Ooma - Q3 2024

Transcript

Operator (participant)

Hello, and welcome to Ooma third quarter fiscal year 2024 financial results. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. I will now like to hand the conference over to Matt Robison. Sir, you may begin.

Matt Robison (Director of IR and Corporate Development)

Thank you, Tawanda. Good day, everyone, and welcome to the fiscal third quarter 2024 earnings call of Ooma, Inc. My name is Matt Robison, Ooma's Director of IR and Corporate Development. On the call with me today are Ooma's CEO, Eric Stang, and CFO, Shig Hamamatsu. After the market closed today, Ooma issued its fiscal third quarter 2024 earnings press release. This release is also available on the company's website, ooma.com. This call is being webcast live and is accessible from a link on the Events and Presentations page of the Investor Relations section of our website. This link will be active for replay of this call for 1 year. During today's presentation, our executives will make forward-looking statements within the meaning of the federal securities laws. Forward-looking statements generally relate to future events or future financial or operating performance.

Our expectations and beliefs regarding these matters may not materialize, and actual results are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks include those set forth in the press release we issued earlier today, and those risks more fully described in our filings with the Securities and Exchange Commission. The forward-looking statements in this presentation are based on information available to us as of the date hereof, and we disclaim any obligation to update any forward-looking statements except as required by law. Please note that other than revenue or as otherwise stated, the financial measures to be disclosed on this call will be on a non-GAAP basis. The non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP.

A discussion of why we present non-GAAP financial measures and a reconciliation of the non-GAAP financial measures discussed in this call to the most directly comparable GAAP financial measures is included in our earnings press release, which is available on our website. On this call, we will give guidance for fourth quarter and full year fiscal 2024 on a non-GAAP basis. Also, in addition to our press release and 8-K filing, the Overview page and Events and Presentations page in the Investor section of our website, as well as the Quarterly Results page of the Financial Information section of our website, include links to information about costs and expenses not included in our non-GAAP values and key metrics of our core subscription businesses. These are titled Supplemental Financial Disclosure One and Supplemental Financial Disclosure Two.

Additionally, our investor presentation slides include GAAP to non-GAAP reconciliation that also provides resolution of GAAP expenses that are excluded from non-GAAP metrics. Now, I will hand the call over to Ooma CEO, Eric Stang.

Eric Stang (President, CEO and Chairman)

Thank you, Matt. Hi, everyone. Welcome to Ooma's third quarter fiscal year 2024 earnings call. Thanks for joining us. I can report that Q3 was another strong quarter for Ooma. We performed well financially and made a major advance by acquiring 2600Hz during the quarter. I look forward to reviewing our progress with you. Our Q3 results include $59.9 million in revenue, $4 million of non-GAAP net income, and $5 million of EBITDA. Organically for Q3, which is to say, excluding the impact of 2600Hz, we increased our business subscription and services revenue 14% year-over-year. We held our OPEX spending nearly flat to a year ago, and we grew our EBITDA by 17% versus Q3 last year. Our annual exit recurring revenue, including 2600Hz, is now $225 million.

We feel these results demonstrate good progress for the company and strong performance for the quarter. During Q3, we continued to pursue the strategies we have outlined throughout this year to expand Ooma's revenues from business customers. Ooma Office, our award-winning solution for small to medium-sized businesses, added premium features and new integrations. One of our most exciting new integrations is with Clio, the number one software used in the legal industry. Users of Clio can now integrate their Ooma calling and communications with their Clio experience. This integration is available as part of Ooma's Pro Plus service tier and contributes to our long-term strategy of increasing our premium office users and raising our average revenue per user. I'm pleased to report that in Q3, we once again sequentially increased our ARPU from business customers.

I'm also pleased to report that 56% of our new office customers were premium users and that premium users now make up 28% of our total office customer base. It was exciting in Q3 to announce finally the name of our largest customer, International Workplace Group, or IWG, which is also known by the name Regus. We made the announcement in conjunction with the launch of our services for IWG in Asia. In Q3, we rolled out our platform for the Africa region and started serving IWG in South Africa. In total, we now serve IWG in 30 countries across five different regions, and we are working with them to expand further. We anticipate slower international expansion in Q4, given the holidays, followed by a pickup in Q1 as we roll out to new countries throughout the first half of next year.

Outside of North America, we also expanded with Ooma Enterprise, which began serving a new customer with locations spread across Australia, Netherlands, Spain, and the U.K., in addition, of course, to here in the USA. In our targeted hospitality vertical, we once again landed over 50 new hospitality locations, the largest of which being a property with 474 rooms and another being our second airport hotel. In general, we believe our strategy and enterprise to focus on select verticals is giving us advantages in the market. In Q3, we continued to pursue our AirDial strategy aggressively. In particular, we hired additional sales personnel and signed a total of 4 new AirDial resellers, one of which, TouchTone Communications, we announced in a press release. These resellers join a number of others we are already partnered with for AirDial, including T-Mobile and more recently, US Cellular.

We also announced that Viking Electronics, who is a manufacturer of more than 500 security and communications products, including emergency phones, entry systems, elevator phones, and campus safety phones, began recommending AirDial to its customers and distributors after performing their own extensive testing of AirDial. As we've mentioned, we believe AirDial offers the best solution in the marketplace for replacing increasingly expensive and soon-to-be decommissioned copper lines that are connected to elevators, fire and alarm panels, older PBX equipment, and more. We are thrilled by the validation we are seeing by the many resellers we have signed up for AirDial. We are also thrilled to have announced in Q3 that Elevator World Magazine, the leading media voice in the vertical transportation industry, selected Ooma for the 2023 Ellies Awards in the category of Best Communication System Supplier, honoring the Ooma AirDial solution for POTS replacement.

We're not standing still either in our continued improvement of AirDial. Just recently, we announced that AirDial now incorporates Ooma's patented MultiPath technology. MultiPath creates a continuous dual connection between AirDial and the public switched telephone network by transmitting data packets simultaneously through two separate data links. Unlike other approaches, where calls are dropped on failover, where they can—where there can be delays before failover occurs, and where other issues can occur related to the quality of individual transport links, Ooma's MultiPath technology provides seamless backup for customers who enable two internet connections to their AirDial device. MultiPath provides one more example of how Ooma stands out by providing the full end-to-end AirDial solution, encompassing both cloud and customer premise equipment. While not announced, we also made additional improvements in Q3 to AirDial's Remote Device Manager, or RDM, as we call it.

RDM gives our AirDial customers the ability to provision, monitor, manage, and control all of their AirDial devices from one portal. We view RDM as another key differentiator for AirDial. I'm pleased to report that in Q3, we landed what we expect will become our two largest AirDial customers today. One of these customers is a large retailer with many individual brands. We've already started rolling out AirDial to one brand of stores owned by this customer, where we are displacing another POTS replacement solution. We expect this rollout is just phase one with this customer. The other customer is a provider in the elevator industry with access to a very large number of opportunities. I'm pleased to report our backlog of potential sales opportunities grew again in Q3, and we have many large opportunities that we are pursuing.

I'd like to turn now to 2600Hz, which is the new business we acquired back in October. As a reminder, 2600Hz provides open source core calling functionality, named KAZOO, that is in use today by many telecom providers. Since initially launching KAZOO over a decade ago, 2600Hz has also expanded to provide its own non-open source suite of pre-built UCaaS, CPaaS, and call center applications. Telecom providers have the choice of relying solely on open source KAZOO and building applications themselves, or contracting with 2600Hz for a more complete solution. 2600Hz today provides hosted cloud, private cloud, and customer-hosted solutions to approximately 130 paying customers who serve hundreds of thousands of end users.

The company runs data centers in 8 locations spread across North America, Europe, and Oceania, maintains a workforce of about 100 employees and contractors, and has revenues of approximately $7 million annually. 3 main reasons drove our decision to acquire 2600Hz. We made this acquisition to capitalize on the opportunity we see in the wholesale marketplace, to unlock significant operational benefits between Ooma and 2600Hz, and to enhance Ooma's strategic position and ability to serve the fundamental needs of large carriers and other partners. It's now been about 6 weeks since 2600Hz became part of Ooma. In that time, we have blended our two teams together, rationalized spending in certain areas, and established our new combined strategy. Central to our strategy is to strengthen 2600Hz in the marketplace by leveraging Ooma's application technology, scale, and low-cost position, and by launching new services.

We are now actively working internally to provide 2600Hz customers telecom services delivered in a CPaaS business model. We're also working to leverage some of Ooma's key user applications for the benefit of 2600Hz customers. 2600Hz's customer base has responded with positive feedback on our acquisition. They are excited about our strategic direction and the intellectual property and resources we bring as a larger scale and more mature organization. Similarly, we already have active conversations underway with a number of possible new customers. These conversations will take time as possible customers evaluate KAZOO and get to know us, but we are optimistic about their potential. Overall, I believe our integration with 2600Hz is going well, and we are on track, as promised, to make the acquisition adjusted EBITDA accretive to Ooma within six months.

Finally, I'm thrilled to mention that the publication you see today recently named the KAZOO Communications Solution from 2600Hz as the best white label solution at the prestigious UC Partner Awards 2023. KAZOO was chosen by a panel of 12 leading analysts in the cloud communications industry from a field of four finalists. Of course, we're not surprised, since we know KAZOO's modern, API-based architecture sets it apart in the industry. With that, I will now turn the call over to Shig, our CFO, to discuss our results and outlook in more detail, and then return with some closing remarks.

Shig Hamamatsu (Senior VP and CFO)

Thank you, Eric, and good afternoon, everyone. Before I dive into our third quarter financial results, I'd like to quickly recap the financial aspects of the 2600Hz acquisition we completed on October 20, 2023, right before the end of the third quarter. We acquired 2600Hz for approximately $33 million in cash, and there are no other contingency payments for this acquisition. With regard to funding of cash purchase price, we used approximately $50 million of our cash from balance sheet, and the remaining $80 million came from a new $30 million revolving line of credit from Citizens Bank. 2600Hz is expected to add approximately $7 million in annual recurring revenue to Ooma.

The acquisition of 2600Hz is expected to be accretive to our adjusted EBITDA within six months and to make increasing contribution to our overall adjusted EBITDA as operational synergies are realized in subsequent periods. Now I'm going to review our third quarter financial results and then provide our outlook for the fourth quarter and full year fiscal 2024. We delivered another solid quarter with a total revenue of $59.9 million, which included $0.23 million of subscription and services revenue from 2600Hz for the last twelve days of the quarter. Excluding 2600Hz revenue contribution, Q3 revenue came in at $59.6 million, at the high end of our guidance range of $59 million-$59.6 million.

On a year-over-year basis, total revenue grew 6% in the third quarter, driven by the growth of Ooma business, which accounted for 58% of total subscription and services revenue, as compared to 55% in the prior year quarter. Q3 product and other revenue came in at $4 million, as compared to $4.9 million in the prior year. The prior year Q3 product revenue included certain accessory sales that did not recur this year. On the profitability front, the third quarter non-GAAP net income was $4 million.

Excluding $0.3 million of net loss from 2600Hz, the third quarter non-GAAP net income was $4.3 million, exceeding our guidance range of $3.8 million-$4.8 million—$4.1 million, and represented 24% increase over $3.5 million in the prior year quarter. Now, some details on our Q3 revenue. Excluding the impact of 2600Hz, Ooma business subscription and services revenue grew 14% year-over-year in Q3, driven by user growth. On the residential side, subscription and services revenue were flat year-over-year. As a reminder, we had a one-time churn event during the first quarter of this fiscal year with a particular customer with an unusual application, where we lost approximately 4,000 Telo users, which continued to impact our year-over-year comparison in Q3.

For the third quarter, total subscription and services revenue was $55.9 million, or 93% of total revenue, as compared to $51.7 million, or 91% of total revenue in the prior year quarter. Now some details on our key customer metrics. Please note that the key metrics I'm about to discuss do not include any metrics related to 2600Hz users. Given the wholesale nature of 2600Hz's business, we do not intend to blend 2600Hz user metrics into our traditional core user metrics, which will continue to represent the key metrics related to Ooma business and residential users only. We ended the third quarter with 1,241,000 core users, up from 1,237,000 core users at the end of the second quarter.

At the end of the third quarter, we had 475,000 business users, or 38% of our total core users, an increase of 8,000 from Q2. Our blended average monthly subscription and services revenue per core user or ARPU increased 3% year-over-year to $14.63, driven by an increase in mix of business users, including higher ARPU Office Pro and Pro Plus users. During the third quarter, we continued to see a healthy Office Pro and Pro Plus take rate, with 56% of new Office users opting for these higher-tier services, which was up from 50% in the prior year quarter. Overall, 28% of Ooma Office users have now subscribed to our Pro or Pro Plus tier.

Our net dollar subscription retention rate for the quarter was 99%, as compared to 99% in the second quarter. Our annual exit recurring revenue, which now consists of recurring revenue from Ooma core users and 2600Hz users, grew to $225 million and was up 10% year-over-year. Now some details on our gross margin. Our subscription and services gross margin for the third quarter was 72%, as compared to 73% in the prior year. Q3 subscription and services gross margin this year was impacted by certain investments we made for our largest customer as we started the further expansion into Asia and Africa in the third quarter, as well as investments in our customer support resources for ongoing AirDial ramp.

Products and other gross margin for the third quarter was -73%, as compared to -35% for the same period last year. As mentioned on the previous calls, the decline in Q3 product gross margin this year versus last year was anticipated and primarily due to the following two factors. First, we saw the sell-through impact of certain higher-cost components that we had procured in the last fiscal year to stay ahead of pandemic-driven supply chain issues. And second, the prior Q3 product gross margin benefited from certain accessory sales that did not recur this year. We continue to expect product and other gross margin for the remainder of fiscal 2024 to be negatively impacted by one-time excess component costs running through the PNL, and currently estimate product and other gross margin for the fourth quarter to be in the neighborhood of -70%.

On an overall basis, total gross margin for Q3 was 62% as compared to 64% in the prior-year quarter. Now some details on operating expenses. Total operating expenses for the third quarter were $33.4 million, up $0.6 million, or 2% from the same period last year. Excluding the impact of 2600Hz, the total operating expenses increased $0.1 million, or effectively flat from the same period last year. Sales and marketing expenses for the third quarter were $16.8 million, or 28% of total revenue, and flat year-over-year. Excluding the impact of 2600Hz, sales and marketing expenses for the third quarter were $16.6 million, or a decrease of $0.3 million from the same period last year as we controlled our spending to increase profitability.

Research and development expenses were $11.3 million, or 19% of total revenue, up 3% on a year-over-year basis from $11 million, $11 million, driven by investments in new features for Ooma Office and Enterprise, as well as AirDial. Excluding the impact of 2600Hz, R&D expenses for the third quarter were $11 million, flat compared to the same period last year. G&A expenses were $5.3 million, or 9% of total revenue for the third quarter, compared to $4.9 million for the prior year quarter. The year-over-year increase in G&A expenses was primarily due to an increase in personnel costs. Non-GAAP net income for the third quarter was $4 million, or diluted earnings per share of $0.15.

Excluding the impact of 2600Hz, non-GAAP net income for the third quarter was $4.3 million, or diluted earnings per share of $0.16, as compared to $0.14 in the prior year quarter. Adjusted EBITDA for the quarter was $5 million, or 8% of total revenue.... excluding the impact of 2600Hz, adjusted EBITDA for the quarter was $5.2 million, or 9% of total revenue, and represented 17% increase over $4.5 million for the same period last year. We ended the quarter with total cash investments of $18.9 million. We generated cash from operations of $1.9 million, as compared to $2.5 million in the same period last year.

As mentioned earlier, we funded a cash purchase price of 2600Hz with a combination of cash from our balance sheet and an $18 million draw from a new $30 million revolving line of credit. The new credit facility has a 3-year term, and the borrowing under it will bear interest rate based on SOFR plus two hundred and ten basis points, or approximately 7.5% all-in borrowing rate at the time of the drawdown in October. The additional details on the credit facility are available in our Form 8-K, filed on October 23, 2023, as well as in our Form 10-Q, to be filed later this week. On the headcount front, we ended the quarter with 1,192 employees and contractors, which included new team members from 2600Hz.

Now I'll provide guidance for the fourth quarter and full fiscal year 2024. Our guidance is on a non-GAAP basis and has been adjusted for expenses such as stock-based compensation, amortization of intangibles, and certain non-recurring items. Additionally, the guidance reflects a full quarter impact of 2600Hz starting in the fourth quarter, as well as interest expense for the outstanding balance under the new credit facility and the partial benefit of related acquisition activities took place earlier in the fourth quarter. We expect total revenue for the fourth quarter of fiscal 2024 to be in the range of $61.2 million-$61.8 million, which includes $3.8-$4.1 million of product revenue. We expect the fourth quarter net income to be in the range of $3.1-$3.4 million.

As mentioned earlier, Q4 net income guidance includes a full quarter impact of interest expense related to the new credit facility, which is estimated to be approximately $0.4 million. Additionally, the guidance assumes interest expense will be sequentially lower by approximately $0.2 million, given that $15 million of cash from balance sheet was spent towards the cash purchase price of 2600Hz. Non-GAAP diluted EPS is expected to be between $0.12 and $0.13. We have assumed 26.7 million weighted average diluted shares outstanding for the fourth quarter. For full fiscal year 2024, we expect total revenue to be in the range of $236.3 million-$236.9 million.

In terms of revenue mix for the year, we expect 93.5% of total revenue to come from subscription and services revenue, and the remaining 6.5% from products and other revenue. We expect non-GAAP net income for fiscal 2024 to be in the range of $14.9 million-$15.2 million. Fiscal 2024 net income guidance also reflects an increase in interest expense related to the new credit facility of approximately $0.4 million, as well as a reduction in interest income of approximately $0.2 million for the reasons stated earlier. Based on this non-GAAP net income guidance range, we estimate our adjusted EBITDA for fiscal 2024 to be $19.4 million-$19.7 million, or approximately 8% of revenue.

We expect non-GAAP diluted EPS for fiscal 2024 to be in the range of $0.57-$0.58. We have assumed approximately 26.3 million weighted average diluted shares outstanding for fiscal 2024. In summary, we are pleased with our solid performance in the third quarter. The team has done a great job of growing business subscription revenue 14% year-over-year organically, while keeping operating expenses effectively flat in today's economic environment, which resulted in year-over-year organic non-GAAP net income and adjusted EBITDA growth of 24% and 17% respectively. I'll now pass it back to Eric for some closing remarks. Eric?

Eric Stang (President, CEO and Chairman)

Thanks, Shig. Q3 was a busy quarter for us. We worked to grow our business user base and to expand internationally. We also invested significantly to increase our AirDial sales team, number of resellers, and pipeline of opportunities, and with those, our AirDial installed user base. On top of these, we also closed on our 2600Hz acquisition and took steps to integrate 2600Hz into Ooma, and along with that, optimize our cost structure. I feel we're well along on our plans for 2600Hz, and the acquisition is going smoothly. Our plans for Q4 entail continued focus on our multiple strategies for growth, in combination with sensible expense management and continued cash generation from operations. Thank you. We'll now take questions.

Operator (participant)

... Thank you. Ladies and gentlemen, as a reminder, to ask the question, please press star one one on your telephone and then wait to hear your name announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Mike Latimore with Northland Capital Markets. Your line is open.

Mike Latimore (Managing Director and Senior Research Analyst)

Great. Yeah, thanks very much. On your largest customer, which is now Regus, how many users do you think that they will have by fiscal year-end now? And then I think you said you expect to launch new countries next year. I guess, what's the kind of incremental opportunity next year?

Eric Stang (President, CEO and Chairman)

Yeah. Hi, Mike. Well, so, hello. We're over 85,000 users with them now. And we did not have as much growth in Q3 as we might have because some of these new countries are taking a little bit more work on both sides to bring up and get going. And Q4 will be a little slower, too, just with... You know, it's a lot of work to do this, and the teams need a little bit of a break. But you know, we'll be up over 90,000 at the end of the fiscal year.

And, you know, I've talked in the past that we could get to, maybe 120,000 or so, and, that's where we're working towards for the first half of next year. But, you know, each, it's, it's an extra effort, every country we add, and the countries are smaller now than the ones at the outset. So how fast we get there, I'm not exactly sure. But we're anticipating the first half of next year is still busy with adding users.

Mike Latimore (Managing Director and Senior Research Analyst)

Great. Great. And then how much is the, you know, the US small business market? Any noticeable change versus last quarter in terms of just, I don't know, sales cycles, collections, just general activity in sort of small business you guys land?

Eric Stang (President, CEO and Chairman)

Actually, no. Sales cycles are similar. No collections issues other than the normal ones we have. You know, we're a little cautious for Q4 because as we remember last year, with the holidays and all, small businesses were busy or finishing up their years. And then, you know, obviously, we kicked off in January with a good market opportunity. But we think the markets, you know, it was stronger during the COVID time when everyone was figuring out new solutions, but it's still robust. And most importantly, there's a big market that's yet to be brought up to a modern communication solution like Ooma provides, so we see lots of opportunity to go after.

Mike Latimore (Managing Director and Senior Research Analyst)

Great. Just last one on product gross margin. Once some of the anomalies come out of the mix here, what should that product gross margin normalize to?

Shig Hamamatsu (Senior VP and CFO)

Yeah. So, you know, it's probably we're talking about Q2 next year, once we get through, you know, the consumption of the higher-cost components, Mike. But I think a normalized range, I would say 50-55 kind of range. We traditionally were there before we had this component, so that's, that's what I would say.

Mike Latimore (Managing Director and Senior Research Analyst)

Mm-hmm. Okay. Very good. Thanks a lot.

Shig Hamamatsu (Senior VP and CFO)

Thank you.

Operator (participant)

Thank you. Please stand by for our next question. Our next question comes from the line of Eric Martinuzzi with Lake Street Capital Markets. Your line is open.

Eric Martinuzzi (Senior Research Analyst)

Yeah, thanks for taking the question. First off, just on the outlook for Q4, it does seem as though you're looking for relatively flat sequential growth on the subscription revenue on an organic basis. Is there any reason you're more conservative there?

Shig Hamamatsu (Senior VP and CFO)

So, on an overall total revenue basis, you know, one of the reason is we had about $400,000 of non-recurring product revenue in Q3 that we're not gonna have in Q4. So, you know, that's one of the total revenue seems flat quarter-over-quarter. And then there's one adjustment that on the business subscription side that in a sequential basis we're making, that really just one-time in nature, and it's not fundamentally nothing different about the trend itself. So if you take out these two items, fundamentally, we see still the subscription revenue growing at more normalized level, which is, you know, I would say, $700,000 quarter-over-quarter.

It's a little bit hard to see, obviously, without some of these pointers, but that's what we see.

Eric Martinuzzi (Senior Research Analyst)

Okay. And then you said, Regus could reach, I think you said, 120,000 end users. How many countries would you anticipate that will be?

Eric Stang (President, CEO and Chairman)

70 or so. Over 50, for sure. We're already able to serve more countries than they're—we're now in with them as we wait for conversions and rollout to happen. I believe we'll be in vast majority of the countries that are now in. They're in a total of about 100 countries, but I need to be a little conservative because I think we'll see how it runs out in the tail. Some of the countries are quite small.

Eric Martinuzzi (Senior Research Analyst)

Okay, and then how do you anticipate generating follow-on business with those countries? Is that kind of-- Can you talk a little bit about the timing around that?

Eric Stang (President, CEO and Chairman)

Well, right now we're-

Eric Martinuzzi (Senior Research Analyst)

Follow-on business with additional customers, that is.

Eric Stang (President, CEO and Chairman)

Sure, sure. So obviously, the next 6-9 months is just rollout phase of, as we've discussed here. They're a growing organization, so that's potential growth for us. And also, we're serving their, you know, the kinds of users of theirs that we're serving are the ones that have, that are operating in their buildings. They have other users that do other things with them, that are potential for us down the road, as are more premium solutions that we could roll out with them as well. I don't wanna get too much into where we see it evolving next, but, we think we'll have more opportunities for growth after we get this rollout under our belt.

Eric Martinuzzi (Senior Research Analyst)

Got it. Okay. Thank you.

Operator (participant)

Thank you. Please stand by for our next speaker. One moment. Our next question comes from the line of Josh, Josh Nichols with B. Riley. Your line is open.

Josh Nichols (Senior Research Analyst)

Yeah, thanks for taking my question. I was wondering if you could elaborate a little bit. I think you mentioned that in the quarter, you landed two AirDial customers that you think ultimately are probably gonna become the largest customers. I know AirDial has taken a little bit longer to ramp than originally anticipated, but, could you provide a little bit more clarity on the type of market opportunity that those two customers represent? And do you have any visibility into what type of, install units these two customers alone could represent if we think about over the next 12-18 months?

Eric Stang (President, CEO and Chairman)

Sure. Hi, Josh. Yeah, to clarify my words, we mentioned they could be our two largest customers to date. We do have other customers we are pursuing in our sales funnel that are even larger. But each one is thousands of users, and let me put it that way. Not over 10,000, but thousands of users, potential. The other thing we've seen is all through this year, all the first three quarters of this year, the number of opportunities in our sales funnel, particularly the number of potential users in our late-stage sales process, has grown each quarter. And that also helps us get a better understanding of where we can go with this. We did make a big step in Q3.

We were able to fill several sales positions for AirDial, which will allow us to go after the market more strongly. We have 10 different verticals that we're pursuing with AirDial. And if you look at the opportunities we have and even just what these couple customers can represent, it continues to be a very positive opportunity for us. But obviously, as you said, we need to get. We would like to move faster, and we're investing to do that.

Josh Nichols (Senior Research Analyst)

Thanks. Then just one or two small things. Shig, did you mention? I think you said product revenue would be between $3.8 million and $4.1 million for the fourth quarter?

Shig Hamamatsu (Senior VP and CFO)

Yes, correct.

Josh Nichols (Senior Research Analyst)

Okay.

Shig Hamamatsu (Senior VP and CFO)

Josh, that's correct.

Josh Nichols (Senior Research Analyst)

So it's kind of in line. Yep, and then last question. I know that there's like a big delta between the GAAP and the non-GAAP guidance for 4Q. I know that that's not super surprising, given the acquisition. I was just kind of curious what you were expecting for one-time costs. Just trying to think about how to manage or model the cash flow for 4Q.

Shig Hamamatsu (Senior VP and CFO)

Yeah, so the fourth quarter, you know, we're gonna have a few one-time costs. So, one item is a restructuring cost, restructuring activities we undertook, as costs associated with it. It's in the press release, Josh, but it's $500,000 that we're incurring there in Q4. And, we also have some additional acquisition-related costs. But, we can get it; it's actually in the press release, too, and happy to get you a little more detail there.

Josh Nichols (Senior Research Analyst)

Sounds good. Appreciate it. Thank you.

Shig Hamamatsu (Senior VP and CFO)

Thank you.

Operator (participant)

Thank you. Please stand by for our next question. Our next question comes from the line of Brian Kinstlinger with Alliance Global Partners. Your line is open.

Brian Kinstlinger (Managing Director, Senior Technology Analyst)

Great. Thanks so much for taking my question. Congrats on the successes with AirDial. My one question is, last quarter, you talked about there were challenges in-

... the pace of installation. Some of it were people, some of it were the various places where installs might happen. What progress has the company made, especially within its control, the pieces that are in its control, if any, to help improve installation rates? Thank you.

Eric Stang (President, CEO and Chairman)

Yeah. Hi, Brian. I feel we've got that well in hand, actually. We have a customer right now who wanted to roll out to a quite significant number of locations and do it all in a week, and we did it. So when a customer is ready to move, and if the customer knows what their needs are and where their needs are, and has the access and all that planned out, we can move quickly with them. Not all our customers are like that. Some customers can take several months just to even, you know, stand up a proof of concept and test something for then a couple months more, but sometimes you get customers who have a deadline, and they want to move.

So I feel like the pace of rollout is being driven more from what customers can accomplish than what our team. We're ready to go.

Brian Kinstlinger (Managing Director, Senior Technology Analyst)

I guess my second question for Shig would be: When the installations start ramping, and they become a more meaningful piece of revenue, just remind us the puts and takes to product revenue and margin versus, subscription and services?

Shig Hamamatsu (Senior VP and CFO)

Yeah. So as the installation ramps, Brian. So we're reporting the cost and revenue related to installation activity itself in a product, along with the product itself. And so, you know, we're gonna start to see that product revenue increase as we ramp on the installation. And I think we talked about earlier, but, you know, our intent is to not lose money on the installation activities, meaning that, you know, we pass on a cost to customer to achieve that. And so, my take on that is, as we have more AirDial-related product installation revenue, product margin should improve as well over time. Obviously, that would precede the ramp on the subscription revenue related to AirDial because the installation needs to happen in front of it.

You know, we're still seeing a pretty good trend on AirDial ARPU on the service side, and we think it's gonna be accretive to our subscription margin today as we ramp on the subscription side as well.

Brian Kinstlinger (Managing Director, Senior Technology Analyst)

Great. Thank you so much.

Operator (participant)

Thank you. As a reminder, ladies and gentlemen, that's star one one to ask the question. Please stand by for our next question. Our next question comes from the line of Matthew Harrigan with Benchmark. Your line is open.

Matthew Harrigan (Managing Director, Senior Equity Research Analyst)

Oh, thank you. Firstly, you know, since you're not including 2600Hz in your KPIs, and it's pretty evident we're gonna be modeling that in the longer term, you talked about some of the growth opportunities there with some of the customized apps and certainly even better monetization of KAZOO. What's your ambition in terms of the long-term growth rate there, which would presumably exceed that for your core business? And then secondly, on your existing subscription business, you said that 28% are taking Pro or Pro Plus right now. You know, I mean, you've got a good product incrementally at pretty low incremental cost. Why is it, and I know I've asked you this before, but how often do you consider devoting more to marketing to upgrade the installed base?

I don't know whether it's much more of a, you know, brotherly shove than it looks like on the surface to get people to upgrade, but presumably, you could be affording more utility for your customers and ramping up your growth rate while you do it at the same time. Thanks.

Eric Stang (President, CEO and Chairman)

Yeah. Hi. Hi, Matthew. Well, we do a bit of outreach to our existing customer base around Pro and Pro Plus. You gotta keep in mind that when they came on board as users, they self-selected at the time with our solution, so they're pretty happy with what they've got, many of those users. In some cases, it's hard to reach out to them, too, because you know, marketing emails don't always get the flow through. But we do see customers as they expand, starting to tap into some of our new capabilities. And as I said, the new customers coming on board are coming on, you know, more than half of them are taking a premium tier.

You know, we, it might be part of it, a little bit might be, too, just you really need to explain it to customers, and our salespeople are able to do that with the new customers. It's a little bit hard to have those conversations at that level with our installed base. But it is something we work on, and we can devote more resources to going forward. First question again?

Matthew Harrigan (Managing Director, Senior Equity Research Analyst)

Would there be any way-

Eric Stang (President, CEO and Chairman)

Go ahead.

Matthew Harrigan (Managing Director, Senior Equity Research Analyst)

Would there be any way to do a sort of a push free trial for, like, a month or, or three months to just show them the capabilities? I assume the expenses wouldn't be high, wouldn't be that high to do it, or is that, that's just awkward in terms of the software upgrade?

Eric Stang (President, CEO and Chairman)

... No, we do different kinds of things, sometimes more or less of that nature. Yeah, it's a good question, and we—what we tend to do today is just send emails with a little bit of information of some of the features that people could get. But, free trials aren't a bad way to go either. You know, keep that in mind.

Shig Hamamatsu (Senior VP and CFO)

I think, Matt, your first question was something along the line of, with respect to 2600Hz, what sort of growth rate that you could assume in relation to the core business or something like that, right?

Matthew Harrigan (Managing Director, Senior Equity Research Analyst)

Exactly. Because it's pretty obvious people are gonna be modeling that, you know, separately since you're not including that in your core KPIs, as you stipulated.

Eric Stang (President, CEO and Chairman)

Yeah. We're a little reluctant to try to answer that question with too much detail because it's only been six or seven weeks that we've been developing this opportunity now and owned it. But we do see real meaningful opportunities. You know, there are users out there of the KAZOO platform from an open source perspective that could be converted over into paying users by, you know, offering them more than what they have today. There are significant opportunities for new customers to be brought onto the platform, some of whom would be moving off another platform that's out there, and others that just are gonna sunset maybe something they've built internally and wanna move to something more modern.

I think we are close to getting our first customer to move off of another company's platform and onto KAZOO, but we'll have to wait and see if we close that in Q4. And then thirdly, the CPaaS services. And we have a very specific effort in place today to bring Ooma's cost structure and scale in telecom services as a CPaaS offering to the installed base and then move from there. Predicting what that will be for next fiscal year is hard for us. I think that we'll learn a lot the next three months in our sales efforts and then be able to give better guidance at the end of the next quarter.

Matthew Harrigan (Managing Director, Senior Equity Research Analyst)

Great. Well, thanks, Eric. Thanks, Shig.

Shig Hamamatsu (Senior VP and CFO)

Thanks, Matt.

Eric Stang (President, CEO and Chairman)

You bet.

Operator (participant)

Thank you. Please stand by for our next question. Our next question comes from the line of Arjun Bhatia with William Blair. Your line is open.

Arjun Bhatia (Partner, Co-Head of Technology Equity Research)

All right. Thank you, guys, for taking the question. If I could just go back to the user growth. I know it sounded like it was your largest customer, Regus, that was driving some of the headwinds there. But if we looked to other customers, are you seeing similar kind of muted growth there in Q3 and Q4, or is it largely related to Regus, where we're seeing slower growth from the customer base, from the user base, rather?

Eric Stang (President, CEO and Chairman)

Yeah. Hi. Well, we're thinking for both Q3 and Q4, particularly Q4 now, we're gonna see, as you said, muted growth with our large customer. But beyond that, we wanna be cautious because Q4 is an interesting quarter. With the holidays involved, and small businesses taking time off or being very busy with the holiday time, it's not always the best time for customer acquisition. We're being very sensible about that in our investment strategies. We are controlling our sales and marketing spend. We're happy with our customer acquisition costs, and we're improving the EBITDA commensurately. Our EBITDA is growing faster than the growth of our other metrics. So I think we have a good plan for Q4.

Yeah, we're being a little guarded, just to wait and see how it turns out. I can give one more data point. I know you didn't ask about residential, but we're pleased with our residential business thus far into the quarter. We're through Black Friday and Cyber Monday and that, you know, Thanksgiving period when we wanna drive some sales on the residential front, and we were happy with what we achieved this year compared to a year ago. So that's one piece of positive news that we already have.

Arjun Bhatia (Partner, Co-Head of Technology Equity Research)

Okay. Perfect. That's, that's helpful. And then maybe going back to Regus. I know you're talking about expanding into other countries and the, the opportunity that it could pose longer term. How should we think about what, what that process is like to go into other countries? How long does it typically take to open up a new geography? How many resources are required? What are the challenges? Maybe just help us understand that process a little bit better.

Eric Stang (President, CEO and Chairman)

Sure. I'm gonna repeat some of the things I may have said in previous calls. I apologize. But so it starts with putting our capabilities into the region. Because we're dealing with communication services, you have to be mindful of inter-internet distances and delays that can affect the quality. So we have to have fully standalone instances of what we do in each region where we want to serve the countries there. As I said, we're in five regions today, and we can serve all the countries now, pretty much in those regions, although we aren't yet. And then we have two more regions to stand up between now and the middle of next year... Once we have those seven regions in place, we'll have very good coverage.

And then it comes down to what you need to do to be in that particular country. There may be certain laws and regulations you have to conform to, certainly language and other adaptations to the platform, maybe calling patterns. You have to decide how you're going to deliver services from a carrier partner status. And then, once you have that in place, plan a rollout strategy that involves, you know, converting away from something already in place, and there's a lot of work to do that. So, we tend to roll out with our large customer, kind of, country by country or a couple countries in a region at a time, and then you move on to the next ones. And, I, you know, we went into Hong Kong in Q3.

We went into South Africa in Q3. There are other countries in Asia that we're expanding in, in Q4. We'll be finishing up South Africa in Q4, and we'll just be rolling out from there. You know, it's giving us an incredible footprint, on a much bigger stage than we've operated on in North America. And, and I think that's a really valuable asset for Ooma, as we look forward, not only for our UCaaS solutions, but also, frankly, for AirDial. And, we're, you know, going through the thinking right now on what our priorities will be for next year to start to capitalize on this asset, beyond North America.

AirDial will be a very strong contender for that because we think we have such a unique solution there and kind of a unique market opportunity at this time. So it's exciting for us to have this in place. We're well down the train on all of this. Not to go on, but, you know, it's been years in the making to be where we are today, and we're just getting over, I think, the final hurdles.

Arjun Bhatia (Partner, Co-Head of Technology Equity Research)

And sorry, one more if I can just follow up. On the... Is the subscription and services gross margin following this international build-out, meaning once you have the additional regions stood up by the middle of next year, should that be the trough in subscription gross margins, or are there other factors that maybe I'm not considering there?

Shig Hamamatsu (Senior VP and CFO)

Yeah. So certainly, you know, we talked about this a little bit, but, you know, the-- we're making some investments related to the expansion that Eric and I talked about, we just talked about. So, you know, it's pulling down revenue a little bit upfront, I mean, the gross margin a little bit upfront on the subscription side. I think going into second half of next year, I think we start to see more, scale efficiency there, with respect to the largest customer as well. And also in the near term, remember that, 2600Hz gross margin on recurring revenue, isn't quite at, at the level that, corporate Ooma margin is either.

So as we work through the, you know, further expansion of largest customer, along with the synergies related to 2600Hz, I think second half of next year is a good point to start to see some improvements on the subscription margin.

Arjun Bhatia (Partner, Co-Head of Technology Equity Research)

Okay, very helpful. Thank you for taking my questions.

Eric Stang (President, CEO and Chairman)

You bet.

Operator (participant)

Thank you. I am showing no further questions in the queue. I would now like to turn the call back over to Eric for closing remarks.

Eric Stang (President, CEO and Chairman)

Well, thank you, everyone. We've gone the full hour, so I won't say more, but appreciate your attendance today. Thank you very much. Bye-bye.

Operator (participant)

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.