Edgar Filing: VONAGE HOLDINGS CORP

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2018



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From __________ to __________

Commission File Number 001-32887

VONAGE HOLDINGS CORP.

(Exact name of registrant as specified in its charter)



Delaware		11-3547680
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

23 Main Street, Holmdel, NJ		07733
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (732) 528-2600

(Former name, former address and former fiscal year, if changed since last report): Not Applicable

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	x	Accelerated filer	o

Non-accelerated filer	o
Smaller reporting company	o	Emerging growth company	o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.



Class	Outstanding at		July 30, 2018
Common Stock, par value $0.001		239,058,980		shares

VONAGE HOLDINGS CORP.

INDEX



Part 1 - Financial Information

		Page
Item 1.	Condensed Consolidated Financial Statements and Notes
	Condensed Consolidated Balance Sheets as of June 30, 2018 (Unaudited) and December 31, 2017	3
	Unaudited Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2018 and 2017	4
	Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2018 and 2017	5
	Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017	6
	Unaudited Condensed Consolidated Statement of Stockholders’ Equity for the Six Months Ended June 30, 2018	7
	Notes to Unaudited Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41

Item 4	Controls and Procedures	41

Part II. Other Information

Item 1.	Legal Proceedings	42

Item 1A.	Risk Factors	42

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42

Item 3.	Defaults Upon Senior Securities	42

Item 4.	Mine Safety Disclosures	42

Item 5.	Other Information	42

Item 6.	Exhibits	43

	Signature	44

Financial Information Presentation

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

PART 1 - FINANCIAL INFORMATION

ITEM 1 - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES

VONAGE HOLDINGS CORP.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

(Unaudited)



	June 30, 2018			December 31, 2017
Assets
Current assets:
Cash and cash equivalents	$	26,077		$	31,360
Accounts receivable, net of allowance of $2,342 and $2,258, respectively	49,460			44,159
Inventory, net of allowance of $236 and $108, respectively	2,033			2,971
Deferred customer acquisition costs, current portion	9,640			—
Prepaid expenses	23,099			23,763
Other current assets	5,035			7,522
Total current assets	115,344			109,775
Property and equipment, net of accumulated depreciation of $92,972 and $87,792, respectively	43,992			46,754
Goodwill	369,760			373,764
Software, net of accumulated amortization of $98,015 and $93,858, respectively	18,092			22,252
Deferred customer acquisition costs	32,258			—
Restricted cash	1,940			1,967
Intangible assets, net of accumulated amortization of $142,035 and $124,573, respectively	152,901			173,270
Deferred tax assets	112,478			110,892
Other assets	23,637			20,007
Total assets	$	870,402		$	858,681
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	36,999		$	29,766
Accrued expenses	79,563			85,706
Deferred revenue, current portion	28,440			30,255
Current portion of notes payable	18,750			18,750
Total current liabilities	163,752			164,477
Indebtedness under revolving credit facility	116,000			141,000
Notes payable, net of debt related costs and current portion	63,560			72,765
Other liabilities	7,978			7,541
Total liabilities	351,290			385,783

Commitments and Contingencies (Note 7)

Stockholders’ Equity:
Common stock, par value $0.001 per share; 596,950 shares authorized at June 30, 2018 and December 31, 2017; 308,569 and 298,174 shares issued at June 30, 2018 and December 31, 2017, respectively; 238,818 and 230,939 shares outstanding at June 30, 2018 and December 31, 2017, respectively	309			298
Additional paid-in capital	1,396,407			1,375,391
Accumulated deficit	(614,630		)	(672,561		)
Treasury stock, at cost, 69,751 shares at June 30, 2018 and 67,235 shares at December 31, 2017	(271,890		)	(244,239		)
Accumulated other comprehensive income	8,916			14,009
Total stockholders’ equity	519,112			472,898
Total liabilities and stockholders’ equity	$	870,402		$	858,681

See accompanying notes to condensed consolidated financial statements.

VONAGE HOLDINGS CORP.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

(Unaudited)



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017

Total revenues	$	259,875		$	251,836		$	513,448		$	495,183

Operating Expenses:
Cost of revenues (exclusive of depreciation and amortization)	107,204			103,861			210,771			198,750
Sales and marketing	77,685			79,738			154,821			161,669
Engineering and development	10,375			6,670			21,195			15,040
General and administrative	32,174			36,514			59,756			71,600
Depreciation and amortization	19,062			18,394			35,862			36,341
Total operating expenses	246,500			245,177			482,405			483,400
Income from operations	13,375			6,659			31,043			11,783
Other Income (Expense):
Interest expense	(3,097		)	(3,861		)	(6,258		)	(7,564		)
Other income (expense), net	337			690			84			475
Total other income (expense), net	(2,760		)	(3,171		)	(6,174		)	(7,089		)
Income before income taxes	10,615			3,488			24,869			4,694
Income tax (expense) benefit	(2,056		)	1,337			8,214			6,044
Net income	$	8,559		$	4,825		$	33,083		$	10,738

Earnings per common share:
Basic	$	0.04		$	0.02		$	0.14		$	0.05
Diluted	$	0.03		$	0.02		$	0.13		$	0.04
Weighted-average common shares outstanding:
Basic	237,919			223,492			235,490			221,930
Diluted	248,256			239,938			248,373			239,923

See accompanying notes to condensed consolidated financial statements.

VONAGE HOLDINGS CORP.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017

Net income	$	8,559		$	4,825		$	33,083		$	10,738
Other comprehensive (loss) income:
Foreign currency translation adjustment, net of tax (benefit) expense of ($1,358), $2,007, ($1,356), and $2,436, respectively	(12,434		)	14,185			(6,101		)	17,232
Unrealized (loss) gain on available-for-sale securities, net of tax (benefit) expense of $0, $0, $0, and $0, respectively	—			(20		)	—			1
Unrealized gain on derivatives, net of tax expense of $89, $0, $391, and $0, respectively	228			—			1,008			—
Total other comprehensive (loss) income	(12,206		)	14,165			(5,093		)	17,233
Comprehensive (loss) income	$	(3,647	)	$	18,990		$	27,990		$	27,971

See accompanying notes to condensed consolidated financial statements.

VONAGE HOLDINGS CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



	Six Months Ended
	June 30,
	2018			2017
Cash flows from operating activities:
Net income	$	33,083		$	10,738
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	17,515			17,381
Amortization of intangibles	18,181			18,826
Deferred income taxes	(10,305		)	(8,111		)
Amortization of deferred customer acquisition costs	4,423			—
Allowance for doubtful accounts	1,129			452
Allowance for obsolete inventory	298			293
Amortization of debt issuance costs	511			204
Gain on sale of business	—			(928		)
Loss on disposal of fixed assets	166			134
Share-based expense	15,972			20,891
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable	(7,256		)	1,280
Inventory	623			353
Prepaid expenses and other current assets	3,032			2,302
Deferred customer acquisition costs	(11,837		)	—
Accounts payable	7,794			(8,124		)
Accrued expenses	(3,535		)	(23,787		)
Deferred revenue	(1,713		)	(1,506		)
Other assets and liabilities	(2,146		)	2,295
Net cash provided by operating activities	65,935			32,693
Cash flows from investing activities:
Capital expenditures	(7,787		)	(8,995		)
Maturities and sales of marketable securities	—			602
Acquisition and development of software assets	(4,220		)	(6,884		)
Proceeds from sale of business	—			1,000
Net cash used in investing activities	(12,007		)	(14,277		)
Cash flows from financing activities:
Principal payments on capital lease obligations and other financing obligations	(95		)	(4,861		)
Principal payments on notes and revolving credit facility	(44,375		)	(19,375		)
Proceeds received from draw down of revolving credit facility and issuance of notes payable	10,000			15,000
Common stock repurchases	—			(9,542		)
Employee taxes paid on withholding shares	(28,618		)	(14,562		)
Proceeds from exercise of stock options	5,055			11,962
Net cash used in financing activities	(58,033		)	(21,378		)
Effect of exchange rate changes on cash	(1,205		)	660
Net decrease in cash, cash equivalents, and restricted cash	(5,310		)	(2,302		)
Cash, cash equivalents, and restricted cash, beginning of period	33,327			30,929
Cash, cash equivalents, and restricted cash, end of period	$	28,017		$	28,627
Supplemental disclosures of cash flow information:
Cash paid during the periods for:
Interest	$	5,695		$	6,722
Income taxes	$	4,855		$	3,554
Non-cash investing activities:
Capital expenditures included in accounts payable and accrued liabilities	$	1,373		$	3,492

See accompanying notes to condensed consolidated financial statements.

VONAGE HOLDINGS CORP.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(In thousands)

(Unaudited)



	Shares		Common Stock		Additional Paid-in Capital		Accumulated Deficit			Treasury Stock			Accumulated Other Comprehensive Income			Total
Balance at December 31, 2017	230,939		$	298	$	1,375,391	$	(672,561	)	$	(244,239	)	$	14,009		$	472,898
Cumulative effect adjustment upon the adoption of Topic 606							24,848									24,848
Stock option exercises	10,395		11		5,044											5,055
Share-based expense					15,972											15,972
Employee taxes paid on withholding shares	(2,516	)								(27,651		)				(27,651		)
Foreign currency translation adjustment													(6,101		)	(6,101		)
Unrealized gain on derivatives													1,008			1,008
Net income							33,083									33,083
Balance at June 30, 2018	238,818		$	309	$	1,396,407	$	(614,630	)	$	(271,890	)	$	8,916		$	519,112

See accompanying notes to condensed consolidated financial statements.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Note 1. Nature of Business

Nature of Operations

Vonage Holdings Corp. (“Vonage”, “Company”, “we”, “our”, “us”) is incorporated as a Delaware corporation. At Vonage, we are redefining business communications. We are embracing technology to transform how businesses communicate to create better business outcomes. Our cloud communications platform enables businesses of all sizes to collaborate more productively and engage their customers more efficiently across any device. All of our cloud communications solutions are designed to allow businesses to be more productive by integrating communications with all their existing business productivity tools and our programmable solutions allow customers to engage with their customers via embedded voice, chat, or messaging to create seamless and contextual communications that makes doing business easier for end customers.

For our business customers, we provide innovative, cloud-based Unified Communications as a Service, or UCaaS, solutions, comprised of integrated voice, text, video, data, collaboration, and mobile applications over our flexible, scalable Session Initiation Protocol, or SIP, based Voice over Internet Protocol, or VoIP, network. We also offer Communications Platform as a Service, or CPaaS, solutions designed to enhance the way businesses communicate with their customers by embedding communications into apps, websites and business processes. In combination, our products and services permit our business customers to communicate with their customers and employees through any cloud-connected device, in any place, at any time without the often costly investment required with on-site equipment.

We provide a robust suite of feature-rich residential communication solutions that allow consumers to connect their home phones and mobile phones on one number and we offer attractive international long distance rates that help create a loyal base of satisfied customers.

Customers in the United States represented 79% and 85% of our consolidated revenues for the three months ended June 30, 2018 and 2017 and 81% and 86% for the six months ended June 30, 2018 and 2017, respectively, with the balance in Canada, the United Kingdom, Hong Kong, Singapore and many other countries around the world.

Unaudited Interim Financial Information

The accompanying unaudited interim condensed consolidated financial statements and information have been prepared in accordance with accounting principles generally accepted in the United States and in accordance with the SEC's regulations for interim financial information and with the instructions for Form 10-Q. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, these financial statements contain all normal and recurring adjustments considered necessary to present fairly the Company's financial position, results of operations, comprehensive income, cash flows, and stockholders’ equity for the periods presented. The results for the three and six months ended June 30, 2018 are not necessarily indicative of the results to be expected for the full year.

These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission on February 27, 2018.

Use of Estimates

Our condensed consolidated financial statements and notes thereof are prepared in conformity with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the amounts reported and disclosed in the condensed consolidated financial statements and the accompanying notes. Actual results could differ materially from these estimates.

Reclassifications

Reclassifications have been made to our condensed consolidated financial statements for the prior year periods to conform to classifications used in the current year periods. The reclassifications did not affect results of operations or net assets.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Note 2. Summary of Significant Accounting Policies

This footnote should be read in conjunction with the complete description of our significant accounting policies under Note 2, Summary of Significant Accounting Policies to our Annual Report on Form 10-K for the year ended December 31, 2017.

Cost of Revenues

Cost of revenues excludes depreciation and amortization expense of $6,226 and $6,863 for the three months ended June 30, 2018 and 2017 and $12,660 and $13,645 for the six months ended June 30, 2018 and 2017, respectively. In addition, costs of goods sold included in cost of revenues during the three months ended June 30, 2018 and 2017 were $6,171 and $6,187 and during the six months ended June 30, 2018 and 2017 were $12,468 and $13,480, respectively.

Advertising Costs

We incurred advertising costs which are included in sales and marketing of $14,401 and $14,994 for the three months ended June 30, 2018 and 2017 and $28,922 and $32,337 for the six months ended June 30, 2018 and 2017, respectively.

Engineering and Development Expenses

Engineering and development expenses predominantly include personnel and related costs for developers responsible for research and development of new products.

Sale of Hosted Infrastructure Product Line

On May 31, 2017, we completed the sale of our Hosted Infrastructure product line for up to $4.0 million consideration comprised of $1.0 million received upon closing, an additional $0.5 million of contingent consideration received during the third quarter of 2017 and the potential for up to $2.5 million further consideration based on the achievement of financial objectives for net sales during the 18 months following closing. The results of our Hosted Infrastructure product line have historically been included within the Business segment. As a result of the sale, we recorded a gain $928 for the three months ended June 30, 2017, within other income. This disposal did not represent a strategic shift in operations and, therefore, did not qualify for presentation as discontinued operations.

Fair Value of Financial Instruments

The Company records certain of its financial assets at fair value on a recurring basis as described below. Certain of the Company's other financial instruments, which include cash and cash equivalents, accounts receivable and accounts payable, approximate fair value because of their short-term maturities. The carrying amounts of our capital leases approximate fair value of these obligations based upon management’s best estimates of interest rates that would be available for similar debt obligations at June 30, 2018 and December 31, 2017. We believe the fair value of our debt at June 30, 2018 and December 31, 2017 was approximately the same as its carrying amount as market conditions, including available interest rates, credit spread relative to our credit rating, and illiquidity, remain relatively unchanged from the issuance date of our debt on June 3, 2016 for a similar debt instrument and are classified as Level 3 within the fair value hierarchy.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

We account for financial assets using a framework that establishes a hierarchy that ranks the quality and reliability of the inputs, or assumptions, we use in the determination of fair value, and we classify financial assets and liabilities carried at fair value in one of the following three categories:

•Level 1 - quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets and liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

•Level 2 - observable prices that are based on inputs not quoted on active markets but corroborated by market data; and

•Level 3 - unobservable inputs when there is little or no market data available, thereby requiring an entity to develop its own assumptions. The fair value hierarchy gives the lowest priority to Level 3 inputs.

The following table presents the assets that are measured and recognized at fair value on a recurring basis classified under the appropriate level of the fair value hierarchy as of June 30, 2018 and December 31, 2017:



	June 30, 2018		December 31, 2017
Level 2 Measurements
Interest rate swaps ⁽¹⁾	$	2,684	$	1,285

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

Supplemental Balance Sheet Information

Cash, cash equivalents and restricted cash



	June 30, 2018		December 31, 2017
Cash and cash equivalents	$	26,077	$	31,360

Cash collateralized letter of credit - lease deposits	1,566		1,563
Cash reserves	374		404
Restricted cash	1,940		1,967

Cash, cash equivalents, and restricted cash	$	28,017	$	33,327

Intangible assets, net



	June 30, 2018		December 31, 2017
Customer relationships	$	109,247	$	122,393
Developed technology	40,023		46,004
Patents and patent licenses	3,272		4,030
Trade names	50		352
Non-compete agreements	309		491
Intangible assets, net	$	152,901	$	173,270

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Accrued expenses



	June 30, 2018		December 31, 2017
Compensation and related taxes and temporary labor	$	23,478	$	30,059
Marketing	9,885		10,759
Taxes and fees	12,953		13,353
Acquisition related consideration accounted for as compensation	—		2,534
Telecommunications	19,129		16,068
Other accruals	7,609		7,078
Customer credits	3,152		2,310
Professional fees	2,210		1,618
Inventory	1,147		1,927
Accrued expenses	$	79,563	$	85,706

Goodwill

The following table provides a summary of the changes in the carrying amounts of goodwill which is attributable to our business segment:



Balance at December 31, 2017	$	373,764
Foreign currency translation adjustment	(4,004		)
Balance at June 30, 2018	$	369,760

Recent Accounting Pronouncements

In August 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-12, "Derivatives and Hedging". The ASU improves the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements and simplifies the application of the hedge accounting guidance in current generally accepted accounting principles ("GAAP"). It also amends the disclosures requirements by requiring a tabular disclosure related to the effect on the incomes statement of fair value and cash flow hedges and eliminating the ineffective portion of the change in fair value of hedging instrument disclosures. This ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted in any interim period after issuance and is applied to hedging relationships existing on the date of adoption. We do not expect a material impact of adopting ASU 2017-12 on our condensed consolidated financial statements and related disclosures.

In January 2017, FASB issued ASU 2017-04, "Intangibles - Goodwill and Other". The ASU simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. This ASU is effective for an annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019 on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of ASU 2017-04 will not have a material impact on our condensed consolidated financial statements and related disclosures.

In February 2016, FASB issued ASU 2016-02, "Leases". This ASU increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted for all entities. The adoption of this ASU will increase our assets and liabilities for real estate and equipment operating leases for which we are the lessee. We have made significant progress in the identification and review of contracts in scope and will adopt this ASU when effective.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

The following standards were adopted by the Company during the current period:

In October 2016, FASB issued ASU 2016-16, "Income Taxes". This ASU improves the accounting for income tax consequences of intra-entity transfers of assets other than inventory. This ASU is effective for fiscal years beginning after December 15, 2017 on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We adopted this ASU on January 1, 2018 and the adoption of this ASU did not have a material impact on our condensed consolidated financial statements and related disclosures.

In August 2016, FASB issued ASU 2016-15, "Statement of Cash Flows". This ASU addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This ASU is effective for fiscal years beginning after December 15, 2017 on a retrospective basis. Early adoption is permitted, including adoption in an interim period. We adopted this ASU on January 1, 2018 and the adoption of this ASU did not have a material impact on our condensed consolidated financial statements and related disclosures.

In January 2016, FASB issued ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities". This ASU provide guidance concerning certain matters involving the recognition, measurement, and disclosure of financial assets and financial liabilities. The guidance does not alter the basic framework for classifying debt instruments held as financial assets. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We adopted this ASU on January 1, 2018 and the adoption of this ASU did not have a material impact on our condensed consolidated financial statements and related disclosures.

In May 2014, FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)". This ASU, as amended, provided comprehensive guidance on the recognition of revenue from contracts with customers arising from the transfer of goods and services, guidance on accounting for certain contract costs and new disclosures. Topic 606 also amends the current guidance for the recognition of costs to obtain and fulfill contracts with customers requiring that all incremental costs of obtaining and direct costs of fulfilling contracts with customers such as commissions be deferred and recognized over the expected customer life. On January 1, 2018, we adopted this ASU. Refer to Note 3. Revenue Recognition for related disclosures required upon adoption.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Note 3. Revenue Recognition

On January 1, 2018, the Company adopted the guidance of ASC Topic 606, Revenue from Contracts with Customers using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Our results for reporting periods beginning after January 1, 2018 are presented in accordance with the provisions under Topic 606 but any prior period amounts have not been adjusted and continue to be reported in accordance with our revenue recognition policy as further described in Note 2, Summary of Significant Accounting Policies to our Annual Report on Form 10-K for the year ended December 31, 2017. In connection with our adoption of Topic 606, we recognized a net increase to opening retained earnings of $24,848, net of tax, as of January 1, 2018 related to commissions paid associated with the acquisition of business customers and associated deferred tax liability.

Upon our adoption of Topic 606, we measure revenue based upon consideration specified by contracts with our customers. Revenue is recognized when our performance obligation under the contract is satisfied by transferring control over the product or service to the customer. We derive our revenues for our Consumer and Business segments primarily from the sale of our communication services and customer equipment as further described below. The majority of the Company's contracts with customers have a single performance obligation for service revenues. We recognize revenue with customers when control transfers, which occurs upon delivery of a service or product. For our Business segment, the typical life of a customer for service is 6 years. The adoption of Topic 606 did not result in a change in the timing of how the Company recognizes revenue.

Service Revenues

Substantially all of our revenues are service revenues, which are derived from monthly subscription fees under usage based billing arrangements, and, in Vonage Enterprise, one of our business service offerings, contract-based services plans. For consumer customers in the United States, we offer domestic and international rate plans, including a variety of residential plans and mobile plans. For business customers, we offer small and medium business, mid-market, and enterprise customers several service plans with different pricing structures and contractual requirements ranging in duration from month-to-month to three years. In addition, we provide managed equipment to business customers for a monthly fee. Customers also have the opportunity to purchase premium features for additional fees. We also derive service revenues from per minute fees for international calls if not covered under a plan, including calls made via applications for mobile devices and other stand-alone products, and for any calling minutes in excess of a customer's monthly plan limits. For a portion of our customers, monthly subscription fees are automatically charged to customers' credit cards, debit cards or electronic check payments ("ECP"), in advance and are recognized over the following month as service is provided.

Service revenue also includes supplying messaging (SMS and Voice) services to customers as part of our CPaaS offerings. Revenue is recognized in the period when messages are sent by the customer. We also transact with providers or bulk SMS aggregators and sell services to these customers who then onsell to their customers. Since the aggregator is our customer, revenue is recognized on a gross basis with related costs included in cost of revenues.

In the United States, we charge regulatory, compliance, E-911 and intellectual property-related fees on a monthly basis to defray costs and to cover taxes that we are charged by the suppliers of telecommunications services. These charges, along with the remittance to the relevant government entity, are recorded on a net basis. In addition, we charge customers Federal Universal Service Fund ("USF") fees from customers to recover our obligation to contribute to the fund, as allowed by the Federal Communications Commission ("FCC"). We recognize USF revenue on a gross basis and record the related fees in cost of revenues.

Customer Equipment and Shipping Revenues

Revenues are generated from sales of customer equipment primarily directly to customers for replacement devices, or for upgrading their device at the time of customer sign-up for which we charge an additional fee. In addition, customer equipment and shipping revenues include revenues from the sale of VoIP telephones in order to access our small and medium business services. Customer equipment and shipping revenues also include the fees that customers are charged for shipping their customer equipment to them.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Disaggregation of Revenue

The following table details our revenue from customers disaggregated by primary geographical market, source of revenue, and timing of revenue recognition. The table also includes a reconciliation of the disaggregated revenue for our Business and Consumer segments.



	Three Months Ended						Six Months Ended
	June 30, 2018						June 30, 2018
	Business		Consumer		Total		Business		Consumer		Total
Primary geographical markets
United States	$	103,250	$	102,727	$	205,977	$	204,116	$	209,995	$	414,111
Canada	725		6,106		6,831		1,374		12,494		$	13,868
United Kingdom	7,327		3,200		10,527		13,810		6,449		$	20,259
Other Countries ⁽¹⁾	36,540		—		36,540		65,210		—		$	65,210
	147,842		112,033		259,875		284,510		228,938		513,448
Major Sources of Revenue
Service revenues	$	127,692	$	100,467	$	228,159	$	243,994	$	204,861	$	448,855
Access and product revenues	12,716		289		13,005		25,247		380		25,627
USF revenues	7,434		11,277		18,711		15,269		23,697		38,966
	147,842		112,033		259,875		284,510		228,938		513,448

⁽¹⁾ No individual other international country represented greater than 10% of total revenue during the periods presented.

In addition, the Company recognizes service revenues from its customers through subscription services provided or through usage or pay-per-use type arrangements. During the three months ended June 30, 2018, the Company recognized $150,186 related to subscription services, $61,249 related to usage, and $48,440 related to other revenues such as USF, other regulatory fees, and credits. During the six months ended June 30, 2018, the Company recognized $302,639 related to subscription services, $112,434 related to usage, and $98,375 related to other revenues such as USF, other regulatory fees, and credits.

Contract Assets and Liabilities

The following table provides information about receivables and contract liabilities from contracts with customers:



	June 30, 2018
Receivables⁽¹⁾	$	49,460
Contract liabilities ⁽²⁾	28,726

⁽¹⁾ Amounts included in accounts receivables on our condensed consolidated balance sheet.

⁽²⁾ Amounts included in deferred revenues and other liabilities on our condensed consolidated balance sheet.

Our deferred revenue represents the advance consideration received from customers for subscription services and is predominantly recognized over the following month as transfer of control occurs. During the three and six months ended June 30, 2018, the Company recognized revenue of $107,615 and $226,986, respectively, related to its contract liabilities. We expect to recognize $28,440 into revenue over the next twelve months related to our deferred revenue as of June 30, 2018.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Contract Acquisition Costs

We have various commission programs for which eligible employees and third parties may earn commission on sales of services and products to customers. We expect that these commission fees are recoverable and, therefore, we have capitalized $41,898 (net of accumulated amortization) and $34,484 as contract costs as of June 30, 2018 and January 1, 2018, respectively, included within deferred customer acquisitions costs, current and deferred customer acquisition costs on our condensed consolidated balance sheet. In addition, we established a deferred tax liability associated with the transition asset of $9,636. Capitalized commission fees are amortized to sales and marketing expense over estimated customer life, which is six years for Business customers. During the three and six months ended June 30, 2018, the amounts amortized to sales and marketing were $2,264 and $4,423, respectively, and there were no impairment losses recognized in relation to the costs capitalized. In addition, the Company expenses sales commissions for commission plans related to customer arrangements deemed less than a year and for residuals and renewals.

Note 4. Earnings Per Share

The following table sets forth the computation for basic and diluted earnings per share for the three and six months ended June 30, 2018 and 2017:



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2018		2017		2018		2017
Numerator
Net income	$	8,559	$	4,825	$	33,083	$	10,738
Denominator
Basic weighted average common shares outstanding	237,919		223,492		235,490		221,930
Dilutive effect of stock options and restricted stock units	10,337		16,446		12,883		17,993
Diluted weighted average common shares outstanding	248,256		239,938		248,373		239,923
Basic earnings per share
Basic earnings per share	$	0.04	$	0.02	$	0.14	$	0.05
Diluted earnings per share
Diluted earnings per share	$	0.03	$	0.02	$	0.13	$	0.04

For the three and six months ended June 30, 2018 and 2017, the following were excluded from the calculation of diluted earnings per common share because of their anti-dilutive effects:



	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2018	2017	2018	2017
Restricted stock units	3,591	4,540	1,896	3,344
Stock options	1,977	4,605	1,126	4,254
	5,568	9,145	3,022	7,598

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Note 5. Long-Term Note and Revolving Credit Facility

This footnote should be read in conjunction with the complete description of our financing arrangements under Note 7, Long-Term Debt and Revolving Credit Facility to our Annual Report on Form 10-K for the year ended December 31, 2017.

A schedule of long-term note and revolving credit facility at June 30, 2018 and December 31, 2017 is as follows:



	June 30, 2018		December 31, 2017
2.50-3.25% Term note - due 2020, net of debt related costs	$	63,560	$	72,765
2.50-3.25% Revolving credit facility - due 2020	116,000		141,000
Total Long-term note and revolving credit facility	$	179,560	$	213,765

Term Note and Revolving Credit Facility

On June 3, 2016, we entered into Amendment No. 1 to the Amended and Restated Credit Agreement (the “2016 Credit Facility”) consisting of a $125.0 million term note and a $325.0 million revolving credit facility. The co-borrowers under the 2016 Credit Facility are the Company and Vonage America Inc., the Company’s wholly owned subsidiary. Obligations under the 2016 Credit Facility are guaranteed, fully and unconditionally, by the Company’s other United States material subsidiaries and are secured by substantially all of the assets of each borrower and each guarantor.

During the six months ended June 30, 2018, we made mandatory repayments of $9.4 million under the term note and made discretionary repayments of $35.0 million under the revolving credit facility and borrowed $10.0 million under the revolving credit facility. In addition, the effective interest rate was 4.88% as of June 30, 2018.

On July 31, 2018, the Company entered into a Second Amended and Restated Credit Facility (the "2018 Credit Facility") consisting of a $100.0 million senior secured term loan and a $500.0 million revolving credit facility. See Note 10. Subsequent Events for further discussion.

Interest Rate Swaps

On July 14, 2017, we executed on three interest rate swap agreements in order to hedge the variability of expected future cash interest payments related to the 2016 Credit Facility. The swaps have an aggregate notional amount of $150 million and became effective on July 31, 2017 and will expire on June 3, 2020 concurrent with the term of the 2016 Credit Facility. Under the swaps our interest rate is fixed at 4.7%. The interest rate swaps are accounted for as cash flow hedges in accordance with ASC 815, Derivatives and Hedging.

As of June 30, 2018, the fair market value of the swaps was $2,684, which is included in other assets on our condensed consolidated balance sheet. As of June 30, 2018, the critical terms of the swap agreements have not changed and therefore, there is no ineffectiveness to be recorded and all changes in the fair value of the interest rate swaps are recorded in accumulated other comprehensive income ("OCI"). The following table summarizes the effects of ASC 815 on the Company's accumulated OCI balance attributable to cash flow derivatives:



	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2018		2018

Accumulated OCI beginning balance	$	1,745	$	965
Mark-to-market of cash flow hedge accounting contracts	228		1,008
Accumulated OCI ending balance, net of tax of $711	$	1,973	$	1,973
Gains expected to be realized from accumulated OCI during the next 12 months	$	—	$	—

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Note 6. Common Stock

As of June 30, 2018 and December 31, 2017, the Company had 596,950 shares of common stock authorized and had 8,550 shares available for grants under our share-based compensation programs as of June 30, 2018. For a detailed description of our share-based compensation programs refer to Note 10, Employee Stock Benefit Plans in our Annual Report on Form 10-K for the year ended December 31, 2017.

Common Stock Repurchases

On December 9, 2014, Vonage's Board of Directors authorized a program for the Company to repurchase up to $100.0 million of its outstanding common stock (the "2014 $100.0 million repurchase program"). Repurchases under the 2014 $100.0 million repurchase program are expected to be made over a four-year period ending on December 31, 2018.

We repurchased the following shares of common stock with cash resources under the 2014 $100.0 million repurchase program during the six months ended June 30, 2018 and 2017:



	Six Months Ended
	June 30,
	2018		2017
Shares of common stock repurchased	—		1,599
Value of common stock repurchased	$	—	$	9,510

There were no repurchases for the three and six months ended June 30, 2018 and the three months ended June 30, 2017.

As of June 30, 2018, $42,533 remained of our 2014 $100.0 million repurchase program. The repurchase program expires on December 31, 2018 but may be suspended or discontinued at any time without notice.

In any period under the 2014 $100.0 million repurchase program, cash used in financing activities related to common stock repurchases may differ from the comparable change in stockholders' equity, reflecting timing differences between the recognition of share repurchase transactions and their settlement for cash.

Note 7. Commitments and Contingencies

From time to time, in addition to those identified below, we are subject to legal proceedings, claims, investigations, and proceedings in the ordinary course of business, including claims of alleged infringement of third-party patents and other intellectual property rights, commercial, employment, and other matters. From time to time, we receive letters or other communications from third parties inviting us to obtain patent licenses that might be relevant to our business or alleging that our services infringe upon third party patents or other intellectual property. In accordance with generally accepted accounting principles, we make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss or range of loss can be reasonably estimated. These provisions, if any, are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. We believe that we have valid defenses with respect to the legal matters pending against us and are vigorously defending these matters. Given the uncertainty surrounding litigation and our inability to assess the likelihood of a favorable or unfavorable outcome in the matters noted below and our inability to reasonably estimate the amount of loss or range of loss, it is possible that the resolution of one or more of these matters could have a material adverse effect on our condensed consolidated financial position, cash flows or results of operations.

Litigation

IP Matters

RPost Holdings, Inc. On August 24, 2012, RPost Holdings, Inc., RPost Communications Limited, and RMail Limited (collectively, “RPost”) filed a lawsuit against StrongMail Systems, Inc. (“StrongMail”) in the United States District Court for the Eastern District of Texas alleging that StrongMail’s products and services, including its electronic mail marketing services, are covered by United States Patent Nos. 8,224,913, 8,209,389, 8,161,104, 7,966,372, and 6,182,219. On February 11, 2013, RPost filed an amended complaint, adding 27 new defendants, including Vonage America Inc. RPost’s amended complaint alleges willful infringement of the RPost patents by Vonage and each of the other new defendants because they are customers of StrongMail. StrongMail has agreed to fully defend and indemnify Vonage in this lawsuit. Vonage answered the complaint on May 7, 2013. On September 17, 2015, the Court ordered the consolidation for pre-trial purposes of this case with other cases by RPost. The lead

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

case has been administratively closed and stayed since January 30, 2014 due to multiple pending actions by third parties regarding ownership of the patents at issue. In a parallel Arizona district court litigation involving RPost, certain of the asserted patent claims were invalidated on June 7, 2016, which decision was affirmed by the Federal Circuit, with the Supreme Court denying certiorari on December 11, 2017. On June 2, 2018, the parties in the consolidated actions filed a joint notice regarding status of the co-pending actions. Plaintiffs requested that the stay be lifted, while defendants maintain that the stay should remain in place.

Commercial Litigation

Merkin & Smith, et al. On September 27, 2013, Arthur Merkin and James Smith filed a putative class action lawsuit against Vonage America, Inc. in the Superior Court of the State of California, County of Los Angeles, alleging that Vonage violated California’s Unfair Competition Law by charging its customers fictitious 911 taxes and fees. On October 30, 2013, Vonage filed a notice removing the case to the United States District Court for the Central District of California. On November 26, 2013, Vonage filed its Answer to the Complaint. On December 4, 2013, Vonage filed a Motion to Compel Arbitration, which the Court denied on February 4, 2014. On March 5, 2014, Vonage appealed that decision to the United States Court of Appeals for the Ninth Circuit. On March 26, 2014, the district court proceedings were stayed pending the appeal. On February 29, 2016, the Ninth Circuit reversed the district court’s ruling and remanded with instructions to grant the motion to compel arbitration. On March 22, 2016, Merkin and Smith filed a petition for rehearing. On May 4, 2016, the Ninth Circuit withdrew its February 29, 2016 decision and issued a new order reversing the district court’s order and remanded with instructions to compel arbitration. The Ninth Circuit also declared as moot the petition for rehearing. On June 27, 2016, the lower court stayed the case pending arbitration. A joint status report was filed with the District Court on December 23, 2016. A second joint status report was filed with the District Court on March 23, 2017. A third joint status report was filed with the District Court on June 27, 2017. A fourth joint status report was filed with the District Court on September 26, 2017. A fifth joint status report was filed with the District Court on December 26, 2017. Counsel for Vonage spoke with counsel for plaintiffs in mid-February 2018, seeking voluntary dismissal. Plaintiff's counsel advised they intended to seek public injunctive relief. The parties are reviewing their respective positions. The parties will be filing a status report once plaintiffs decide their next steps.

Regulation

Telephony services are subject to a broad spectrum of state, federal and foreign regulations. Because of the uncertainty over whether Voice over Internet Protocol (“VoIP”) should be treated as a telecommunications or information service, we have been involved in a substantial amount of state and federal regulatory activity. Implementation and interpretation of the existing laws and regulations is ongoing and is subject to litigation by various federal and state agencies and courts. Due to the uncertainty over the regulatory classification of VoIP service, there can be no assurance that we will not be subject to new regulations or existing regulations under new interpretations, and that such change would not introduce material additional costs to our business.

Federal - Net Neutrality

Clear and enforceable net neutrality rules make it more difficult for broadband Internet service providers to block or discriminate against Vonage service. In addition, explicitly applying net neutrality rules to wireless broadband Internet service providers could create greater opportunities for VoIP applications that run on wireless broadband Internet service. In December 2010, the Federal Communications Commission, or FCC, adopted net neutrality rules that applied strong net neutrality rules to wired broadband Internet service providers and limited rules to wireless broadband Internet service providers. On January 14, 2014, the D.C. Circuit Court of Appeals vacated a significant portion of the 2010 rules. On May 15, 2014, the FCC issued a Notice of Proposed Rulemaking, or NPRM, proposing new net neutrality rules. After public response to the NPRM, the FCC adopted new neutrality rules on February 26, 2015. These rules prohibit broadband Internet service providers from: (1) blocking or throttling lawful content applications, or services; (2) imposing paid prioritization arrangements; and (3) unreasonably interfering or unreasonably disadvantaging consumers or edge providers. In addition, broadband Internet service providers are required to make certain disclosures regarding their network management practices, network performance, and commercial terms. These net neutrality rules apply the same requirements to wired and wireless broadband Internet service providers. In December 2017, the FCC issued a decision reversing its prior position on net neutrality. The decision allows for paid prioritization. Numerous public interest groups and some companies are currently or expected to challenge the order in court. It is also anticipated that Congress may introduce legislation to overrule the FCC's decision and reinstate net neutrality. Nonetheless, on June 4, 2018, the old Net Neutrality rules were repealed. Various states are enacting their own laws to require net neutrality within their state.

Federal - Rural Call Completion Issues

On February 7, 2013, the FCC released a NPRM on rural call completion issues. The NPRM proposed new detailed reporting requirements to gauge rural call completion performance. Rural carriers have argued that VoIP provider call completion performance to rural areas is generally poor. On October 28, 2013, the FCC adopted an order on rural call completion imposing new reporting

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

obligations and restricting certain call signaling practices. The call signaling rules went into effect on January 31, 2014. We filed for extensions of the rules, which the FCC granted, and as of April 17, 2014, we were compliant with the FCC call signaling rules. The effective date for the reporting requirements was April 1, 2015. We could be subject to an FCC enforcement action in the future in the event the FCC took the position that our rural call completion performance is inadequate or we were not compliant with the FCC’s order. On June 22, 2017, the FCC issued a Second Further Notice of Proposed Rulemaking. The FCC has proposed changes to the FCC's rules that allegedly would more effectively address rural call completion problems while reducing burdens on covered providers. Vonage reviewed and evaluated the FCC's proposed changes and provided input to The Voice on the Net, or VON, Coalition, an organization that works to advance regulatory policies for IP-enabled communications. Comments to the Rural Call Completion Second Report and Order and Third Further Notice of Proposed Rulemaking were adopted by the FCC on April 17, 2018. Comments were due on June 4, 2018 and replies were due on June 19, 2018. On April 24, the FCC Wireline Competition Bureau granted a waiver of the rural call completion reporting requirements, including a temporary waiver with respect to the report on May 1, 2018.

Federal - NPRM - Number Slamming

On July 13, 2017, the FCC adopted a NPRM regarding ways to protect consumers from number "slamming" and "cramming" without impeding competition or impairing the ability of consumers to switch providers. Vonage is monitoring this NPRM. On June 7, 2018, the FCC adopted new consumer protections against slamming and cramming. The amended rules reinforce the FCC's ability to take action against slammers and crammers and to deter carriers from slamming and cramming. Specifically, the FCC codified a ban on material misrepresentations on sales calls and unauthorized charges on telephone bills, and improved the effectiveness of the existing third-party verification process. At the same time, the FCC declined to adopt additional measures that may unduly hinder consumers' ability to switch providers.

Federal - NPRM Toll Free Assignment Modernization

On September 26, 2017, the FCC issued a NPRM regarding the modernization of toll free number assignment. The FCC proposes amending its rules to allow for the use of an auction to assign certain toll free numbers - such as vanity and repeater numbers - in order to better promote the equitable and efficient use of numbers (especially as afforded by the opening of the 833 toll free code). Vonage continues to monitor activity with respect to this NPRM.

Federal - NOI - Enterprise Communications Systems Access to 911

On September 26, 2017, the FCC adopted a Notice of Inquiry, or NOI, with respect to 911 access, routing and location in Enterprise Communication Systems. Vonage continues to monitor activity related to this NOI.

Federal - Access to Telecommunication Equipment and Services by Persons with Disabilities

At its open meeting on for October 24, 2017, the FCC applied its wireline hearing aid compatibility rules/standards to handsets that provide advanced communication services, which includes interconnected and non-interconnected VoIP. The rules include certain coupling and volume control requirements that would allow the handsets to work better for persons with hearing aids. There are also testing and certification requirements, which typically apply to the handset manufacturer. The FCC also adopted a requirement for volume control in wireless handsets. The new rules have a two-year phase in for new phones and do not require the modification to existing handsets. On April 5, 2018 the FCC’s Consumer and Governmental Affairs Bureau issued a public notice seeking comment on the accessibility of communications technologies for the 2018 Biennial Report required by the Twenty First Century Communications and Video Accessibility Act. The report must be filed with Congress on or before October 8, 2018. The Bureau sought comments by April 26, 2018. Vonage will monitor activity via the VON Coalition.

Federal - Rules and Policies Regarding Caller ID Services

At its open meeting on October 24, 2017, the FCC issued a report and order regarding amendments to the FCC's rules to exempt threatening calls from current Caller ID blocking roles so that, among other changes, law enforcement and security personnel have timely access to information they need to aid their investigations. The order exempts threatening calls from the CPN privacy rules.

Federal - Number Portability NPRM and NOI

At its open meeting on October 24, 2017, the FCC released a NPRM that would allow carriers flexibility in conducting number portability database queries to promote nationwide number portability and eliminate the dialing party requirement as it applies to interexchange service. The NOI seeks comments on industry number portability models and how number administration might be improved for more efficient technical, operational, administrative and legal processes. Vonage is working with the VON Coalition and is monitoring this NPRM and NOI.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Federal - Second Further Notice of Proposed Rulemaking - Unwanted calls to reassigned telephone numbers

On March 23, 2018, the FCC issued its Second NPRM seeking comments on ways to address unwanted calls to reassigned telephone numbers. The FCC is seeking comment on, among other issues, (1) the specific information that callers need from a reassigned numbers database, and (2) the best way to make that information available to callers that want it. The rules are intended to benefit consumers by reducing unwanted calls intended for another consumer while helping callers avoid the costs of calling the wrong consumer, including potential violations of the TCPA. Vonage will continue to monitor this rulemaking through the VON Coalition.

State Telecommunications Regulation

In general, the focus of interconnected VoIP telecommunications regulation is at the federal level. On November 12, 2004, the FCC issued a declaratory ruling providing that our service is subject to federal regulation and preempted the Minnesota Public Utilities Commission, or MPUC, from imposing certain of its regulations on us. The FCC's decision was based on its conclusion that our service is interstate in nature and cannot be separated into interstate and intrastate components. On March 21, 2007, the United States Court of Appeals for the 8th Circuit affirmed the FCC's declaratory ruling preempting state regulation of our service.

While this ruling does not exempt us from all state oversight of our service, it effectively prevents state telecommunications regulators from imposing certain burdensome and inconsistent market entry requirements and certain other state utility rules and regulations on our service. State regulators continue to probe the limits of federal preemption in their attempts to apply state telecommunications regulation to interconnected VoIP service. On July 16, 2009, the Nebraska Public Service Commission and the Kansas Corporation Commission filed a petition with the FCC seeking a declaratory ruling or, alternatively, adoption of a rule declaring that state authorities may apply universal service funding requirements to nomadic VoIP providers. We participated in the FCC proceedings on the petition. On November 5, 2010, the FCC issued a declaratory ruling that allowed states to assess state USF on nomadic VoIP providers on a going forward basis provided that the states comply with certain conditions to ensure that imposing state USF does not conflict with federal law or policy.

On July 28, 2015, the MPUC found that it has authority to regulate Charter’s fixed, interconnected VoIP service. Charter challenged the MPUC’s order at the U.S. District Court for Minnesota. This challenge is currently pending. In September 2017 amicus briefs were filed in support of the Minnesota PUC's appeal of the Charter decision by AARP, the AARP Foundation, Professor Barbara Cherry, the National Association of Regulatory Utility Commissioners and the national Association of State Consumer Advocates and the Mid-Minnesota Legal Aid.

On August 14, 2017, the Arizona Corporation Commission issued an opinion and order with respect to amendments to the Arizona Universal Services Fund. The rulemaking allows for, among other things, the collection of additional USF surcharges in Arizona to fund the E-rate Broadband Special Construction Project Matching Fund Program. The Arizona Corporation Commission held hearings on September 12 and 13, 2017. Vonage will continue to monitor this rulemaking to determine its effect upon its business activities within Arizona.

California PUC transitioning local number portability from Neustar to iConectiv

The Number Portability Administration Center in California is transitioning from Neustar to iConectiv/Telcordia on May 20, 2018. Vonage is taking the necessary actions to ensure continued access to the NPAC after the transition.

We expect that state public utility commissions and state legislators will continue their attempts to apply state telecommunications regulations to nomadic VoIP service.

State and Municipal Taxes

In accordance with generally accepted accounting principles, we make a provision for a liability for taxes when it is both probable that a liability has been incurred and the amount of the liability or range of liability can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. For a period of time, we did not collect or remit state or municipal taxes (such as sales, excise, utility, use, and ad valorem taxes), fees or surcharges (“Taxes”) on the charges to our customers for our services, except that we historically complied with the New Jersey sales tax. We have received inquiries or demands from a number of state and municipal taxing and 911 agencies seeking payment of Taxes that are applied to or collected from customers of providers of traditional public switched telephone network services. Although we have consistently maintained that these Taxes do not apply to our service for a variety of reasons depending on the statute or rule that establishes such obligations, we are now collecting and remitting sales taxes in certain of those states including a number of states that have changed their statutes to expressly include VoIP. In addition, many states address how VoIP providers should contribute to support public safety

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

agencies, and in those states we remit fees to the appropriate state agencies. We could also be contacted by state or municipal taxing and 911 agencies regarding Taxes that do explicitly apply to VoIP and these agencies could seek retroactive payment of Taxes. As such, we have established reserves of $1,267 and $1,147 as of June 30, 2018 and December 31, 2017, respectively, as our best estimate of the potential tax exposure for any retroactive assessment.

UK OFCOM Investigation

On April 3, 2018, the UK Office of Communications ("OFCOM") launched an investigation to determine Vonage Limited’s compliance with General Condition 3.1 and Section 105A of the Communications Act 2003, which cover obligations of communication providers to take necessary measures to, among other things, maintain network availability and access to emergency services. In cases where violations are found, OFCOM has the authority to issue monetary penalties in accordance with its Guidelines and limitations imposed by statute. In April 2018, Vonage submitted its responses to OFCOM’s first request for information, and in May 2018, Vonage submitted its responses to OFCOM’s second request for information. OFCOM is reviewing the submitted information and will contact us in due course.

Note 8. Industry Segment and Geographic Information

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

Business

For our Business customers, we provide innovative, cloud-based UCaaS solutions, comprised of integrated voice, text, video, data, collaboration, and mobile applications over our flexible, scalable SIP based VoIP network. Through Nexmo, the Vonage API Platform, we also offer CPaaS solutions designed to enhance the way businesses communicate with their customers embedding communications into apps, websites and business processes. Together we have a robust set of product families tailored to serve the full range of the business value chain, from the SMB, market, through mid-market and enterprise markets. We provide customers with multiple deployment options, designed to provide the reliability and quality of service they demand. We provide customers the ability to integrate our cloud communications platform with many cloud-based productivity and CRM solutions, including Google’s G Suite, Zendesk, Salesforce’s Sales Cloud, Oracle, Clio, and other CRM solutions. In combination, our products and services permit our business customers to communicate with their customers and employees through any cloud-connected device, in any place, at any time without the often costly investment required with on-site equipment.

Consumer

For our Consumer customers, we enable users to access and utilize our UCaaS services and features, via a single “identity,” either a number or user name, regardless of how they are connected to the Internet, including over 3G/4G, LTE, Cable, or DSL broadband networks. This technology enables us to offer our Consumer customers attractively priced voice and messaging services and other features around the world on a variety of devices.

For our segments we categorize revenues as follows:

Services revenues. Services revenues consists primarily of revenue attributable to our communication services for Consumer and Software Defined Wide Area Network, or SD-WAN, UCaaS and CPaaS services for Business,

Access and product revenues. Product revenues include equipment sold to customers, shipping and handling, professional services, and broadband access. Beginning January 1, 2018, we also included revenues associated with providing access services to Business customers. We have adjusted the three and six months ended June 30, 2017 to include these revenues in access and product revenues which were previously included in service revenues.

USF revenues. USF revenues represent fees passed on to customers to offset required contributions to the USF.

For our segments we categorize cost of revenues as follows:

Services cost of revenues. Services cost of revenues consists of costs associated with network operations and technical support personnel, communication origination, and termination services provided by third party carriers and excludes depreciation and amortization.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Access and product cost of revenues. Product cost of revenues includes equipment sold to customers, shipping and handling, professional services, cost of certain products including equipment or services that we give customers as promotions, and broadband access. As noted above, beginning January 1, 2018, we also included costs associated with providing access services to Business customers. We have adjusted the three and six months ended June 30, 2017 to include these costs in access and product revenues which were previously included in service cost of revenues.

USF cost of revenues. USF cost of revenues represents contributions to the Federal USF and related fees.

Information about our segment results for the three and six months ended June 30, 2018 were as follows:



	Three Months Ended									Six Months Ended
	June 30, 2018									June 30, 2018
	Business			Consumer			Total			Business			Consumer			Total
Revenues
Service revenues	$	127,692		$	100,467		$	228,159		$	243,994		$	204,861		$	448,855
Access and product revenues⁽¹⁾	12,716			289			13,005			25,247			380			25,627
Service, access and product revenues	140,408			100,756			241,164			269,241			205,241			474,482
USF revenues	7,434			11,277			18,711			15,269			23,697			38,966
Total revenues	147,842			112,033			259,875			284,510			228,938			513,448

Cost of revenues
Service cost of revenues⁽²⁾	60,335			12,375			72,710			113,317			26,389			139,706
Access and product cost of revenues⁽¹⁾	13,913			1,870			15,783			28,404			3,664			32,068
Service, access and product cost of revenues	74,248			14,245			88,493			141,721			30,053			171,774
USF cost of revenues	7,434			11,277			18,711			15,274			23,723			38,997
Total cost of revenues	81,682			25,522			107,204			156,995			53,776			210,771

Segment gross margin
Service margin	67,357			88,092			155,449			130,677			178,472			309,149
Access and product margin	(1,197		)	(1,581		)	(2,778		)	(3,157		)	(3,284		)	(6,441		)
Gross margin ex-USF (Service, access and product margin)	66,160			86,511			152,671			127,520			175,188			302,708
USF margin	—			—			—			(5		)	(26		)	(31		)
Segment gross margin	$	66,160		$	86,511		$	152,671		$	127,515		$	175,162		$	302,677

Segment gross margin %
Service margin %	52.7		%	87.7		%	68.1		%	53.6		%	87.1		%	68.9		%
Gross margin ex-USF (Service, access and product margin %)	47.1		%	85.9		%	63.3		%	47.4		%	85.4		%	63.8		%
Segment gross margin %	44.8		%	77.2		%	58.7		%	44.8		%	76.5		%	58.9		%

(1) Includes customer premise equipment, access, and shipping and handling.

(2) Excludes depreciation and amortization of $4,978 and $1,248 for the three months ended June 30, 2018 and $9,951 and $2,709 for the six months ended June 30, 2018, respectively.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Information about our segment results for the three and six months ended June 30, 2017 were as follows:



	Three Months Ended									Six Months Ended
	June 30, 2017									June 30, 2017
	Business			Consumer			Total			Business			Consumer			Total
Revenues
Service revenues	$	103,198		$	115,636		$	218,834		$	194,995		$	234,753		$	429,748
Access and product revenues ⁽¹⁾	14,019			201			14,220			27,873			404			28,277
Service, access and product revenues	117,217			115,837			233,054			222,868			235,157			458,025
USF revenues	6,497			12,285			18,782			12,648			24,510			37,158
Total revenues	123,714			128,122			251,836			235,516			259,667			495,183

Cost of revenues
Service cost of revenues⁽²⁾	47,554			21,435			68,989			84,963			43,535			128,498
Access and product cost of revenues ⁽¹⁾	14,148			1,942			16,090			29,136			3,958			33,094
Service, access and product cost of revenues	61,702			23,377			85,079			114,099			47,493			161,592
USF cost of revenues	6,497			12,285			18,782			12,648			24,510			37,158
Total cost of revenues	68,199			35,662			103,861			126,747			72,003			198,750

Segment gross margin
Service margin	55,644			94,201			149,845			110,032			191,218			301,250
Access and product margin	(129		)	(1,741		)	(1,870		)	(1,263		)	(3,554		)	(4,817		)
Gross margin ex-USF (Service, access and product margin)	55,515			92,460			147,975			108,769			187,664			296,433
USF margin	—			—			—			—			—			—
Segment gross margin	$	55,515		$	92,460		$	147,975		$	108,769		$	187,664		$	296,433

Segment gross margin %
Service margin %	53.9		%	81.5		%	68.5		%	56.4		%	81.5		%	70.1		%
Gross margin ex-USF (Service, access and product margin %)	47.4		%	79.8		%	63.5		%	48.8		%	79.8		%	64.7		%
Segment gross margin %	44.9		%	72.2		%	58.8		%	46.2		%	72.3		%	59.9		%

(1) Includes customer premise equipment, access, and shipping and handling.

(2) Excludes depreciation and amortization of $5,003 and $1,860 for the three months ended June 30, 2017 and $9,878 and $3,767 for the six months ended June 30, 2017, respectively.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

A reconciliation of the total of the reportable segments' gross margin to consolidated income before income taxes is as follows:



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017
Total reportable gross margin	$	152,671		$	147,975		$	302,677		$	296,433
Sales and marketing	77,685			79,738			154,821			161,669
Engineering and development	10,375			6,670			21,195			15,040
General and administrative	32,174			36,514			59,756			71,600
Depreciation and amortization	19,062			18,394			35,862			36,341
Income from operations	13,375			6,659			31,043			11,783

Interest expense	(3,097		)	(3,861		)	(6,258		)	(7,564		)
Other income (expense), net	337			690			84			475
Income before income taxes	$	10,615		$	3,488		$	24,869		$	4,694

Information about our operations by geographic location is as follows:



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2018		2017		2018		2017

Revenues:
United States	$	205,977	$	214,182	$	414,111	$	427,506
Canada	6,831		9,002		13,868		16,447
United Kingdom	10,527		6,926		20,259		12,271
Other Countries⁽¹⁾	36,540		21,726		65,210		38,959
	$	259,875	$	251,836	$	513,448	$	495,183

(1) No individual other international country represented greater than 10% of total revenue during the periods presented.



	June 30, 2018		December 31, 2017
Long-lived assets:
United States	$	583,819	$	615,432
United Kingdom	301		365
Israel	625		243
	$	584,745	$	616,040

Note 9. Income Taxes

The income tax (expense) benefit consisted of the following:



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017
Income before income taxes	$	10,615		$	3,488		$	24,869		$	4,694
Income tax (expense) benefit	(2,056		)	1,337			8,214			6,044
Effective tax rate	19.4		%	(38.3		)%	(33.0		)%	(128.8		)%

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

We recognize income tax equal to pre-tax income multiplied by our annual effective income tax rate. In addition, adjustments are recorded for discrete period items and changes to our state effective tax rate which can cause the rate to fluctuate from quarter to quarter.

For the three and six months ended June 30, 2018, our effective tax rate was different than the statutory rate due to a forecasted permanent adjustment of $6,702 for both periods related to the new Global Intangible Low-Taxed Income ("GILTI") tax rules that were enacted as part of tax reform in December 2017. In addition, the Company recorded a discrete period tax benefit of $2,009 and $17,316, respectively, which were recognized related to excess tax benefits on equity compensation for three and six months ended June 30, 2018.

For the three and six months ended June 30, 2017, our effective tax rate was different than the statutory rate due to a discrete period tax benefits of $8,325 and $1,433, respectively which were recognized related to excess tax benefits on equity compensation

recognized primarily in the first quarter of 2017 as well as an adjustment to our deferred asset related to stock compensation.

On December 22, 2017, the United States enacted the Tax Cuts and Jobs Act ("TCJA") which reformed tax policy in the United States with the primary impact resulting in reducing the corporate tax rate from 35% to 21% beginning January 1, 2018. This resulted in an expense of $69,378 recognized by the Company during the year ended December 31, 2017 attributable to the re-measurement of the Company's deferred tax assets as of December 31, 2017. Due to the timing of the enactment and the complexity involved in applying the provisions of the TCJA, the Company has made reasonable estimates of the effects and recorded provisional amounts in our financial statements as of December 31, 2017.

During the first half of 2018, we reviewed further information and interpreted the TCJA utilizing additional guidance issued by the U.S. Treasury Department, the Internal Revenue Service and other regulatory bodies. We have made no adjustments to the provisional amounts recorded related to the re-measurement of the deferred tax asset as well as the conclusion regarding the applicability of repatriation tax. The Company will continue to analyze the effects of the TCJA on the Company’s operations and will record any adjustments associated with the enactment of the legislature during the measurement period as provided by SAB 118.

Uncertain Tax Positions

The Company had an uncertain tax position of $1,086 as of December 31, 2017. The Company no longer has any uncertain tax positions as of June 30, 2018 as a result of acceptance by the Internal Revenue Service of requested accounting method change relating to the reporting of tenant incentive allowance income. Generally, the Company recognizes interest and penalties related to uncertain tax positions in income taxes. The Company did not have any interest or penalties related to this uncertain tax position during the six months ended June 30, 2018 and June 30, 2017.

Net Operating Loss Carry Forwards ("NOLs")

As of June 30, 2018, we had cumulative domestic Federal NOLs of $559,041 and cumulative state NOLs of $146,254, expiring at various times through 2037. In addition, we had NOLs for United Kingdom tax purposes of $50,142 with no expiration date.

VONAGE HOLDINGS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Note 10. Subsequent Events

On August 1, 2018, the Company announced that, through its wholly-owned subsidiary Nexmo Inc., it had acquired 100% of the issued and outstanding shares of Telefonica Digital, Inc. (“TDI”), a subsidiary of Telefonica, S.A., and TDI’s subsidiaries, TokBox, Inc. (“TokBox”) and TokBox Australia Pty Limited, in an all-cash transaction for an enterprise value of $35 million, including certain assumed net liabilities. The acquisition is effective immediately.

San Francisco-based TokBox develops and operates the OpenTok Platform and is the industry leader in the WebRTC programmable video segment of the cloud communications market.

On July 31, 2018, the Company entered into the 2018 Credit Facility consisting of a $100 million senior secured term loan and a $500 million revolving credit facility bearing interest at LIBOR plus 2.25% at closing. The 2018 Credit Facility represents a $150 million increase from the 2016 Credit Agreement and has a maturity date of July 31, 2023. The Company used $232 million of the proceeds from the 2018 Credit Facility to retire all outstanding indebtedness under the 2016 Credit Facility and to cover transaction fees and expenses. The co-borrowers under the 2018 Credit Facility are the Company and Vonage America Inc., the Company’s wholly owned subsidiary. Obligations under the 2018 Credit Facility are guaranteed, fully and unconditionally, by the Company’s other United States material subsidiaries and are secured by substantially all of the assets of each borrower and each guarantor.



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

You should read the following discussion together with our condensed consolidated financial statements and the related notes included elsewhere in this Form 10-Q and our audited financial statements included in our Annual Report on Form 10-K. This discussion contains forward-looking statements. These forward-looking statements are based on information available at the time the statements are made and/or management’s belief as of that time with respect to future events and involve risks and uncertainties that could cause actual results and outcomes to be materially different. Important factors that could cause such differences include but are not limited to: the competition we face; the expansion of competition in the cloud communications market; our ability to adapt to rapid changes in the cloud communications market; the nascent state of the cloud communications for business market; our ability to retain customers and attract new customers cost effectively; the risk associated with developing and maintaining effective internal sales teams and effective distribution channels; risks related to the acquisition or integration of businesses we have acquired; security breaches and other compromises of information security; risks associated with sales of our services to medium-sized and enterprise customers; our reliance on third party hardware and software; our dependence on third party facilities, equipment, systems and services; system disruptions or flaws in our technology and systems; our ability to scale our business and grow efficiently; our dependence on third party vendors; the impact of fluctuations in economic conditions, particularly on our small and medium business customers; our ability to comply with data privacy and related regulatory matters; our ability to obtain or maintain relevant intellectual property licenses; failure to protect our trademarks and internally developed software; fraudulent use of our name or services; intellectual property and other litigation that have been and may be brought against us; reliance on third parties for our 911 services; uncertainties relating to regulation of business services; risks associated with legislative, regulatory or judicial actions regarding our business products; risks associated with operating abroad; risks associated with the taxation of our business; risks associated with a material weakness in our internal controls; governmental regulation and taxes in our international operations; liability under anti-corruption laws or from governmental export controls or economic sanctions; our dependence on our customers' broadband connections; restrictions in our debt agreements that may limit our operating flexibility; foreign currency exchange risk; our ability to obtain additional financing if required; any reinstatement of holdbacks by our credit card processors; our history of net losses and ability to achieve consistent profitability in the future; our ability to fully realize the benefits of our net operating loss carry-forwards if an ownership change occurs; certain provisions of our charter documents/ and other factors that are set forth in the “Risk Factors” in our Annual Report on Form 10-K, in our Quarterly Reports on Form 10-Q and in our Current Reports on Form 8-K. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, and therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to the date this Form 10-Q is filed with the Securities and Exchange Commission.

Financial Information Presentation

For the financial information discussed in this Quarterly Report on Form 10-Q, other than per share and per line amounts, dollar amounts are presented in thousands, except where noted. All trademarks are the property of their owners.

Overview and Strategy

At Vonage, we are redefining business communications. True to our roots as a technology disruptor, we are embracing technology to transform how businesses communicate to create better business outcomes. Our cloud communications platform enables businesses of all sizes to collaborate more productively and engage their customers more efficiently across any device. Vonage customers can choose among two separate delivery models to suit their specific communication needs: They can purchase Vonage Business with a Software-as-a-Service, or SaaS, model for a complete and configured unified communications solution or they can purchase Nexmo's "the Vonage API Platform" with a Platform-as-a-Service, or PaaS, model and consume our cloud communication in programmable modules, delivered via application programming interfaces, or APIs. We also provide a robust suite of feature-rich residential communication solutions.

Business

For our Business customers, we provide innovative, cloud-based Unified Communications as a Service, or UCaaS, solutions, comprised of integrated voice, text, video, data, collaboration, and mobile applications over our flexible, scalable Session Initiation Protocol based Voice over Internet Protocol, or VoIP, network. We also offer Communications Platform as a Service, or CPaaS, solutions designed to enhance the way businesses communicate with their customers by embedding communications into apps, websites and business processes. In combination, our products and services permit our business customers to communicate with their customers and employees through any cloud-connected device, in any place, at any time without the often costly investment required with on-site equipment. We have a robust set of product families tailored to serve the full range of the business value chain, from the SMB market, through mid-market and enterprise markets. We provide customers with multiple deployment options, designed to provide the reliability and quality of service they demand. We provide customers the ability to integrate our cloud communications platform with many cloud-based productivity and CRM solutions, including Google’s G Suite, Zendesk, Salesforce’s Sales Cloud, Oracle, and Clio. With our ability to integrate these cloud-based, workplace tools, Vonage integrates the entire business communications value chain - from employee communications that maximize productivity to the direct engagement with customers that CPaaS provides. When combined with our MPLS network, as well as voice services over customers' broadband networks via our SmartWan solution, we create a differentiated offering.

Our Business strategy is to support the full range of business customers, using two product families: Vonage Business Cloud, based on our proprietary call processing platform that is purpose-built for SMB and mid-market customers; and Vonage Enterprise, based on Broadsoft’s call processing platform in combination with other Vonage cloud based solutions, which serves larger customers, from mid-market businesses through large enterprises. We also organized our salesforce to address the full business market. We believe operating two platforms at scale enables us to deliver the right products and solutions to address the needs of diverse customers while maximizing our subscriber economics, regardless of segment served. Revenues are generated primarily through the sale of subscriptions for our UCaaS services. Our revenue generation efforts are focused on customer acquisition and retention as well as providing additional services to existing customers as they grow and scale.

Our diverse customer base spans a wide variety of industries, including manufacturing, automotive, legal, information technology, financial services, construction, real estate, engineering, healthcare, and non-profit.

Vonage Business Cloud. Vonage Business Cloud customers subscribe to our cloud-based communication services, delivered through our proprietary platform that is purpose-built for SMB and mid-market customers. Vonage Business Cloud provides a cost-effective, scalable, feature-rich solution, delivered over-the-top of a customer’s broadband, typically month-to-month without a commitment and is sold primarily through our direct telesales and online channels, and is increasingly sold through our channel partners and field sales teams. We believe the strength of the Vonage brand directly contributes to a lower-cost customer acquisition model and provides attractive subscriber economics.

Vonage Enterprise. Our Vonage Enterprise offerings are tailor-made for the large mid-market and enterprise segments. Vonage Enterprise is a feature-rich/fully managed solution that utilizes Broadsoft Inc.’s ("Broadsoft") enterprise-grade call processing platform, in combination with other cloud services like advanced contact center, video conferencing and speak2dial, and can be provided with high-level quality of service ("QoS"), which is generally delivered over our national MPLS network, with 21 network Points of Presence (POPs) across the country. Vonage can also provide QoS-level quality over-the-top of the customer’s broadband through our Smart-WAN router solution. Customers value our proprietary provisioning and feature-management tool, named Zeus, which enables the rapid deployment of solutions directly by Vonage while giving full visibility to our channel partners and our customers. Further differentiating Vonage is our robust service delivery team comprised of team members specializing in project management, voice and data provisioning, and line number porting. This team is intensely focused on providing an outstanding customer experience, and is rapidly becoming a competitive differentiator.

Our Vonage Enterprise offering is sold primarily through our channel partner, and our field and enterprise sales teams, and generally requires a three-year contract. We are a preferred provider for many of the largest master agents in the country, harnessing a network of over 20,000 sub agents selling both Vonage Enterprise and Vonage Business Cloud. We believe we have one of the largest multi-channel distribution sales platforms in our industry to serve the full range of business customers. We plan to capitalize on the growing adoption of cloud-based communications and collaboration solutions by continuing to expand our salesforce, expand into new markets, and enhance our relationships with existing customers to provide additional functionality and overall business value that can be achieved with our UCaaS platform.

Nexmo, the Vonage API Platform. We are a global leader in the CPaaS segment of the cloud communications market, providing innovative communication APIs for text messaging and voice communications, allowing developers and enterprises to embed contextual communications into mobile apps, websites and business workflows via text, social media, chat apps and voice. With just few lines of code, developers can send and receive text messages and build programmable voice applications. Nexmo, the Vonage API Platform can scale from one API call to billions. The platform makes it easy for any of our developers to access communication services via software and APIs. Through Nexmo we have a global network of interconnected carriers delivering our API-based communications platform, enabling businesses to communicate with their customers reliably and with ease, no matter where in the world they are located. The integration of our CPaaS services to our Business offering allows our customers to address their full communications needs, from employee to employee communications through business to customer communications.

Consumer

For our Consumer customers, we enable users to access and utilize our services and features, via their existing internet connections, including over 3G/4G, LTE, Cable, or DSL broadband networks. This technology enables us to offer our Consumer customers attractively priced voice communication services and other features around the world on a variety of devices.

We generate revenue through the acquisition and retention of Consumer customers. We are focused on optimizing the Consumer business for profitability to improve the strong cash flows of the business. We continue our disciplined focus on marketing efficiency by shifting customer acquisition spend to our higher performing channels, improving the quality of customers we acquire and driving lower churn, all of which drive higher customer life-time value. This focus has led to a reallocation of marketing spend to our Business segment.

The result of these initiatives has been to create a strong cash flow business which provides financial stability, as well as cost synergies and structural advantages to our Business segment.

Services outside of the United States. We currently have UCaaS and consumer operations in the United States, United Kingdom, and Canada and believe that our low-cost Internet based communications platform enables us to cost effectively deliver voice and messaging services to other locations throughout the world. Through Nexmo, we have operations in the United States, United Kingdom, Hong Kong, and Singapore, and provide CPaaS solutions to our customers located in many countries around the world.

Customers in the United States represented 79% and 81% of our consolidated revenues for the three and six months ended June 30, 2018, respectively, with the balance in Canada, the United Kingdom, Hong Kong, Singapore and many other countries around the world.

Trends in Our Industry

A number of trends in our industry have a significant effect on our results of operations and are important to an understanding of our financial statements.

Competitive landscape. We face intense competition from traditional telephone companies, wireless companies, cable companies, and alternative communication providers. Most traditional wireline and wireless telephone service providers and cable companies are substantially larger and better capitalized than we are and have the advantage of a large existing customer base. In addition, because our competitors provide other services, they often choose to offer VoIP services or other voice services as part of a bundle that includes other products, such as video, high speed Internet access, and wireless telephone service, which we do not offer. We also compete against alternative communication providers. Some of these service providers have chosen to sacrifice telephony revenue in order to gain market share and have offered their services at low prices or for free. As we continue to introduce applications that integrate different forms of voice and messaging services over multiple devices, we are facing competition from emerging competitors focused on similar integration, as well as from alternative voice communication providers. We also are subject to the risk of future disruptive technologies. In connection with our emphasis on the international long distance market in the United States, we face competition from low-cost international calling cards and VoIP providers in addition to traditional telephone companies, cable companies, and wireless companies, each of which may implement promotional pricing targeting international long distance callers.

Regulation. Our business has developed in a relatively lightly regulated environment. The United States and other countries, however, are examining how VoIP services should be regulated. In particular, state telecommunications regulators continue to try to regulate VoIP service despite the FCC’s 2004 Vonage Preemption Order that preempted state regulation. For example, on July 28, 2015, the Minnesota Public Utility Commission found that it has authority to regulate Charter’s ‘fixed' interconnected VoIP service. In addition to regulatory matters that directly address VoIP, a number of other regulatory initiatives could impact our business. One such regulatory initiative is net neutrality. On February 26, 2015, the FCC adopted strong net neutrality rules. On December 14, 2017 the FCC voted to reverse its 2015 neutrality rules. The FCC's recent reversal of its stance on net neutrality may have a negative long term impact on businesses such as ours who rely on the Internet to create and deliver products and services. Challenges to the FCC's ruling are underway, with public interest groups, states, local municipalities and companies seeking redress in the courts and/or through legislation. See also the discussion under "Regulation" in Note 7 to our financial statements for a discussion of regulatory issues that impact us.

Key Operating Data

The table below includes key operating data that our management uses to measure the growth and operating performance of the Business segment:



Business	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017
Service revenue per customer	$	348		$	327		$	338		$	321
Business revenue churn	1.2		%	1.1		%	1.2		%	1.2		%

Service Revenue per Customer. Service revenue per customer for a particular period is calculated by dividing the average monthly service revenues for the period by the average number of customers over the number of months in the period. The average number of customers is the number of customers on the first day of the period, plus the number of customers on the last day of the period, divided by two. Service revenue excludes revenues from trading and auction customers. Service revenue per customer increased from $327 for the three months ended June 30, 2017 to $348 for the three months ended June 30, 2018 primarily driven by the Company's successful efforts to attract larger business customers and to expand services provided to our existing business customers. Service revenue per customer increased from $321 for the six months ended June 30, 2017 to $338 for the six months ended June 30, 2018 also primarily driven by the Company's successful efforts to attract larger business customers and to expand services provided to our existing business customers.

Business Revenue Churn. Business revenue churn is calculated by dividing the revenue from customers or customer locations that have been confirmed to be foregone during a period by the simple average of the total revenue from all customers in that period. Revenue for purposes of determining Business revenue churn is service revenue excluding revenue from our trading and auction customers, and usage in excess of a customer’s contracted service plan, regulatory fees charged to customers, and credits. The simple average of total revenue from all customers during the period is the total revenue as defined herein on the first day of the period, plus the total revenue as defined herein on the last day of the period, divided by two. Terminations, as used in the calculation of churn statistics, do not include customers terminated during the period if termination occurred within the first month after activation. Other companies may calculate business revenue churn differently, and their business revenue churn data may not be directly comparable to ours. Business revenue churn increased from 1.1% for the three months ended June 30, 2017 to 1.2% for the three months ended June 30, 2018 and remained flat at 1.2% for the six months ended June 30, 2017 and the six months ended June 30, 2018, respectively. Our revenue churn will fluctuate over time due to economic conditions, seasonality in certain customer's operations, loss of customers who are acquired, and competitive pressures including promotional pricing. We are continuing to invest in our overall quality of service which includes customer care headcount and systems, billing systems, on-boarding processes and self-service options to ensure we scale our processes to our growth and continue to improve the overall customer experience.

The table below includes key operating data that our management uses to measure the growth and operating performance of the Consumer segment:



Consumer	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017
Average monthly revenues per subscriber line	$	26.37		$	26.33		$	26.45		$	26.18
Subscriber lines (at period end)	1,393,131			1,594,857			1,393,131			1,594,857
Customer churn	1.7		%	1.9		%	1.8		%	2.0		%

Average Monthly Revenues per Subscriber Line. Average monthly revenues per subscriber line for a particular period is calculated by dividing our revenues for that period by the simple average number of subscriber lines for the period, and dividing the result by the number of months in the period. The simple average number of subscriber lines for the period is the number of subscriber lines on the first day of the period, plus the number of subscriber lines on the last day of the period, divided by two. Our average monthly revenues per subscriber line increased slightly from $26.33 for the three months ended June 30, 2017 to $26.37 for the three months ended June 30, 2018 and increased slightly from $26.18 for the six months ended June 30, 2017 to $26.45 for the six months ended June 30, 2018, respectively, which is driven by the Company's ability to retain its more tenured customers.

Subscriber Lines. Our subscriber lines include, as of a particular date, all paid subscriber lines from which a customer can make an outbound telephone call on that date. Our subscriber lines include fax lines, including fax lines bundled with subscriber lines in our small office home office calling plans and soft phones, but do not include our virtual phone numbers and toll free numbers, which only allow inbound telephone calls to customers. Subscriber lines decreased from 1,594,857 as of June 30, 2017 to 1,393,131 as of June 30, 2018, reflecting planned actions to enhance the profitability of the assisted sales channel by eliminating lower performing locations and restructuring the pricing offers, and to shift investment to our business market.

Customer Churn. Customer churn is calculated by dividing the number of customers that have terminated during a period by the simple average of number of customers in a given period. The simple average number of customers during the period is the number of customers on the first day of the period, plus the number of customers on the last day of the period, divided by two. Terminations, as used in the calculation of churn statistics, do not include customers terminated during the period if termination occurred within the first month after activation. Other companies may calculate customer churn differently, and their customer churn data may not be directly comparable to ours. Customer churn decreased from 1.9% for the three months ended June 30, 2017 to 1.7% for the three months ended June 30, 2018 and decreased from 2.0% for the six months ended June 30, 2017 to 1.8% for the six months ended June 30, 2018, respectively. We monitor customer churn on a daily basis and use it as an indicator of the level of customer satisfaction. Customers who have been with us for a year or more tend to have a lower churn rate than customers who have not. In addition, our customers who are international callers generally churn at a lower rate than customers who are domestic callers. Our customer churn will fluctuate over time due to economic conditions, competitive pressures including promotional pricing targeting international long distance callers, marketplace perception of our services, and our ability to provide high quality customer care and network quality and add future innovative products and services.

Results of Operations

The following table sets forth, as a percentage of total revenues, our consolidated statement of operations for the periods indicated:



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2018		2017		2018		2017

Total revenues	100	%	100	%	100	%	100	%

Operating Expenses:
Cost of revenues (exclusive of depreciation and amortization)	41		41		41		40
Sales and marketing	30		32		30		33
Engineering and development	4		3		4		3
General and administrative	13		14		12		14
Depreciation and amortization	7		7		7		7
Total operating expenses	95		97		94		97
Income from operations	5		3		6		3
Other Income (Expense):
Interest expense	(1	)	(2	)	(1	)	(2	)
Other income (expense), net	—		—		—		—
Total other income (expense), net	(1	)	(2	)	(1	)	(2	)
Income before income taxes	4		1		5		1
Income tax (expense) benefit	(1	)	1		1		1
Net income	3	%	2	%	6	%	2	%

Management's Discussion of the Results of Operations for the Three and Six Months Ended June 30, 2018 and 2017

The Company had income before income taxes of $10,615 and $3,488 for the three months ended June 30, 2018 and 2017 and $24,869 and $4,694 for the six months ended June 30, 2018 and 2017, respectively. The increases in income before income taxes as compared to the prior year were primarily caused by higher business gross margins discussed below as well as lower other operating expenses of $2,020 and $13,016 for the three and six months, respectively, as a result of higher general and administrative expenses during the three and six months ended June 30, 2017 related to acquisition related consideration for Nexmo in the prior year.

The Company had net income of $8,559 and $4,825 for the three months ended June 30, 2018 and 2017 and $33,083 and $10,738 for the six months ended June 30, 2018 and 2017, respectively. The increase in net income for the three months ended June 30, 2018 is the result of the aforementioned increase in income before income taxes partially offset by an increase in income tax expense of $3,393. The increase in net income for the six months ended June 30, 2018 is primarily the result of the aforementioned increase in income before income taxes and by an increase in income tax benefit of $2,170 primarily driven by the exercise of stock options and vesting of restricted stock during the first quarter of 2018.

We calculate gross margin in order to evaluate operating revenues as total revenues less cost of revenues, which primarily consists of fees that we pay to third parties on an ongoing basis in order to provide our services and costs incurred when a customer first subscribes to our service. The following table presents consolidated revenues, cost of revenues and the composition of gross margin for the three and six months ended June 30, 2018 and 2017:



(in thousands, except percentages)	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2018		2017		Dollar Change		Percent Change		2018		2017		Dollar Change		Percent Change
Revenues	$	259,875	$	251,836	$	8,039	3	%	$	513,448	$	495,183	$	18,265	4	%
Cost of revenues⁽¹⁾	107,204		103,861		3,343		3	%	210,771		198,750		12,021		6	%
Gross margin	$	152,671	$	147,975	$	4,696	3	%	$	302,677	$	296,433	$	6,244	2	%

(1) Excludes depreciation and amortization of $6,226 and $6,863 for the three months ended June 30, 2018 and 2017, respectively, and $12,660 and $13,645 for the six months ended June 30, 2018 and 2017, respectively.

Consolidated revenues and cost of revenues were impacted by the following trends and uncertainties:

Three Months Ended June 30, 2018 compared to Three Months Ended June 30, 2017

•Consolidated revenues increased 3% for the three months ended June 30, 2018 as compared to the prior year period. The increase is primarily due to business customer growth of 12% driving an increase in revenues of $24,128 offset by declining consumer revenues of $16,089 in connection with the continued decline of subscriber lines. The Company continues to expect that the Consumer portion of the Company's overall business will become less significant as the Company reallocates resources to increase market share in its Business communications platforms.

•Cost of revenues increased 3% for the three months ended June 30, 2018 as compared to the prior year period driven by increased costs incurred in servicing our business customers of $13,483 due to the increase in customer growth. This was offset by a decrease in costs associated with our consumer costs of $10,140 as subscriber lines continues to decline resulting in lower international and long-distance termination costs.

Six Months Ended June 30, 2018 compared to Six Months Ended June 30, 2017

•Consolidated revenues increased 4% for the six months ended June 30, 2018 as compared to the prior year period. The increase is primarily due to business customer growth driving an increase in revenues of $48,994 offset by declining consumer revenues of $30,729 in connection with the continued decline of subscriber lines. The Company continues to expect that the Consumer portion of the Company's overall business will become less significant as the Company reallocates resources to increase market share in its Business communications platforms.

•Cost of revenues increased 6% for the six months ended June 30, 2018 as compared to the prior year period driven by increased costs incurred in servicing our business customers of $30,248 driven by an increase in customers of 12% along with costs associated with trading activities at Nexmo that are recognized on a gross basis beginning in the second quarter of 2017 which were reported as net in the prior year quarter. This was offset by a decrease in costs associated with our consumer costs of $18,227 as subscriber lines continues to decline resulting in lower international and long-distance termination costs.

Business Gross Margin for the Three and Six Months Ended June 30, 2018 and 2017



	Three Months Ended									Six Months Ended
	June 30,									June 30,
(in thousands, except percentages)	2018		2017		Dollar Change			Percent Change		2018		2017		Dollar Change			Percent Change
Revenues
Service revenues	$	127,692	$	103,198	$	24,494		24	%	$	243,994	$	194,995	$	48,999		25	%
Access and product revenues⁽¹⁾	12,716		14,019		(1,303		)	(9	)%	25,247		27,873		(2,626		)	(9	)%
Service, access and product revenues	140,408		117,217		23,191			20	%	269,241		222,868		46,373			21	%
USF revenues	7,434		6,497		937			14	%	15,269		12,648		2,621			21	%
Total revenues	147,842		123,714		24,128			20	%	284,510		235,516		48,994			21	%

Cost of revenues
Service cost of revenues⁽²⁾	60,335		47,554		12,781			27	%	113,317		84,963		28,354			33	%
Access and product cost of revenues⁽¹⁾	13,913		14,148		(235		)	(2	)%	28,404		29,136		(732		)	(3	)%
Service, access and product cost of revenues	74,248		61,702		12,546			20	%	141,721		114,099		27,622			24	%
USF cost of revenues	7,434		6,497		937			14	%	15,274		12,648		2,626			21	%
Total cost of revenues	81,682		68,199		13,483			20	%	156,995		126,747		30,248			24	%

Segment gross margin
Service margin	67,357		55,644		11,713			21	%	130,677		110,032		20,645			19	%
Gross margin ex-USF (Service, access and product margin)	66,160		55,515		10,645			19	%	127,520		108,769		18,751			17	%
Segment gross margin	$	66,160	$	55,515	$	10,645		19	%	$	127,515	$	108,769	$	18,746		17	%



Segment gross Margin %
Service margin %	52.7	%	53.9	%	53.6	%	56.4	%
Gross margin ex-USF (Service, access and product margin) %	47.1	%	47.4	%	47.4	%	48.8	%
Segment gross margin %	44.8	%	44.9	%	44.8	%	46.2	%


(1)	Includes customer premise equipment, access, and shipping and handling.


(2)	Excludes depreciation and amortization of $4,978 and $5,003 for the three months ended June 30, 2018 and 2017, respectively and $9,951 and $9,878 for the six months ended June 30, 2018 and 2017, respectively.

Three Months Ended June 30, 2018 compared to Three Months Ended June 30, 2017

The following table describes the increase in business gross margin for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017:



	(in thousands)
Service gross margin increased 21% primarily due to continued growth of our service offerings to our Business customers consistent with our overall organic growth in our Business customer base of 12% as compared to the prior year quarter	$	11,713
Access and product gross margin decreased due to higher costs providing access services to Business customers during the current quarter	(1,068		)
Increase in segment gross margin	10,645

While service gross margin has increased, it is noted that service gross margin percentage decreased to 52.7% for the three months ended June 30, 2018 from 53.9% for the three months ended June 30, 2017. The decrease in business service margin percentage is a result of the sale of a greater proportion of lower margin services across our Business segment during the current quarter as compared to the same period in the prior year along with higher costs as the Company has reallocated resources towards the Business segment as part of a strategic effort to continue to increase customer growth. Our gross margin percentage may continue to be impacted by changes in the mix of service offerings provided to our customers across our Business segment.

Six Months Ended June 30, 2018 compared to Six Months Ended June 30, 2017

The following table describes the increase in business gross margin for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017:



	(in thousands)
Service gross margin increased 19% primarily due to continued growth of our service offerings to our Business customers consistent with our overall organic growth in our Business customer base of 12% as compared to the prior year period	$	20,645
Access and product gross margin decreased due to higher costs providing access services to Business customers during the current period	(1,894		)
USF gross margin decreased mainly due to payment during the first quarter of 2018 for USF fees not collected in 2017	(5		)
Increase in segment gross margin	18,746

While service gross margin has increased, it is noted that service gross margin percentage decreased to 53.6% for the six months ended June 30, 2018 from 56.4% for the six months ended June 30, 2017. The decrease in business service margin percentage is a result of the sale of a greater proportion of lower margin services across our Business segment during the six months as compared to the same period in the prior year along with higher costs as the Company has reallocated resources towards the Business segment as part of a strategic effort to continue to increase customer growth. Our gross margin percentage may continue to be impacted by changes in the mix of service offerings provided to our customers across our Business segment.

Consumer Gross Margin for the Three and Six Months Ended June 30, 2018 and 2017



	Three Months Ended									Six Months Ended
	June 30,									June 30,
(in thousands, except percentages)	2018		2017		Dollar Change			Percent Change		2018		2017		Dollar Change			Percent Change
Revenues
Service revenues	$	100,467	$	115,636	$	(15,169	)	(13	)%	$	204,861	$	234,753	$	(29,892	)	(13	)%
Access and product revenues⁽¹⁾	289		201		88			44	%	380		404		(24		)	(6	)%
Service, access and product revenues	100,756		115,837		(15,081		)	(13	)%	205,241		235,157		(29,916		)	(13	)%
USF revenues	11,277		12,285		(1,008		)	(8	)%	23,697		24,510		(813		)	(3	)%
Total revenues	112,033		128,122		(16,089		)	(13	)%	228,938		259,667		(30,729		)	(12	)%

Cost of revenues
Service cost of revenues⁽²⁾	12,375		21,435		(9,060		)	(42	)%	26,389		43,535		(17,146		)	(39	)%
Access and product cost of revenues⁽¹⁾	1,870		1,942		(72		)	(4	)%	3,664		3,958		(294		)	(7	)%
Service, access and product cost of revenues	14,245		23,377		(9,132		)	(39	)%	30,053		47,493		(17,440		)	(37	)%
USF cost of revenues	11,277		12,285		(1,008		)	(8	)%	23,723		24,510		(787		)	(3	)%
Total cost of revenues	25,522		35,662		(10,140		)	(28	)%	53,776		72,003		(18,227		)	(25	)%

Segment gross margin
Service margin	88,092		94,201		(6,109		)	(6	)%	178,472		191,218		(12,746		)	(7	)%
Gross margin ex-USF (Service, access and product margin)	86,511		92,460		(5,949		)	(6	)%	175,188		187,664		(12,476		)	(7	)%
Segment gross margin	$	86,511	$	92,460	$	(5,949	)	(6	)%	$	175,162	$	187,664	$	(12,502	)	(7	)%



Segment gross Margin %
Service margin %	87.7	%	81.5	%	87.1	%	81.5	%
Gross margin ex-USF (Service, access and product margin) %	85.9	%	79.8	%	85.4	%	79.8	%
Segment gross margin %	77.2	%	72.2	%	76.5	%	72.3	%


(1)	Includes customer premise equipment and shipping and handling.


(2)	Excludes depreciation and amortization of $1,248 and $1,860 for the three months ended June 30, 2018 and 2017, respectively and $2,709 and $3,767 for the six months ended June 30, 2018 and 2017, respectively.

Three Months Ended June 30, 2018 compared to Three Months Ended June 30, 2017

The following table describes the decrease in consumer gross margin for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017:



	(in thousands)
Service gross margin decreased primarily due to a decrease in subscriber lines of 13% resulting in lower gross margin of $8,019 as we have reallocated resources to attract more profitable business customers. This was offset by a slight increase in average revenue per customer and lower overall costs incurred by the Consumer segment resulting in increased gross margin of $1,910	$	(6,109	)
Access and product gross margin increased 9% primarily due lower equipment costs associated with sales to customers during the current quarter	160
Decrease in segment gross margin	(5,949		)

Consumer service gross margin percentage increased to 87.7% for the three months ended June 30, 2018 from 81.5% for the three months ended June 30, 2017. The increase in consumer service margin percentage is primarily driven by overall lower costs attributed to consumer services as the Company shifts resources towards attracting more profitable business customers.

Six Months Ended June 30, 2018 compared to Six Months Ended June 30, 2017

The following table describes the decrease in consumer gross margin for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017:



	(in thousands)
Service gross margin decreased primarily due to a decrease in subscriber lines of 13% resulting in lower gross margin of $14,614 as we have reallocated resources to attract more profitable business customers. This was offset by a slight increase in average revenue per customer and lower overall costs incurred by the Consumer segment resulting in increased gross margin of $1,868	$	(12,746	)
Access and product gross margin increased 8% primarily due lower equipment costs associated with sales to customers during the six months	270
USF gross margin decreased mainly due to payment during the quarter for USF fees not collected in 2017	(26		)
Decrease in segment gross margin	(12,502		)

Consumer service gross margin percentage increased to 87.1% for the six months ended June 30, 2018 from 81.5% for the six months ended June 30, 2017. The increase in consumer service margin percentage is primarily driven by overall lower costs attributed to consumer services as the Company shifts resources towards attracting more profitable business customers.

Other Operating Expenses

The following table presents our other operating costs during the three and six months ended June 30, 2018 and 2017, respectively:



	Three Months Ended									Six Months Ended
	June 30,									June 30,
(in thousands, except percentages)	2018		2017		Dollar Change			Percent Change		2018		2017		Dollar Change			Percent Change
Sales and marketing	$	77,685	$	79,738	$	(2,053	)	(3	)%	$	154,821	$	161,669	$	(6,848	)	(4	)%
Engineering and development	10,375		6,670		3,705			56	%	21,195		15,040		6,155			41	%
General and administrative	32,174		36,514		(4,340		)	(12	)%	59,756		71,600		(11,844		)	(17	)%
Depreciation and amortization	19,062		18,394		668			4	%	35,862		36,341		(479		)	(1	)%
Total other operating expenses	$	139,296	$	141,316	$	(2,020	)	(1	)%	$	271,634	$	284,650	$	(13,016	)	(5	)%

Three Months Ended June 30, 2018 compared to Three Months Ended June 30, 2017

Total other operating expenses decreased by $2,020 as compared to the three months ended June 30, 2017 due to the following:

•

Sales and marketing expense decreased by $2,053 due to a reduction in marketing through traditional media outlets. Also attributing to the decline in sales and marketing expense was a decrease in commissions upon adoption of Topic 606 as costs to acquire Business customers are deferred and amortized over the life of the associated customer. Prior to adoption, commissions were expensed as they were earned.


•	Engineering and development expense increased by $3,705 in connection with the Company's continued transformation focused on innovation especially in regards to developing further functionality related to its proprietary platform in order to support customers through the mid-market and enterprise sector.


•	General and administrative expense decreased by $4,340 due in part to integration and severance costs incurred during the prior year quarter which did not occur during the three months ended June 30, 2018.


•	Depreciation and amortization expense increased by $668 primarily due to accelerated software amortization partially offset by the expiration of the Company's capital lease in August 2017 associated with its office location in Holmdel, New Jersey.

Six Months Ended June 30, 2018 compared to Six Months Ended June 30, 2017

Total other operating expenses decreased by $13,016 as compared to the six months ended June 30, 2017 due to the following:

•

Sales and marketing expense decreased by $6,848 due to a reduction in marketing through traditional media outlets. Also attributing to the decline in sales and marketing expense was a decrease in commissions upon adoption of Topic 606 as costs to acquire Business customers are deferred and amortized over the life of the associated customer. Prior to adoption, commissions were expensed as they were earned.


•	Engineering and development expense increased by $6,155 in connection with the Company's continued transformation focused on innovation especially in regards to developing further functionality related to its proprietary platform in order to support customers through the mid-market and enterprise sector.


•	General and administrative expense decreased by $11,844 due in part to integration and severance costs incurred during the prior year period which did not occur during the six months ended June 30, 2018.


•	Depreciation and amortization expense decreased by $479 primarily due to the expiration of the Company's capital lease in August 2017 associated with its office location in Holmdel, New Jersey offset in part by accelerated software amortization.

Other Income (Expense)



(in thousands, except percentages)	Three Months Ended											Six Months Ended
	June 30,											June 30,
	2018			2017			Dollar Change			Percent Change		2018			2017			Dollar Change			Percent Change
Interest expense	(3,097		)	(3,861		)	(764		)	(20	)%	(6,258		)	(7,564		)	(1,306		)	(17	)%
Other income (expense), net	337			690			(353		)	(51	)%	84			475			(391		)	(82	)%
	$	(2,760	)	$	(3,171	)	$	(411	)			$	(6,174	)	$	(7,089	)	$	(915	)

Three Months Ended June 30, 2018 compared to Three Months Ended June 30, 2017

Interest expense. The decrease in interest expense of $764, or 20%, was mainly due to lower principal balances on our credit facility that we entered into in June 2016 (the "2016 Credit Facility") as compared to the prior year, which was offset by slightly higher interest rates.

Six Months Ended June 30, 2018 compared to Six Months Ended June 30, 2017

Interest expense. The decrease in interest expense of $1,306, or 17%, was mainly due to lower principal balances on our credit facility that we entered into in June 2016 (the "2016 Credit Facility") as compared to the prior year, which was offset by slightly higher interest rates.

Income Taxes

We recognize income tax expense equal to pre-tax income multiplied by our effective income tax rate. In addition, adjustments are recorded for discrete period items and changes to our state effective tax rate which can cause the rate to fluctuate from quarter to quarter.

During the three months ended June 30, 2018, we recognized an additional discrete period tax benefit of $2,009 related to excess tax benefits on equity compensation recognized during the quarter. During the six months ended June 30, 2018, we recognized a discrete period tax benefit of $17,316 related to excess tax benefits on equity compensation recognized in the first half of 2018.

During the three and six months ended June 30, 2017, we recognized discrete period tax benefits of $8,325 and $1,433 which were recognized related to excess tax benefits on equity compensation recognized primarily in the first quarter of 2017 as well as an adjustment to our deferred asset related to stock compensation.

Liquidity and Capital Resources

For the six months ended June 30, 2018, we generated higher cash from operations compared to the prior year. We expect to continue to balance efforts to grow our revenue while consistently achieving operating profitability. To grow our revenue, we continue to make investments in growth initiatives, marketing, application development, network quality and expansion, and customer care. Although we believe we will achieve consistent profitability in the future, we ultimately may not be successful and we may not achieve consistent profitability. We believe that cash flow from operations and cash on hand will fund our operations for at least the next twelve months.

The following table sets forth a summary of our cash flows for the periods indicated:



	Six Months Ended
	June 30,
(in thousands)	2018			2017			Dollar Change
Net cash provided by operating activities	$	65,935		$	32,693		$	33,242
Net cash used in investing activities	(12,007		)	(14,277		)	2,270
Net cash used in financing activities	(58,033		)	(21,378		)	(36,655		)

Operating Activities

Cash provided by operating activities increased to $65,935 for the six months ended June 30, 2018 compared to $32,693 for the six months ended June 30, 2017, primarily due to an increase in earnings as compared to the prior period, offset by a decrease in stock compensation expense during the six months ended June 30, 2018 of $4,919 driven by higher acquisition related stock compensation expense in the prior year period and a decrease in deferred tax expense during the six months ended June 30, 2018 of $2,194.

Changes in working capital include changes in accounts receivable, inventory, prepaid and other assets, accounts payable, accrued and other liabilities, and deferred revenue and costs. Cash used for working capital requirements decreased by $12,149 during the six months ended June 30, 2018 compared to the prior year period primarily due to the timing of payments.

Investing Activities

Cash used in investing activities for the six months ended June 30, 2018 of $12,007 was mainly attributable to the purchase of capital expenditures of $7,787 and development of software assets of $4,220.

Cash used in investing activities for the six months ended June 30, 2017 of $14,277 was mainly attributable to the capital expenditures of $8,995 and development of software assets of $6,884, offset by the sales of marketable securities of $602 and cash proceeds of $1,000 associated with the sale of the Hosted Infrastructure product line in the second quarter of 2017.

Financing Activities

Cash used in financing activities for the six months ended June 30, 2018 of $58,033 was primarily attributable to $9,375 in 2016 term note principal payments, $35,000 in 2016 revolving credit facility principal payments, $95 in capital lease payments, and $28,618 in employee taxes paid on withholding shares, offset by $5,055 in proceeds received from the exercise of stock options and $10,000 in proceeds received from 2016 revolving credit facility.

Cash used in financing activities for the six months ended June 30, 2017 of $21,378 was primarily attributable to $9,375 in 2016 term note principal payments, $10,000 in 2016 revolving credit facility principal payments, $2,500 in patent license payments, $2,361 in capital lease payments, $9,542 in common stock repurchases, and $14,562 in employee taxes paid on withholding shares, offset by $11,962 in proceeds received from the exercise of stock options and $15,000 in proceeds received from issuance of notes payable.

Available Borrowings Under the 2016 Credit Facility

We maintain significant availability under our lines of credit to meet our short-term liquidity requirements. As of June 30, 2018, amounts available under the 2016 Credit Facility totaled $209 million.

State and Local Sales Taxes

We also have contingent liabilities for state and local sales taxes. As of June 30, 2018, we had a reserve of $1,267. If our ultimate liability exceeds this amount, it could affect our liquidity unfavorably. However, we do not believe it will significantly impair our liquidity.

Capital Expenditures

For the six months ended June 30, 2018, capital expenditures were primarily for the implementation of software solutions and purchase of network equipment as we continue to expand our network. Our capital expenditures for the six months ended June 30, 2018 were $12,007, of which $4,220 was for software acquisition and development. The majority of these expenditures are comprised of investments in information technology and systems infrastructure, including an electronic data warehouse, online customer service, and customer management platforms. For 2018, we believe our capital and software expenditures will be approximately $30,000.

Common Stock Repurchases

On December 9, 2014, Vonage's Board of Directors authorized a new program for the Company to repurchase up to $100.0 million of its outstanding common stock. Repurchases under the program are expected to be made over a four-year period ending on December 31, 2018.

Under the current program, the timing and amount of repurchases will be determined by management based on its evaluation of market conditions, the trading price of the stock and will vary based on available capital resources and other financial and operational performance, market conditions, securities law limitations, and other factors. Repurchases may be made in the open market or through private transactions from time to time. The repurchases will be made using available cash balances.

As of June 30, 2018, approximately $42,533 remained of our 2014 $100.0 million repurchase program. The repurchase program expires on December 31, 2018 but may be suspended or discontinued at any time without notice.

Off-Balance Sheet Arrangements

Obligations under Certain Guarantee Contracts

We enter guarantee arrangements in the normal course of business to facilitate transactions with third parties. These arrangements include financial and performance guarantees, stand-by letters of credit, debt guarantees and indemnifications. As of June 30, 2018 and December 31, 2017 we had stand-by letters of credit totaling $1,566 and $1,563, respectively.

Contractual Obligations and Commitments

Except as set forth below and in Note 7. Commitments and Contingencies included in Part 1, Item 1 of this Form 10-Q, there were no significant changes in our commitments under contractual obligations as disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2017.

Contingencies

There has been and may be in the future substantial litigation in the areas in which we operate regarding alleged infringement of third-party patents and other intellectual property rights, commercial, employment and other matters. We record a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss or range of loss can be reasonably estimated. Such legal proceedings are inherently unpredictable and subject to further uncertainties. Should any of these estimates and assumptions change it is possible that the resolution of the matters described in Note 7. Commitments and Contingencies

included in Part 1, Item 1 of this Form 10-Q could have a material adverse effect on our consolidated financial position, cash flows or results of operations.

Critical Accounting Policies

Our consolidated statements and accompanying notes are prepared in accordance with U.S. GAAP. Our significant accounting policies are described in Note 2, Summary of Significant Accounting Policies to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017. The preparation of financial statements and related disclosures in compliance with GAAP requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenues and expenses as well as the disclosure of contingent assets and liabilities. The application of these policies involves judgment regarding future events and these judgments could materially affect the financial statements and disclosures based on varying assumptions, which may be appropriate to use.

We identify our most critical accounting policies as those that are the most pervasive and important to the portrayal of our financial position and results of operations, and those that require the most difficult, subjective or complex judgments by management regarding estimates. Our critical accounting policies include revenue recognition, valuation of goodwill and intangible assets, income taxes and capitalized software. Effective January 1, 2018, the Company adopted ASC Topic 606. Refer to Note 3, Revenue Recognition for changes to our critical accounting policy with respect to recognition of revenue for contracts with customers as a result of the adoption. As of June 30, 2018, our goodwill is attributable to our Business operating segment. We perform our annual test of goodwill on October 1st. Additionally, we will assess our goodwill for impairment between annual tests when specific circumstances dictate.



Item 3.	Quantitative and Qualitative Disclosures about Market Risk

We are exposed to financial market risks, including changes in currency exchange rates and interest rates.

Foreign Exchange Risk

We sell our products and services primarily in the United States, Canada, the European Union, and Asia. Changes in currency exchange rates affect the valuation in our financial statements of the assets and liabilities of these operations. We also have a portion of our sales denominated in Euros, the Canadian Dollar, and the British Pound, which are also affected by changes in currency exchange rates. Our financial results could be affected by changes in foreign currency exchange rates, although foreign exchange risks have not been material to our financial position or results of operations to date.

Interest Rate and Debt Risk

Our exposure to market risk for changes in interest rates primarily relates to our long-term debt. In order to hedge the variability of expected future cash interest payments related to the 2016 Credit Facility we have entered into three interest rate swap agreements which were executed on July 14, 2017. The swaps have an aggregate notional amount of $150 million and are effective on July 31, 2017 through June, 3, 2020 concurrent with the term of the 2016 Credit Facility. Under the swaps our interest rate is fixed at 4.7%. The interest rate swaps will be accounted for as cash flow hedges in accordance with ASC 815, Derivatives and Hedging.

As of June 30, 2018, if the interest rate on our variable rate debt changed by 1% on our 2016 term note, our annual debt service payment would change by approximately $200. As of June 30, 2018, if the interest rate on our variable rate debt changed by 1% on our 2016 revolving credit facility, our annual debt service payment would change by approximately $300.



Item 4.	Controls and Procedures

Evaluation of Disclosure Controls and Procedures. Based on the evaluation of our disclosure controls and procedures (as defined in Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) required by Securities Exchange Act Rules 13a-15(b) or 15d-15(b), our Chief Executive Officer and our Chief Financial Officer have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective.

Changes in Internal Controls. There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II—Other Information



Item 1.	Legal Proceedings

We are subject to a number of lawsuits, government investigations and claims arising out of the conduct of our business. See a discussion of our litigation matters in Note 7 of Notes to our Condensed Consolidated Financial Statements, which is incorporated herein by reference.



Item 1A.	Risk Factors

There have been no material changes from the risk factors previously disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.



Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds

Item 2(a) and (b) are not applicable.

During the three months ended June 30, 2018, we did not repurchase Vonage Holdings Corp. common stock pursuant to the 2014 $100.0 million repurchase program. When executed, repurchases occur in the open market and pursuant to a trading plan under Rule 10b5-1 of the Securities Exchange Act of 1934. As of June 30, 2018, approximately $42,533 remained of our 2014 $100.0 million repurchase program.



Item 3.	Defaults Upon Senior Securities

None.



Item 4.	Mine Safety Disclosures

Not applicable.



Item 5.	Other Information

None.



Item 6.	Exhibits

See accompanying Exhibit Index for a list of the exhibits filed or furnished with this Quarterly Report on Form 10-Q.

EXHIBIT INDEX




10.1			Separation Agreement and General Release, by and among Vonage Holdings. Corp. and Ted Gilvar, dated May 14, 2018(1)*

31.1			Certification of the Company’s Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)

31.2			Certification of the Company’s Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)

32.1			Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)

101			The following financial statements from Vonage Holdings Corp.’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2018, filed with the Securities and Exchange Commission on August 1, 2018, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets; (ii) the Condensed Consolidated Statements of Operations; (iii) the Condensed Consolidated Statements of Comprehensive Income; (iv) the Condensed Consolidated Statements of Cash Flows; (v) the Condensed Consolidated Statements of Stockholders’ Equity; and (vi) the Notes to Condensed Consolidated Financial Statements.

(1) Filed herewith.


*	Management contract or compensatory plan or arrangement.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		VONAGE HOLDINGS CORP.

Dated:	August 1, 2018	By:	/s/ David T. Pearson
			David T. Pearson Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer)