Erin Rheaume – IR, The Blueshirt Group Eric Stang - CEO Ravi Narula - CFO.

Michael Nemeroff - Credit Suisse Sarah Shizas - William Blair Matt Robison - Wunderlich Patrick Walravens - JMP Securities LLC Joy Singh - Bank of America Mike Crawford - B Riley and company.

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'd like to turn the conference over to Erin Rheaume from Investor Relations. Please go ahead ma'am..

Thank you. This is Erin Rheaume, Ooma's Investor Relations and I am pleased to welcome you to Ooma's conference call to discuss its second quarter fiscal 2017 earnings result. With me on the call today is Ooma's CEO, Eric Stang and CFO, Ravi Narula. After the market closed today, Ooma issued a press release in PR Newswire.

The release is also available in the company's website at ooma.com. This call is being webcast live on the Investor Relations page, the Ooma website and will be available for 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 initiative 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 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 as required by law.

Please note that 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 why present non-GAAP financial measures and a reconciliation of the non-GAAP financial measures discussed in this call and mostly simply 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 FY17 Q2 earnings call. I am 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 improved 28% year-over-year.

In Q2, our subscription service gross margins expanded four 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 this segments as demonstrated for example by our incredibly low customer churn rate. Our go forward strategy is to penetrate this 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 multi dimensional 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 such strategic priorities and reinvest our gross profit dollar 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.

And like our major competitors, Ooma now provides 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 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'll 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 this 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 reduce the general consumer mindshare in the category. This we believe is contributed to a payback time on our sales and marketing investment for Telo which is now longer than we experienced 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 planned the 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'll 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 revenue 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 voice mail 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 virility 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 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'll 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 am going to review the results of our second quarter fiscal 2017 and then I'll 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 and 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've 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.

This improvement in gross margin were due to continued growth in core user, 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 & 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. Recession development expenses were $5 million, an increase of approximately $900,000 over the prior year quarter.

Increased R&D spent 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 second 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 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 $53.8 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 IPO we've 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 product 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 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] Your first question will come from Michael Nemeroff with Credit Suisse..

Hey, guys. Thanks for taking my questions and nice job on the results this quarter. Eric just heard the prepared remarks and it is a little bit of shift in strategy focusing more on Office. You had mentioned something about specific things around VAR channel.

I am 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 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've signed up some VARs; we have some that are doing very well for us. But it's still small numbers at this point and I think this would 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 is a quite number out there and we are particularly looking for VARs that would serve small business which is 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'll 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 channels works is you have to share some we call it monthly recurring revenue with the VARs. But we factor that into 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. .

And Michael, this is Ravi here. Just one other factor we are building VAR relationship now so this will be -- this is -- there will be reasonable payback - -reasonable period over where we will build a decent VAR. We believe it is a big market.

And at the same time as Eric said the unit economics in terms of CAC, 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 are -- have been a little bit more challenging and you've de-emphasizing 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, this is still -- 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. .

From William Blair we will hear from Sarah Shizas..

Hi, guys. This is Sarah Shizas in for Bhavan. Quick question on your investment in R&D. You mentioned kind of scaling back on the Telo but increasing your investment in the Ooma Office. What overall impact it is this going to have on total R&D spending? I know you spend 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. And 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 has been. It is 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. .

And Sarah, this 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 and you mentioned your low churn rate.

Can you kind of give us a sense of what that was or how it has 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%, 6.5%, 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 is the lowest, the best it is 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's ever been in the company. So those kinds of core metrics for us, we think we are right on track yes. .

And next we will hear from Matt Robison with Wunderlich. .

Hey, thanks for taking the questions. I just had -- most of my questions have been answered but just want a little follow up on the churn, revenue retention was - kind of spiked in the April quarter.

Was there a little bit more churn in the second quarter that caused it to ?.

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 over Q2 the decline is primarily because of Business Promoter. .

[Operator Instructions] From JMP Securities we will hear from Patrick Walravens..

Okay, thank you. Hi, guys. Congratulations on the quarter. I have a bunch of questions so I am 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. Hey, Pat, so we do believe 2018 our key focuses initiative whether it's Ooma Office, whether its 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 revenue.

So but at the same time adding more and more core users would be our key focus there. So I'd expect the growth to continue in some of these areas. Ooma Office probably driving the growth within 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. I mean that does affect us when we comp year-over-year a little bit but I think Ravi is given you the --.

But you are seeing the growth, the improvements in margin primarily because one, product revenue is smaller portion. Secondly, we are adding increasing our ARPU and adding more and more Ooma Office. So as it 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 so we are talking about EBITDA being positive in three quarters right.

Did I hear that right?.

That's right. Yes. .

Okay and where would it go from there? Would it like flat now or would you expect it to keep going up in certain amount of year? How would you think about that?.

So that's a strategic decision we 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 onboard are very valuable customers. And investing in growth is important for us. But I believe we are going to get more specifics around that in upcoming conference call. .

Okay, great.

And then Eric what is changed in the Telo business? What's made it more challenging?.

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 home service by switching to internet based phone service.

And we think that has a little bit of effect on us. Now that said, we know some of our standalone voice 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 targeted 18 months or less payback on our sales and marketing spend and we are achieving that on little more Office today but we are not quite achieving it on Telo and so it make sense for us at least at this time to put more emphasis on Office. .

That's helpful. And then last one for me as I am sitting in my kitchen here, I am 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 speaker phone?.

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

Next we will hear from Nikolay Beliov with Bank of America..

Hi. This is [Joy Singh] for Nikolay. Congratulation on a great quarter, Ravi and Eric. I just have question on since 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 lot more opportunities on that -- on the Ooma Office side?.

Yes. 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. And what we are doing is shifting some from Telo on to 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 on to Office than we have in the past.

And so that's where the shift is occurring..

Yes, got it.

And so in terms of kind of your dot on the split between Telo versus Office, has that changed given that you are now it sounds like you are stepping on I guess for sales and marketing for the Office say three to five years out?.

I am not sure if I am 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 and 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. And we have something I think we are going to continue to do as a company as we go forward.

But that 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 is right thing to do and it will -- I believe it will be something that we continue for a while. .

And Joy 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 investments we are making in Ooma Office and marketing I think we will continue to invest incremental dollars even in that one.

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

You mean more than this peer-- more than a share for Telo meaning the investing dollars right?.

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

[Operator Instructions] We will go back to Mike Crawford with B Riley and company..

Thank you.

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

$8.05, yes, that's right. .

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 and the Business Promoter, so small ARPU overall 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 are 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 turns from $8.12 in Q1 --.

That's right because of its promoter.

And then Talkatone, is that still about 6% of revenues or is that --.

It is in single digit yes. 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 that still that leaves room for another $1.8 million that is missing and would that the rest of that be Talkatone or --.

That would be largely be yes you go the math largely correct yes. .

I see.

And then given the shift towards Office from Telo where do you expect to see most effective channels like for example may be less coming from retail, it is more -- or how do you see that transitioning?.

From marketing to Office customers it is 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.

And that's where we will step up our spending where we -- when we move some budget from Telo on to Office. .

Okay. Great.

And then the company overall is trading just one time service revenue even though you have 67% service margins other comparable companies can trade 3x, 4x, 5x 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 specialist and trying to figure that sort of thing out. I do believe the company is performing well. I am excited about the things we are investing in.

We generate over $50 million of gross profit and we ploughed it back into the 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 the better company next year.

And that's where we are all about doing and I don't know why we trade so below our peers like that but hopefully you guys can figure that out. .

And we will go to Michael Nemeroff with Credit Suisse..

Yes, hey, guys. Just a couple of follow up. And I am actually using my Telo phone right now so and I love it. It's a great service so I don't understand why it is back trade 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. So that's what we had earlier mention and we believe we are on track for that. .

Okay.

And then on the Telo side, I am curious Eric specifically taking how much dollars are you going to take out or how much budget you are 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 overtime.

But I am curious specifically what is going to change about the marketing to Telo and I know that you said that you had expected 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 expected will even with the lower level of investment. .

Yes. As Ravi kind of said earlier, traditionally we've taken ourselves in marketing budget and more or less split it in half between Telo and Office. A couple of years ago it was Telo and we managed through grow to get that point and 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 large part of where we spend it as well as retailer programs and some online advertising that we do. And we are 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 dollar to shift over on to Office.

But Office will be a meaningful majority of the spend for Q3 as we look forward. But it is 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 that what we see others accomplishing.

So we don't want to give up the growth but we think we have better returns spending on our Office and so we are going to shift the way I described here. .

And Michael we will -- 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. Then the question is how aggressively do we want to invest is a 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 expansions grow commensurate with the increased spend? Or would you expect that it will take a couple of quarters?.

It is a little bit of both, believe or not. Partly what will drive it is a hiring on the Office side and particularly for inside sales in such so it doesn't happen immediately. But over the next couple quarters I think we will 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 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 have factored into our outlook as well.

But it is something we can execute relatively quickly but I would say it takes a couple quarters to kind of change the momentum..

Okay. And then lastly on the Telo pricing.

Do you think that the pricing -- 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 that when we track up the price of Telo in 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 some advertising each quarter and you may see us at 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 as we've 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. And I don't think that's going to change so we are -- we believe we are where we need to be and don't see a lot of value and trying to take it lower at this time. .

So those prices that we saw that was not you discounting that was potentially the channel, the different channels we are looking at discounting. .

I don't know what you saw so it's hard to comment specifically. But sometimes it is us; sometimes it is the channel doing certain things particularly based on whatever is happening at the moment. You even see sometimes you can see retailers just do -- just make errors and price something incorrectly.

But, no, we are not fundamentally trying to move up the $99 I think that's your question and that's where we are. .

And we will go back Matt Robison with Wunderlich..

Hey, I'll add that there are at least three people with the Telo, talking on Telo on this call. So just quick to add on to Michael's question 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 that maybe that was part of your calculation that it wasn't time to spend to more to chase residential order you already have..

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 kind of the Black Friday time period in Q4 when we know there are 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. .

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

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

Thanks everybody. .

And ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation..