last quarter, I updated you on our four major growth initiatives for this fiscal year. Today I'd like to outline our strategic direction and key priorities for the second half of this fiscal year and update you on our growth plans.

As I've discussed before, Ooma serves the distinct needs of small-business home and mobile users. Our unique business model provides fundamental competitive advantage in these segments as demonstrated, for example, by our incredibly low customer churn rate. Our go-forward strategy is to penetrate these market segments in North America based on the superior quality, features, and value of our number one ranked cloud phone service.

Longer-term, our strategy is both to expand internationally and to leverage our large user base and unique platform to introduce new services, which will also enable us to monetize our customers in more ways. Our strategy is expansive and multidimensional and it presents tremendous scope for long-term growth and profitability.

While we are excited about the potential across all areas of our business, we are also mindful of the need to set strategic priorities and reinvest our gross profit dollars wisely to maximize profitable growth. First and foremost, we are very excited about our Ooma Office strategy, given the competitive advantages we bring to the market. Unlike our major competitors, Ooma now provide small businesses the choice to use a combination of standard analog phones, mobile phones, and IP phones. Our solution meets the specific needs of small businesses and provides the unique combination of quality, features, and value unmatched by competitors. And we now offer service for mobile-only users as well, of course, as for fixed-line users.

We've decided strategically to place even more emphasis on growing Ooma Office for small business. We intend to increase the share of sales and marketing spending that we allocate to Ooma Office, expand our go-to-market strategy by establishing a reseller program directed at independent value-added resellers, and accelerate the development of additional features that expand the appeal of the platform.

We will also ramp up marketing of our newly launched Ooma Office for Mobile service and expand the range of IP phones supported by Ooma Office.

The rationale driving these added initiatives is twofold. First, the small business market is ripe for disruption and provides a great opportunity for rapid growth. And second, we are now achieving a faster payback on our sales and marketing spend for Ooma Office as compared to other areas of our business.

Given our strategy for Ooma Office, we plan to spend less growing Ooma Telo for home consumers. To be clear, we still intend to grow our Telo user base, though at a more modest rate. We believe Telo is the number one best solution in the industry for home phone service and we know it is serving a very large market opportunity of 65 million or more households in North America.

While Telo remains a solid growth opportunity for Ooma, the recent overall industry trend is toward less home phone service advertising, and that reduces general consumer mind share in the category. This we believe has contributed to a payback time on our sales and marketing investment for Telo, which is now longer than we experience for Ooma Office.

While we are shifting some sales and marketing spending away from Telo, we are maintaining our longer-term strategy of investing in additional Telo services to enhance customer value and increase revenue per customer. To this end, I am excited to say we plan to launch before the end of this fiscal year new services on the Telo platform, which will further enhance our differentiation.

Unlike our competitors, Ooma can offer new services that extend the Ooma Telo into a home platform that provides consumers increased value over time. This is an important strategy and I will talk more about it in our next quarterly earnings call.

Our strategy for Business Promoter has been to incorporate it into our business forecast conservatively and to hold our investment in the service to a level where it positively contributes to Ooma's financial results. We achieved both of these goals in Q2. Nonetheless, in Q2 our Business Promoter service did not achieve its upside potential.

While Business Promoter is a great pay-per-call lead generation service for small business customers, it is also dependent on digital agencies for much of its growth, and these agencies are not well positioned to provide a steady customer base or steady level of budget over time.

It was this nature of the business which led to declining growth for Business Promoter in Q2 year-over-year. As such, our strategy for Q3 will be to invest less in growing our Business Promoter service.

The last area of our business I'd like to discuss today is Talkatone, which is our feature-rich, free mobile calling and texting app that serves a large user base of over 1.6 million customers as of the end of Q2. Talkatone is performing well and generated increased revenues year-over-year, and we remain excited about its potential.

Talkatone is strategically important to our longer-term strategy of providing a broad range of advanced calling solutions for mobile only customers. In the short term, we will continue to enhance Talkatone's features as demonstrated by our recent announcement that Talkatone now supports custom voicemail greetings and blocking of unwanted callers, and we will continue to find additional ways to monetize mobile ads on the platform and to expand the virality of the app.

Longer-term, we will leverage our Talkatone capabilities and success to create additional premium mobile app solutions targeting specific customer segments. Our pace of investment will be driven by our existing strategy of holding our investment to a level where Talkatone positively contributes to Ooma's financial results.

We are excited about our strategic direction and outlook. We are targeting a very large market opportunity to disrupt how small-business home and mobile users receive phone service, and we stand alone in our ability to leverage our platform to provide additional new services.

As I have mentioned before, our strong competitive advantage derives from, one, our unique hybrid SaaS platform which better satisfies the special needs of small-business home and mobile users; two, our integrated strategy of serving both small business and home consumers which improves our cost of customer acquisition and drives faster growth; three, our high customer retention and satisfaction which powers the overall success of our business model; and four, our commitment to innovation and launching new services which allows us to break out and seize new opportunities which we believe our competitors cannot.

Now let me turn the call over to Ravi to discuss our results and outlook in more detail. I will then return with final comments and we will take your questions.

Thank you, Eric. As a reminder, all income statement items except revenue are on a non-GAAP basis and exclude expenses such as stock-based compensation, amortization of intangibles and related taxes. The reconciliation of the GAAP to non-GAAP financial data can be found in the press release issued earlier today.

First, I'm going to review the results of our second-quarter fiscal 2017, and then I will provide guidance for the third quarter and full-year fiscal 2017. Total revenue for the second quarter of fiscal 2017 was $25.5 million, an increase of 21% over the same quarter last year. During the same period, our total core users also grew 21% to over 869,000.

Premium users as a percentage of total core users increased to 47% compared to 44% at the end of the prior-year quarter. Due to the growth in core users and even faster growth of Ooma Office users, our overall subscription and services revenue in the second quarter of fiscal 2017 increased by 28% to $22.4 million.

Our small-business core users are now 16% of the total core users as compared to 12% of the total core users at the end of the same quarter last year.

Our small-business revenue grew to 21% of the overall revenue in the second quarter compared to 18% of the overall revenue in the prior-year quarter, despite some decline in Business Promoter revenue on a year-over-year basis. Our average monthly subscription and services revenue per core user was $8.05 for the second quarter, up from $7.78 for the prior-year quarter.

Subscription services revenue grew to 88% of total revenue for the second quarter compared to 83% of total revenue for the same quarter last year. By the end of second quarter, Talkatone had over 1.6 million monthly active users. On a year-over-year basis, we have grown both the overall Talkatone revenue as well as the average revenue from each such monthly active user.

Product and other revenue for the second quarter was $3.1 million, down from $3.7 million for the same quarter last year. This decline was due to lower volume of Telo sales in the quarter compared to a year-ago period.

As Eric mentioned earlier, we are emphasizing more on the growth of Ooma Office as compared to Telo, given the shorter payback period for the Office. This shift towards Ooma Office will continue to have some impact on product revenue in the short-term, but in the long-term it should benefit the growth of high-margin subscription and services revenue.

Annualized exit recurring revenue increased 25% on a year-over-year basis to a record $83.9 million for the second quarter, up from $66.9 million for the prior-year quarter. Our quarterly net dollar subscription retention rate was 97% for the second quarter compared to 96% for the same quarter last year.

Now moving on to gross margins. Our overall gross margins improved to 58% in the second quarter compared to 54% for the same quarter last year. Our subscription services gross margin improved to 68% in the second quarter from 64% for the same quarter last year. These improvements in gross margin were due to continued growth in core users, benefit of economies of scale, as well as increasing mix of Ooma Office customers, which has higher ARPU and higher margins.

Product and other gross margin were negative 12% for the quarter compared to 3% for the prior-year quarter, driven primarily by lower ASPs of our products. Second-quarter operating expenses were $15.8 million, a year-over-year increase of $2.2 million. This increase was driven by investment in sales and marketing, as well as R&D expenses.

Sales and marketing expenses were $8.2 million, an increase of $1.5 million over the prior-year quarter. This increase was primarily due to emphasis on driving growth of Ooma Office customers.

Research and development expenses were $5 million, an increase of approximately $900,000 over the prior-year quarter. Increased R&D spend went to the development of new features and functionalities, including launching of IP phones and mobile-only version of Ooma Office.

G&A expenses in the 2nd quarter were down to $2.6 million, a decrease of approximately $200,000 on a year-over-year basis.

In summary, our net loss in the second quarter of fiscal 2017 was $856,000 or $0.05 loss per basic and diluted share, compared to a net loss of $2.5 million or $0.58 per share for the same quarter last year.

Adjusted EBITDA loss decreased to approximately $500,000 in the second quarter of fiscal 2017, down from a $1.8 million loss in the same quarter last year.

Now turning to the balance sheet. We had cash and investments of $33.8 million with no debt as of the end of the second quarter. During the second quarter, we generated over $600,000 of cash from operations compared to cash used in operations of approximately $2 million at the end of the prior-year quarter.

Deferred revenue at the end of the second quarter increased to $15.2 million, up from $14 million at the end of the prior-year quarter. This increase in deferred revenue was driven primarily by higher deferred service to our core users. We had 162 full-time employees as of the end of the second quarter.

Now for our outlook. The following guidance excludes stock-based compensation expense, amortization of intangibles, and related taxes. For third-quarter fiscal 2017, total revenue is expected to be in the range of $26.5 million to $27.5 million. Non-GAAP net loss is expected to be in the range of $700,000 to $1 million. Non-GAAP net loss per share is expected to be in the range of $0.04 to $0.06. We have assumed 17.7 million shares for Q3.

For full-year fiscal 2017, total revenue is expected to be in the range of $104 million to $107 million. Non-GAAP net loss is expected to be in the range of $3.5 million to $4.5 million. Non-GAAP net loss per share is expected to be in the range of $0.20 to $0.25. We have assumed approximately 17.6 million shares for fiscal 2017.

We recently completed the one-year anniversary of our IPO and as Eric mentioned earlier, since the IPO we have made significant progress on a number of our key initiatives and as a result, have seen continuous growth in our core user base. This growth in core users has led to consistent growth of our subscription and services revenue, thus improving our overall gross margins as well as our bottom line.

With that, let me pass it back to Eric for some closing remarks. Eric.

Thank you, Ravi. In summary, we are executing well and we are on track to achieve strong revenue growth while also significantly improving our bottom line this fiscal year. We are excited about the large market opportunity before us, the new products and services we are introducing, and the growth of our subscription services revenue, driven primarily by Ooma Office. As a SaaS business with high-margin recurring revenue and high customer retention that is disrupting the huge communications market for small-business home and mobile users, we believe we are well placed as a company to continue our growth and to capture the great opportunities in front of us.

Thank you. We are now happy to take your questions.

(Operator Instructions). Michael Nemeroff, Credit Suisse.

Hey guys, thanks for taking my questions and nice job on the results this quarter.

Thank you.

Eric, I heard the prepared remarks and it's a little bit of a shift in strategy focusing, more on Office. You had mentioned something about some specific things around a VAR channel. I was curious if you could maybe quantify the number of VARs that are out there that you think you could target, whether you've started to talk to the VARs already and what kind of an impact you think that will have on the growth in Office lines going forward.

Sure. We made a release maybe about a month ago or so saying that we were -- maybe less than that -- saying we've opened up a program for VARs, value-added resellers. And that involves compensation for VARs who want to bring Ooma onto their plate and offer it to the customers they work with.

We view it as a way to get -- to reach more customers faster, and we are excited about what that can do for us, but it is early days right now. We have signed up some VARs. We have some that are doing very well for us, but it's still small numbers at this point. I think this will be a channel that we build over the longer term. Through the next 12 months or longer, we will be in building mode for this.

We do think there's quite a number out there, and we are particularly looking for VARs that would serve small business, which is a little bit different perhaps from what some others might be searching for, but we feel it can lever up the growth of Ooma Office.

Now, we look at everything from a customer acquisition cost and payback period perspective, and we are not modeling that channel to be any different than the rest of our business and how it operates today. But it will be a new form of growth for us that we will be expanding, particularly this quarter and next.

So do you think that the effect on the ARPU through the VAR channel will be -- will it be the same ARPU as you are seeing -- as you are enjoying with the current Office sales currently?

No, it won't be exactly the same. The way the VAR channel works is you have to share some, we call it, monthly recurring revenue with the VARs. But we factor that in to our overall economics when we look at selling through that channel versus other channels, and we believe the economics for us will be similar working with that channel. But the actual ARPU per month per user will be net of what we have to share with the VAR.

Michael, this is Ravi here. Just one other factor. We have [linked] the VAR relationship now, so this will be -- there will be a reasonable payback -- reasonable period where we will build a decent VAR. We believe it's a big market. At the same time as Eric said, the unit economics in terms of [GAAP], the payback period, all of those we have considered as part of our strategy into this VAR channel.

And just on the Telo side of the business, understanding that the unit sales have been a little bit more challenging and you are deemphasizing that business; what growth rate would you expect the Telo users to grow in fiscal 2017? I think the consensus out there was mid-to-high teens. Would you expect that to be closer to 10% for fiscal 2017, versus the mid-to-high teens previously?

So we grew -- so you are right. We still believe it will be a growth engine for us, and in Q2 we did grow in teens and we do expect it to grow in double digits going forward.

Okay, thanks for taking my questions.

Sarah Shizas, William Blair.

Hi, guys. This is Sarah Shizas in for Bhavan. A quick question on your investment in R&D. You mentioned scaling back on the Telo but increasing your investment in the Ooma Office. What overall impact is this going to have on total R&D spend? I know you said almost close to 20%.

Actually, we are continuing to spend on the R&D front on both platforms, and that's part of our longer-term strategy. We have new services that we want to introduce on the Telo platform that we believe we can independently monetize. We are targeting services, new services, for the back half of this year. So we are continuing to invest for that on the Telo. And as I outlined in my script, we are investing even in some new things on the Office front.

That means our R&D as a percent of revenue is going to largely be what it's been. It's not -- we are not making a shift on that front, I should say. We are excited about what we can do with the Telo to over time increase the ARPU on it. And as we increase the ARPU, I think that will also strengthen that part of our business in terms of growing it as we look forward.

Sarah, the shift actually is more happening on the sales and marketing investment, and we are putting -- since we have a pool of money, we are putting more money towards the growth of Ooma Office than Telo, even though both of them will be growing, but the shift is more on the sales and marketing versus R&D.

Okay, thank you. That was helpful. And then one more if I can. Just on the -- you mentioned your low churn rate. Can you give us a sense of what that was or how it's been tracking relative to prior quarters?

Yes. So the churn rate has been very consistent over the last year or two on a quarterly basis. It has been around 6%; 6%, 6.5%, 7%. It has not moved up at all. Even though when our share of Ooma Office has become bigger, we are still trending churn at remarkably low, around 6%, 7%.

Two things we look closely at and we are excited about. One is if you look at -- we don't give exact numbers for Office, but if you look at our churn rate on office, it's the lowest, the best it's ever been. We continue to do things to drive that down on the platform. And if you look at our take rate of Premier, which is the optional premier service for Telo, it is the highest it has ever been in the Company. So those kind of core metrics for us, we think we are right on track.

Great, thanks, guys. Nice job on the quarter.

Thank you.

Thank you.

Matt Robison, Wunderlich.

Thanks for taking the question. Most of my questions have been answered, but I just want a little follow-up on the churn. Revenue retention kind of spiked in the April quarter. Was there a little bit more churn in the second quarter that caused it to (multiple speakers)?

To go down? Matt, that was not the reason. As I said, in Q2 Business Promoter was down year-over-year and sequentially. That is probably the largest factor why if you were to compare Q1 or Q2, the decline is primarily because of Business Promoter.

Okay, thanks. Thanks for that clarification. That's it for me for now.

(Operator Instructions). Patrick Walravens, JMP Securities.

Hi, guys. Congratulations on the quarter.

Thank you.

Thanks, Pat.

I have a bunch of questions, so I'm going to drag this out a little bit. First of all, Ravi or Eric, can you give us a little -- I know you are not ready to guide yet, but can you give us a little color in terms of how we should think about what fiscal 2018 will look like for you?

Well, I think our strategy is going to remain consistent. You know what we are doing to drive the growth of Ooma Office to increase the services and the monetization on Telo, and we are going to continue those strategies into next year, I believe.

I don't know if you want to speak more specifically to the question, Ravi?

Yes. So we do believe 2018, our key focus initiatives, whether it's the Ooma Office, whether it is Ooma Telo, we will continue to grow on all of those fronts. And as Eric earlier mentioned, Business Promoter and Talkatone, we are managing the growth while making sure we are adding something to the bottom line there. So the focus area is growth of Ooma Office and Telo.

And within that, we do expect subscription services revenue, which is a higher-margin part of the business, will continue to grow. It's right now 88% of overall revenue. We do believe it will get higher than that. Our focus is more on subscription services versus product revenues, but at the same time adding more and more core users would be our key focus there.

So I would expect growth to continue in some of these areas. Ooma Office probably driving the growth in the Company.

There is a small effect that we are experiencing where as we shift towards Ooma Office, we don't bring in as much product revenue as we would with Telo. That does affect us when we comp year-over-year a little bit, but I think Ravi has given you the (multiple speakers).

But you are seeing the growth -- the improvements in margin primarily, because one product revenue is a smaller portion. Secondly, we are adding -- increasing our ARPU and adding more and more Ooma Office. So as that happens, you will see us getting closer to the long-term target model in terms of subscription services over the next couple of years.

Great. And we're talking about EBITDA being positive in three quarters, right? Did I hear that right?

That's right, yes.

Then where would it go from there? Would it like flatten out or would you expect it to keep going up a certain amount of the year? How would you think about that?

You know, that's a strategic decision we will have to make and I don't think we are ready to guide on that. I can tell you that the customers we are bringing on board are very valuable customers and investing in growth is important for us, but I believe we're going to give more specifics around that in an upcoming conference call.

Okay, great. Then, Eric, what has changed in the Telo business? What's made it more challenging?

You know, I put it in my script. We have seen a reduction in the level of general category advertising for home phone service, particularly over the last quarter or two. And we think that just means there are less shoppers out there looking around, being enticed to save money and get a better phone service by switching to an Internet-based phone service. We think that has a little bit of an effect on us.

Now that said, we know some of our stand-alone VoIP competitors are shrinking relatively quickly. We know that the cable companies are relatively flat. We are growing, and as Ravi said, growing in double digits.

So we are still doing well, but we target an 18-month or less payback on our sales and marketing spend, and we are achieving that on Ooma Office today but we are not quite achieving it on Telo. So it makes sense for us, at least at this time, to put more emphasis on Office.

That's helpful. And last one from me as I am sitting in my kitchen here, I'm looking at my Amazon Alexa Tower and I got the Ooma phone. Are we going to see any more progress on that integration where I can use it as a speakerphone?

That's not up to us; that's up to Amazon, and I really can't speak for them. I hope someday they will do that because I think it would enable us to add additional services to what we've already done, which would be exciting, but I can't give you any outlook for that.

Okay. Well, thank you so much for the color. I appreciate it.

Thank you.

[Nikolai Delove], Bank of America.

Hi, this is Joyce Yang for Nikolai. Congratulations on a great quarter, Ravi and Eric. I just have a question on essentially -- it sounds like we should expect sales and marketing budget to shift towards more Ooma Office and less on Business Promoter going forward.

Is that the right way to think about it since it sounds like there are a lot more opportunities on the Ooma Office side?

Actually, most of our sales and marketing goes to either Office or Telo. We don't really spend much on that line item for Business Promoter. What we are doing is shifting some from Telo onto Office.

Now I don't want to overstate that because part of our strategy is to be strong on both fronts. When we spend on Telo, it does also benefit Office and we have a strong retail channel that we want to continue to build. But that said, we are going to -- moving more of our budget onto Office than we have in the past. So that's where the shift is occurring.

Yes, yes, got it. So in terms of your thoughts on the split between Telo versus Office, has that change -- given that you're now -- it sounds like you are stepping on the gas for sales and marketing for the Office, say 3 to 5 years out?

I'm not sure if I'm answering your question, but let me try here. I said in my script that it's kind of our duty to invest our gross profit dollars wisely so that we achieve the maximum in profitable growth. And with our plans to reach EBITDA positive by the end of Q1 FY18, we only have so much to spend. So we are going to make our best decisions on the best way to spend it.

That's something I think we are going to continue to do as a company as we go forward, but we are not saying we are stopping on either front or pulling back in some fundamental way. But this is a shift and I think it's the right thing to do, and I believe it will be something that we continue for a while.

Joyce, this is Ravi. In the longer term we do have expectations that Ooma Office will be a much bigger portion of our overall revenue, and for that purpose we would continue to invest in that. So the investment we are making in Ooma Office sales and marketing, I think we will continue to invest incremental dollars even in that one.

So it will probably get more than the share compared to Telo, at least in the next 12 months, given we are emphasizing a lot more on Ooma Office.

You mean more than this year; more than the share for Telo, meaning the investing dollars, right?

That is right, yes. So right now, it's evenly split, largely split between Telo and Office, and there's more money going into Ooma Office as we expand our sales and marketing budget given the revenue.

Got it, got it. Thank you so much. That makes complete sense. Thank you.

(Operator Instructions). Mike Crawford, B. Riley & Co.

Thank you. Did you say that the average subscription revenue was $8 and -- did you say $0.05?

$8.05, yes, that's right.

So shouldn't we expect that to be expanding, not contracting, given the shift towards small office?

Yes, in the longer term, I would expect that ARPU to increase as Ooma Office becomes a bigger portion of our revenue.

It was $7.78 at the end of -- last year in Q2, so it went up. Business Promoter -- ARPU over our blended is Telo revenue, Business Promoter revenue, as well as Ooma Office revenue. And because Business Promoter declined on a year-over-year basis as well as sequentially, that's why you're seeing a small dip sequentially in terms of ARPU. But on a year-over-year basis you are seeing, even with the decline, you are seeing a growth in ARPU.

I see. That's why it's down from $8.12 in Q1 (multiple speakers).

That's right, because of Business Promoter.

Then Talkatone, is that still about 6% of revenues or is that --?

It is in single digit, yes, it is. It is growing, as I said earlier, it is growing consistently at a reasonable good pace, but it is in single-digit revenue. Both Business Promoter and Talkatone are single digit after overall revenue.

Because if I take 852,000 average users and $8.05 average revenue, I get $20.6 million expected service revenue. And there's still -- that leaves room for another $1.8 million that's missing. Would the rest of that be Talkatone or (multiple speakers)?

That would largely be -- yes, you've got the math largely correct, yes.

I see. And then given this shift towards Office from Telo, where do you expect to see your most effective channels like, for example, maybe less coming from retail and it's more -- well, how do you see that transitioning?

For marketing to Office customers, it's all about reaching out to the small businesses, and we do that several ways today. And that's not a retail channel play primarily. That's primarily a process we follow with inside sales and now some independent resellers and a lot of directed marketing towards the small business channels. That's where we will step up our spending when we move some budget from Telo onto Office.

Okay, great. And then the Company overall is trading at just 1 times service revenue, even though you have 67% service margins. Other comparable companies trade 3, 4 or 5 times and probably aren't growing as fast as you. So to what do you attribute that phenomenon?

I will defer to folks like yourself who are specialists in trying to figure that sort of thing out. I do believe the Company is performing well. I'm excited about the things we are investing in. We generate over $50 million of gross profit, and we plow it back into sales and marketing to add customers and into R&D to drive new services that can bring more monetization.

And as long as we spend that wisely, I think we are going to build a better company next year, and that's what we are all about doing. I don't know why we trade so below our peers like that, but hopefully you guys can figure that out.

Okay, thank you.

Michael Nemeroff, Credit Suisse.

Just a couple of follow-ups, and I'm actually using my telephone right now and I love it. It's a great service, so I don't understand why the stock trades at such a level as well. But on the subscription growth, I just want to confirm; do you guys expect to grow 25% still subscription and services in fiscal 2017, or greater than?

Yes, that's what we had earlier mentioned and we believe we are on track for that.

Okay. And then on the Telo side, I'm curious, Eric, specifically taking -- how much dollars are you going to take out or how much budget are you going to take out and focus on Office Promoter? And I think the market will react favorably because as you rightly mentioned, the return on that investment into the Office business is significantly faster and better over time.

But I'm curious specifically what is going to change about the marketing to Telo? And I know that you said that you expect it to be a double-digit grower, but what could go wrong and how quickly can you adjust that back if Telo starts to deteriorate or not grow as fast as you expect it will, even with the lower level of investment?

Yes. As Ravi kind of said earlier, traditionally we've taken our sales and marketing budget and more or less split it in half between Telo and Office. A couple years ago it was all Telo, and we've managed through growth to get to that point.

Most of what we spend on the Telo side is brand building and outreach to try and convince consumers to consider us. So TV advertising is a large part of where we spend it, as well as retailer programs and some online advertising that we do.

We're not going to cut back any of those three fundamentally, but we are going to cut back across all three. And we believe that will give us a meaningful amount of dollars to shift over onto Office, but Office will be a meaningful majority of the spend for Q3 as we look forward. But it's not going to shift farther than that, because we do want to continue to grow Telo.

We think we are growing faster than anybody else we know when you consider what we see others accomplishing. So we don't want to give up the growth, but we think we have better return spending on Office. So we are going to shift the way I have described here.

Michael, we have retail and e-tail channels, and we will continue to maintain relationships with all of them. So I think we will -- you will see the presence in all of those things. And then the question is how aggressively do we want to invest, is the question.

And how quickly, once you start to move over those marketing dollars to Office, would you expect to see the return on that? Is it in the same quarter would you expect to see unit users and extensions grow commensurate with the increased spend, or do you expect that it will take a couple of quarters?

It's a little bit of both, believe it or not. Partly what will drive it is hiring on the Office side, particularly for inside sales and such. So it doesn't happen immediately, but over the next couple quarters I think we'll see the shift materialize well.

And we also have to keep in mind that as we do this shift, the product revenue for us is not going to be as strong as it otherwise would have, because you sell a Telo with every customer on the Telo side of things and you don't do that for Office. So that will be something we factored into our outlook as well. But it's something we can execute relatively quickly, but I would say it takes a couple quarters to kind of change the momentum.

Okay, then lastly on the Telo pricing, do you think that the price decrease which you put into effect about six months ago, do you think that's about as low as you need to go or do you think that you could still go lower? Because at the end of the quarter, we did see a little bit of a dip on some of the -- when we tracked the price of Telo end of July into the $70s range. Just curious if you can comment on that.

Yes. We don't have any plans at this time to move fundamentally lower. We do do some advertising each quarter, and you may see us in an advertising period, or depending on what channels you are looking at, you could also see certain retailers doing things even on their own sometimes.

But we felt moving to the $99 MSRP was the right place to be, and actually that move didn't cost us as much as you might think because we were already promoting down to it a fair bit. But it still remains the case today that a customer needs to invest in Telo. They need to see the value of free home phone service and pay a little bit more to get a Telo in their home. I don't think that's going to change.

So we believe we are where we need to be and don't see a lot of value in trying to take it lower at this time.

So those prices that we saw, that was not you discounting, that was potentially the channels -- the different channels that were looking at discounting?

I don't know what you saw, so it's hard to comment specifically. But sometimes it's us, sometimes it's the channel doing certain things, particularly based on whatever is happening at the moment. Sometimes you even see retailers just make errors and price something incorrectly. But no, we're not fundamentally trying to move off the $99. I think that's your question and that's where we are.

Okay. Thanks, Eric. Thanks for taking my questions. Good quarter, guys.

Sure, thank you.

Matt Robison, Wunderlich.

I will add that there is at least three people with a Telo -- talking on a Telo on this call. So just quick to add on to Michael's questions because I saw the same thing, in fact, this week, discounted phones on Best Buy and Amazon. And I was wondering if you got any feedback indicating maybe you didn't see a lot of elasticity and, therefore, maybe you thought maybe that was part of your calculation, that it wasn't time to spend more to chase the residential any harder than you already are.

Well, within the last week we have run a couple of major promotions, so you may have seen us as part of that. We don't get many opportunities to run some of those, but actually last week we did get an opportunity and we were excited about it.

We've done our market research and getting under $100 was important, but we don't think a fundamental price move from here is warranted. The one time of year when we will take a little bit of an extra step is the Black Friday time period in Q4 when we know there's a lot of shoppers out and we want to be enticing to them. But outside of that, I think we are trying to execute the same strategy we outlined for you in Q1.

Thanks a lot.

And there are no further questions. I would like to turn the conference back over to today's speakers for any additional or concluding remarks.

Thanks for joining us. We look forward to updating you on our next earnings call.

Thanks, everybody.

Ladies and gentlemen, that does conclude today's presentation and we do thank everyone for your participation.