2600hz, Inc. (OOMA) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to Ooma's discussion of the 2600hz acquisition. [Operator Instructions] I would now like to hand the call over to Matt Robison.

Thank you, Latif. Good day, everyone, and welcome to the corporate update call of Ooma, Inc. to discuss the acquisition of 2600Hz announced this morning. My name is Matt Robison. I'm as Director of IR and Corporate Development. On the call with me today are Ooma's CEO, Eric Stang; and CFO, Shig Hamamatsu. This morning, Ooma issued a press release announcing the acquisition of 2600Hz. This release is available on the company's website, ooma.com. This call is being webcast live and is accessible from a link on the Events and Presentations page under the News and Events tab of the Investor Relations section of our website. This link will be active for replay of this call for at least 1 year. During today's discussion, 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. Our expectations and beliefs regarding these matters may not materialize and actual results 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 we issued today, and those risks more fully described in our filings with the Securities and Exchange Commission. The forward-looking statements made today are based on information available to us as of the date hereof, and we disclaim any obligation to update any forward-looking statements except as required by law. Please note that other than revenue or as otherwise stated, the financial measures that may 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. Please refer to our Q2 earnings release, which is available on our website and discusses our presentation of non-GAAP financial measures generally. Ooma is in the third month and quiet period of its fiscal third quarter, and management does not intend to discuss guidance or other topics unrelated to the 2600Hz acquisition. We expect this call to be complete by 8:15 a.m. Pacific Time. Now I will hand the call over to Ooma's CEO, Eric Stang.

Thank you, Matt. Hi, everyone. Welcome to our call today. We're here to discuss the exciting news that Ooma has acquired 2600Hz. I'd like to share with you today the background and rationale for this acquisition, how this acquisition repositions Ooma strategically and the expanded opportunity created by integrating 2600Hz into Ooma. For background, 2600Hz provides open-source core calling functionality named Kazoo, that is in use today by many telecom providers. Kazoo stands out for its modern API-based architecture, which allows providers to develop their own applications and integrations utilizing the Kazoo core calling functionality. Since initially launching Kazoo over a decade ago, 2600Hz has expanded to provide its own non-open source suite of prebuilt UCaaS, CPaaS and call center applications. Telecom providers have the choice of relying solely on open source Kazoo and building applications themselves are contracting with 2600Hz for a more complete solution. 2600Hz today provides hosted cloud, private cloud and customer-operated solutions to approximately 130 paying customers who serve hundreds of thousands of end users. The company runs data centers in 8 locations spread across North America, Europe and Oceania, maintains a workforce of about 110 employees and contractors and has revenues of approximately $7 million annually. In addition to recurring revenues, typically build on either a per user or per use basis, 2600Hz also earns professional services revenue through paid engagements to assist customer adoption. Ooma and 2600Hz have been close partners for over a decade, going back to when the Kazoo open source functionality was first launched. We employ Kazoo in our business solutions, and our 2 companies have collaborated over the years in a variety of ways, particularly in regard to product road maps, quality assurance and engineering. As such, we know Kazoo and the founders and team at 2600Hz extremely well. At times in the past, we looked at acquiring them, but the timing was never right until now. Recently, 2600Hz was approached by another party and that prompted a restart of our dialogue together. Through that dialogue, we identified a compelling business rationale to move forward in the market together and the 2600Hz founders agreed to proceed. At the core of our rationale is the opportunity we see as a wholesale provider in the marketplace driven by the unique position 2600Hz has in the industry, and Ooma's ability to enhance 2600Hz offerings and credibility. In the marketplace today, there are carriers and others looking for UCaaS, CPaaS and call center and even contact center solutions. Their choices are surprisingly limited. For carriers and others who want to build upon and operate a modern design platform that is customizable, we believe 2600Hz Kazoo stands out versus competition. Kazoo offers open APIs for developers to build their own customer applications and is proven to scale. We believe Kazoo truly is the wholesale solution for the future. As a small company, 2600Hz has been held back by lack of resources on the application side of its business and perhaps more significantly, back of business scale credibility with larger potential customers. Ooma directly addresses each of these challenges. Ooma's engineering and the applications we've developed can improve and expand the paid applications now offered in the market by 2600Hz. And large corporate customers can trust that Ooma, an established public company can be relied upon when they make long-term strategic decisions. By enhancing 2600Hz applications through leveraging what Ooma is also developing and by bringing supplier credibility 2600Hz. Ooma can drive growth in the number and size of telecom providers utilizing 2600Hz technology. Furthermore, by virtue of bringing greater international reach to 2600Hz business, Ooma can engage a larger market opportunity as well. Secondly, and also at the core of our rationale for this acquisition, 2600Hz fundamentally enhances Ooma's strategic position. Ooma today is increasingly developing deep relationships with carriers and other partners. Through our partnerships with T-Mobile and U.S. Cellular, and through the conversations that Air dial in particular, is driving for us with other carriers and partners of all types, we are engaged in exciting opportunities and understand what carriers need from a partner. We believe there are carriers and other partners who want to work more closely with us, not only for air dial, but across all of our solutions. By owning 2600Hz, we place ourselves in the strategic position to control and direct 100% of the technology stack to benefit our existing and hopefully new to come, carrier and other relationships. We have the strategic position to direct a complete engineering program to meet complex requirements and to enable deep and long-term partnerships. These 2 factors, our ability to make 2600Hz more successful in the marketplace and the new strategic position, Ooma can now bring to large partnerships are what make this acquisition compelling to us. Nonetheless, on top of these 2 drivers, there are also other material benefits to be had. Technologically, 2600Hz increases Ooma's capabilities and speed to market. For example, 2600Hz has developed an integration into the IP multimedia subsystem or IMS core of a major carrier. This requires significant development effort. They have interesting AI and contact center applications in development, among other initiatives. And 2600Hz provides CPaaS solutions such as powering a WebRTC client connected to an existing contact center solution, which they do for a large corporate customer today. Their strong engineering team will allow Ooma to move faster and do more. At the same time, there are areas of engineering overlap as well, where synergies can be realized. We estimate Ooma would be able to repurpose or save over $2 million of engineering spend per year. Eventually, this could amount to as much as $4 million per year. This amount of savings is significant to our financial outlook. Similarly, Ooma can bring its lower cost structure and scale to improve 2600Hz business. Our lower cost of providing service can be used to create new products and services for sale across 2600Hz customer base. This could lead to a material increase in revenue for 2600Hz over time. Our first step is, of course, to integrate 2600Hz into Ooma with particular focus on combining the engineering road maps. Our initial actions will be directed toward both growing 2600Hz and making it adjusted EBITDA accretive within 6 months. I will provide more information in a moment. But first, I want to mention that 2600hz' Annual Customer Conference called KazooCon takes place this week in Las Vegas, starting today and going through Wednesday. We're looking forward to talking with everyone at the conference and hearing how we can make Kazoo even more valuable to them. We are also excited that 2600Hz will be making some important new product announcements at the conference. I'll now turn the call over to Shig, our CFO, and then return with some closing remarks.

Thank you, Eric, and good morning, everyone. I'm going to spend a few minutes providing details about the financial aspects of the 2600Hz transaction. We paid $33 million in cash to acquire 2600Hz, and there are no contingency payments for this acquisition. Additionally, following the closing, certain former 2600Hz employees who joined Ooma will be granted equity awards subject to vesting conditions. With regard to the funding of $33 million cash purchase price, we used approximately $15 million of cash from our balance sheet and the remaining $18 million came from a new $30 million revolving line credit with Citizens Bank which was put in place just by the closing of the Strength acquisition. The new credit facility has a 3-year term and the borrowing under it will bear interest rate based on SOFR plus applicable margin or approximately 7.4% today. The additional details on the credit facility will be available in our Form 8-K to be filed after the close of the market today as well as in our Q3 Form 10-Q to be filed in December. As Eric mentioned, 2600Hz is expected to add approximately $7 million of recurring revenue on an annual basis initially. For Ooma's fiscal third quarter ending October 31, 2023, we anticipate 2600Hz will contribute approximately $0.2 million of revenue and $0.4 million of non-GAAP expenses, both of which represent estimates for the last 11 days of October. As with the case for our past acquisitions, we will be undertaking a number of initiatives to realize operational synergies. We expect 2600Hz's operations to be accretive to our adjusted EBITDA within 6 months and make increasing contribution to our overall adjusted EBITDA in subsequent periods. As for the impact of this acquisition on our fiscal fourth quarter, we look forward to providing more details during our next earnings call. I'll now pass it back to Eric for some closing remarks. Eric?

Thanks, Shig. We feel this is truly an exciting time for Ooma. Three considerations are driving our excitement. The first is we see significant potential for growth as a wholesale provider and believe we have the market-leading solution to do so. Furthermore, with Ooma's engineering capability, applications and international reach. We can strengthen 2600Hz's competitive position and potential for growth. Second, we feel our combination with 2600Hz significantly enhances our strategic position and better enables us to serve the fundamental needs of large carriers and other partners, efficiently, and with total in-house control over technology, development road maps and service delivery. And thirdly, we believe we can capitalize on significant operational benefits. Technologically, for example, we now can add improved call center and soon contact center applications to our business, and we strengthened our ability to provide CPaaS applications for customers. From an R&D standpoint, we can drive expanded development and/or spending savings by leveraging our activities now over the full wholesale customer base with 2600Hz. While not the primary reason for this acquisition, these operational benefits alone can have a significant impact on our financial results. Thank you. We'll now take questions.

[Operator Instructions] Our first question comes from the line of Mike Latimore of Northland.

Congratulations on this deal here. I guess on the historic relationship between your firm and 2600Hz, can you just elaborate a little bit on how tightly integrated their technologies with yours to sort of all of your customers leverage some of what they have? Just trying to get a sense of that historic relationship.

Sure, Mike. Yes, we started out the development of Ooma Office in -- and Ooma Enterprise, by the way, is the same. But we started out development of Ooma office, utilizing their open source technology or core calling functionality and have built the user applications and really all the things people do with our platform on top of that open source. So it is fundamental to our solution and one of the benefits of that is that everything we've developed can also be applicable to all the other open source customers of 2600Hz and gives us the ability to leverage our R&D across a much larger base of customers now.

Got it. That makes sense. Okay. And then just on the revenue model, can you touch on that a little bit more. I think you said it was both seed and usage based. I guess what's the mix? How how variable is there revenue? How much is truly recurring versus maybe usage based? And then what has been the growth rate of their business?

Yes. So, they earn revenue from customers who have decided to take advantage of the proprietary applications that they built on top of their open source. And there are a lot of customers out there who just use their open source. I think those customers in themselves are an opportunity. Some of those companies are -- I mean you can debate what's sizable, but by our perspective, sizable. And so their customer base combination of folks who have chosen to utilize their paid applications and those who could in the future. Almost all $7 million is recurring revenue to them today. Their revenues do fluctuate some with whether they have a new engagement and are doing professional services for that customer. They have had substantial professional services revenue in the past currently. They do not have much going on. Almost all of the $7 million is recurring revenue. And we're optimistic that as we help them garner new customer opportunities, new paid customer opportunities, we'll be able to drive both recurring revenue and more professional services revenue.

Got it. And then has the revenue been growing, stable, decline?

It's fluctuated with the new engagements that they brought onboard. We have talked to them over the years and years ago, they were substantially smaller. So I think if you look at it over a time period, they've been steadily growing. And their existing customers do grow each year and have been a solid base for them.

Our next question comes from the line of Josh Nichols of B. Riley.

Just to dig in a little bit deeper. Is the company's gross margin profile similar to that Ooma's at least given that most of this business is recurring, whether it's from seats or subscriptions?

Josh, thanks for the question. So the recurring margin is lower than Ooma's. And we got a number of the synergy initiatives identified as I said earlier. And so we're already taking all those projects pretty quickly here. So similar to kind of onset margin profile, we've been improving over time, even though this is a wholesale market we're talking about on recurring margin, but it's low on Ooma. And I think over the next several months to 18 months, we want to get it up to closer to upper 60% to 70% range, which is much closer to Ooma's recurring profile.

Good to hear but there's is up relatively quickly to be realized, hopefully $2 million in engineering spend per year. Is that really going to be one of the key drivers that gets you to breakeven EBITDA contribution within the first 6 months or so?

I think there are 2 key drivers. That is one. The synergies, operational benefits as we look at all the different things they and we are developing. Second is just the core calling services that they provide their customers today. Our cost structure is much, much less than their. So we can bring cost of goods sold line synergies to that to them. And frankly, I think that can become a growing -- an area of growth as well because many of their customers maybe using third-party solutions today where we can help them with a better solution. So I think it's on both sides. We want to -- it's going to take some time for us to think through engineering road map-wise, where -- what they've built is the best way we want to move forward and what we've built is the best way we want to move forward. And as we make those decisions, it will free up resources to do other new things and to go faster as well.

Yes. And then last question for me is like what would you say is like the biggest opportunity over, let's call it, the next 12 months? Do you think that's like to expand the company's capabilities now as a wholesale provider? Or do you think it's that you're better positioned with these large carriers that you already have relationships with and how that could materialize to the company's growth trajectory overall?