8x8 Inc (EGHT) 2007 Q2 法說會逐字稿

Good morning ladies and gentlemen and welcome to the second quarter 2007 8X8 Incorporated earnings conference call. My name is [Chenique] and I will be your coordinator for today. At this time all participants are in a listen only mode. We will be facilitating a question and answer session toward the end of this conference. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Joan Citelli, 8X8's Director of Corporate Communications. Please proceed.

Thank you, and welcome everyone to our call. This morning I'm joined by 8X8's Chairman and Chief Executive Officer Bryan Martin; and Chief Financial Officer Dan Weirich, to discuss our results for the second quarter of fiscal year 2007. If you have not yet seen this morning's financial results, the press release is available on 8X8's website at www.8x8.com.

Following our comments there will be an opportunity for questions. Please note that participation in the Q&A portion of this call is limited to our financial analysts and market researchers only. All others are welcome to listen in to the Q&A session.

Before I turn the call over to Bryan, I would like to remind all participants that during this conference call any forward-looking statements are made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Expressions of future goals, including financial guidance and similar expressions, including, without limitations, expressions using the terminology may, will, believe, expect, plans, anticipates, predicts, forecasts, and expressions which otherwise request something other than historical fact, are intended to identify forward-looking statements.

These forward-looking statements involve a number of risks and uncertainties, including factors discussed in the risk factor sections of our annual report on Form 10K, and our quarterly reports on Form 10Q, and in our other SEC filings and company releases. Our actual results may differ materially from any forward-looking statements, due to such risks and uncertainties. The company undertakes no obligation to revise or update any forward-looking statements in order to reflect events or circumstances that may arise after this conference call.

Please note that management will be continuing our corporate practice of not offering or providing any forward-looking guidance on the company's financial results, forecasts, or similar future expectations. And your cooperation is appreciated in not asking any questions in this regard. Thank you. And with that I'll turn the call over to Bryan Martin, Chairman and Chief Executive Officer of 8X8.

Thanks Joan; and I would also like to welcome everyone to 8X8's conference call for the second quarter ended September 30, 2006. We released the results for the second quarter earlier this morning, and we are very pleased with the progress we are making.

I would like to highlight a couple of points before I turn the call over to Dan, who will be walking you through the underlying details of our financial report.

In terms of top line revenues, the September quarter was the second best quarter ever in the history of the company, with sales totaling $13.2 million, bested only by the quarter ending December 31, 1997, almost nine years ago, when 8X8 posted total revenues of $15.1 million for the quarter.

Of course that was a very different time, with different products and technologies, and we were selling into a different market. We have successfully rebuilt this company, beginning with the launch of our first Packet8 service at the end of 2002, to be a leader and innovator in IP communication services and technologies, for both business and residential telecommunication customers.

The quarter ended September 30, 2006 was our eleventh consecutive quarter of increasing revenues resulting from these Packet8 services. As we announced earlier this month, the company surpassed a new milestone, with more than 5,000 U.S. companies now using the Packet8 Virtual Office service as a total and complete solution to their business telecommunications service needs. Nearly 1,000 of these companies were added in the September quarter alone.

Also during the quarter, we closed our largest single Virtual Office sale to date, which consisted of 240 extensions; so the size and the scope of the businesses utilizing our communication services continues to grow.

We also continue to expand the Virtual Office footprint across the regional offices of Unisys, a Fortune 500 company that has turned to our hosted business services for their regional business expansion needs. We are finding in the channel that we are beginning to beat out legacy PBX systems and other solutions targeted at the more traditional and larger enterprise market.

Packet8 Virtual Office delivers hosted PBX features and functions over the world wide internet to businesses of any size, thereby replacing the need for a [primaspace] PBX or Centrex phone system. The only equipment required at the customer location is a telephone and our adapter boxes, and individual extensions can be connect to the internet at any location, anywhere in the world, and can even be relocated dynamically just by unplugging the equipment, moving it, and plugging it back in at a new location.

The service is so simple that anyone can provision and install it, and because these services are not tied to any special fixed data line services, you never need to worry about reprovisioning the voice service at a different geographic location. You just pick up the equipment and go, and there's no need to do anything more than that.

Businesses with multiple locations, or with employees who work from home, immediately benefit from the ability to access our Virtual Office services from wherever there's a high speed internet connection. Packet8 Virtual Office also gives a business to extension dialing worldwide, a customized auto attendant, a receptionist call routing application, conferencing services, ring groups, and a host of other features not available in the circuit switch world, nor the current residential voice over IP market. And we do this all for one convenient flat rate price.

Now 8X8 introduced many new services for our small business customers during the September quarter, and those included nationwide professional onsite installation services, the Packet8 Softalk Office service, and the industry's most reliable business fax over IP service.

Our Packet8 Softalk Office client enables road warriors and other travelers to access Packet8 Virtual Office voice and video services from any Windows desktop or from the new Intel enabled PC voice over IP solutions, which have support for a telephone connection built right on to the mother board. No additional equipment is required to be connected to your business PBX. You can now be virtually sitting at your virtual office desk phone even while traveling, or when you're away from the office.

And the newly launched Packet8 business fax over IP service enables our business customers to completely abandon any remaining connections to the PSTN that they used to use for fax or data lines.

Our focus on the small to medium business space with Packet8 Virtual Office affords 8X8 a sustainable and attractive business model. Our gross margins are increasing due to this focus, as these business customers utilize more on net IP to IP traffic, and they send fewer calls back to the PSTN. Our collection rates with these customers are also substantially higher than our other service segments, and our customer churn in the business space is also lower.

In fact, churn from Packet8 Virtual Office customers, as compared with our residential and video services, is actually the lowest of these three types of customers. And this is not only significant in terms of customer retention, we know from our own past experiences with growing pains, that these business customers will switch their telecommunications solution and their service provider at the first sign of any issues or trouble with their phone service or their telecommunications solution.

So the fact that we have the lowest churn amongst our business customers is telling of the underlying quality and the reliability of the telecommunication services we are providing to these customers, and we're doing all of this with 8X8s internally developed specialized IP communications technologies.

For the September quarter, Packet8 Virtual Office and our business services accounted for 25% of our revenues. Our residential and video services accounted for 71% of revenues, and wholesale and private label services accounted for 4% of revenues. Packet8 Virtual Office new customer sales were 52% of all new order receipts. So you can see the results of our increasing focus, over the past few quarters, on the sales of our business services. In fact, this is the first time that the business services have been more than half of our new order receipts.

8X8s bottom line results and fundamentals also rapidly improved with this new focus. Our gross margin for the quarter increased to 52%, up from 37% in the June quarter, and 33% in the March quarter. Our recurring service margins for the quarter increased to 56%, which was up from 52% in the June quarter. And our product margins continued to improve substantially to a positive 29%, up from negative 22%. So once again, that's a positive 29% now on the product margins, up from negative 22% in the June quarter, and negative 60% in the March quarter.

This is the first quarter that 8X8 has recorded positive margins on equipment sales associated with Packet8 services, and I think that's a very significant event. All of these improvements resulted in a net loss of $2.7 million, an improvement of over 50% from the $5.7 million loss posted for the June quarter. And excluding the September quarter's stock option expense charge of $548,000, our operating net loss for the quarter was $2.2 million with a net cash burn of $3.3 million, which shows very substantial progress toward our previously stated goal of obtaining positive monthly cash flow during the quarter ending March 31, 2007.

Now many of us here at 8X8 are big fans of the motto "Anything worth doing, is worth doing for money." And that includes things like obtaining positive margins on our equipment sales. So we are very pleased and excited to see the Packet8 business nearing the turning point for cash flow and profitability. 8X8s last profitable quarter was the quarter ending September 30, 2003, when the company had net income of $747,000 on quarterly revenues of $2.4 million. And that quarter included adjustments from the sale of one of our subsidiaries.

8X8s last profitable year was the fiscal year ending March 31, 1998, and in that year the company had net income of $3.7 million on annual revenues of $49.8 million. So we are pleased that our current Packet8 IP communications services have evolved to a point where they are yielding more than 50% gross margins and that our revenue numbers are nearing all time highs.

Coupled with what we continue to hear from our customers about how much they value and appreciate our services, it's very easy to understand why we are so eager to continue the growth of our financials, our technologies, and our IP communication services. I will now turn the call over to Dan Weirich, the company's Chief Financial Officer, who will walk you through the detailed financial results, and some related operating metrics of the business. Dan?

Thank you Bryan. Good morning to everyone on the call. As Bryan mentioned, revenues for the second fiscal quarter of 2007 were $13.2 million, which represented 8% growth sequentially over the first quarter fiscal 2007; and 88% growth over the same period last year.

As of September 30 Packet8 Virtual Office represented 25% of revenues, Packet8 residential and videophone services represented 71% of revenues, and wholesale and private label services represented 4% of revenues. Average monthly churn for all services for the quarter approximately 3.7%, excluding the subscribers that cancelled within the first 30 days of service, versus 4.1% in the prior quarter. The September quarter's churn excludes the one time loss of approximately 2,500 subscribers resulting from the closure of a private label service partner in the United Kingdom.

Gross margins were 52% for the quarter, versus 37% for the prior quarter. This is a huge improvement, due to a number of factors. First, our focus on selling Packet8 Virtual Office has increased margins due to the higher end user pricing and lower network costs. The incremental cost of customer acquisition to acquire a business customer is more than offset by the higher revenues we receive from these customers.

Our average Packet8 Virtual Office customer subscribes to seven services, and we are seeing more new sales placed with larger companies as well. We continue to uniquely serve the needs of the very small business and home business customer, but our business services scale to any size company with one or more locations.

Next, our product margins have improved to a positive 29%, up from negative 22% sequentially. We continue to obtain lower cost from our overseas partners, and are also offsetting these hardware costs with service activation fees and the outright sale of our end point devices. The negative margin on the Packet8 DV326 videophone product cost has been substantially reduced to the same order of magnitude as that of our other voice telephony products like the Uniden cordless phones.

Next, our service margins also improved to 56%, up from 52% in the prior quarter. Wholesale competition between our carriers continues to benefit our cost structure, and we brought a third major carrier online during the September quarter. Finally, we are seeing the lowest monthly per line cost for customer service since becoming a service provider. Our new back office systems are also enabling more automation and fewer employees in administering our services.

On the marketing front, our subscriber acquisition costs, for the quarter, declined significantly to $99 across all channels, vs. $135 in the first fiscal quarter.

This is a fully loaded cost and it includes costs for advertising, marketing, promotions, commissions, equipment subsidies and rebate programs. The Company's advertising expenses totaled $1.1 million for the second quarter, vs. $1.8 million in the previous period and, substantially, all of this marketing was focused on growing the company's Packet8 Virtual Office subscriber base.

We ended the quarter with approximately 5,000 companies using our Packet8 Virtual Office services. During the September quarter, we added approximately 1,000 companies to our business services, an increase of approximately 25% sequentially, vs. the new companies added in the June quarter.

Given the shift in our company's strategy to emphasize business sales over consumer and other offerings, we believe that tracking the number of companies we serve is a much better measure of the progress of our business models than reporting our service offerings in terms of lines; especially relative to the lesser per-line economic value of line counts of other consumer offerings in the market.

The net loss for the second fiscal quarter was $2.7 million, or $0.04 per share, vs. $5.7 million, or $0.09 in the first fiscal quarter, a 52% improvement sequentially. The second quarter's net loss improved by 51% over the $5.6 million loss for the same period loss last year. The net loss in the second fiscal quarter was impacted by stock option expenses of $548,000, which were not present in the year-ago period.

Moving on to our balance sheet, as of September 30th, 2006, cash and cash equivalents totaled $14.5 million. The company burned approximately $3.3 million cash in the second quarter, vs. $5.2 million in the prior quarter, representing a 37% improvement in the burn rate. Cash outflow for inventory purchases increased by $975,000 over the prior quarter. Cap Ex for the quarter is $240,000. Depreciation for the quarter was $351,000.

As of September 30th, 2006, total shares outstanding were 61 million, and the total fully diluted share count was 79 million. At the end of the quarter, the company's headcount was 174 people, excluding personnel at our outsource call centers.

Based upon all of these operating metrics and the improvements in the fundamentals of our business, the company remains on track to obtain positive monthly cash flow, during the quarter ending March 31st, 2007.

That concludes my prepared remarks and I will now turn the call back over to Bryan.

Thank you, Dan. We are very pleased with these improving financial results and are excited to be talking about profits and positive cash flow, topics that we've not been able to talk about for quite some time now.

There's one final topic I'd like to cover before the Q&A. Since June, the company has received four U.S. patents relating to our Voice over IP inventions and technologies developed by our R&D and engineering teams. In June, we were awarded a patent for the Hosted IP PBX technology that’s used in our Packet8 Virtual Office services.

In August, we received a patent for technology to route telephony signals over the Internet and standard switch telecommunications networks. And in October, we received two additional patents, one for Voice over Internet processor technologies and the other for the use of presence technologies, to select the operating mode of a telephony system.

So in total now, 8X8 has received 64 United States patents that protect the company's inventions and innovations in a variety of voice and video communications technologies. With the development work and the progress our technical employees continue to achieve, we expect to see many additional innovations and, hopefully, patents in the future.

That concludes our prepared remarks and I'll turn the call over to Chenique for any questions.

[OPERATOR INSTRUCTIONS]

Our first question comes from the line of Colby Synesael, with Merriman. Please proceed.

Hey guys, congratulations on getting closer to profitability. As far as the decision not to break out subscribers anymore, I would only point out that, you know, greater than 70% of your revenues are still coming from other areas. So, for modeling the company, I would think that it's kind of important that you guys continue to break that out.

That said, if you're not going to, can you at least give us some color as far as were net adds higher this quarter? Were they similar to what they were last quarter? Anything there would be very helpful; thank you.

Okay, and we understand that, Colby and I do understand that three quarters of the continuing revenues are coming from those older kinds of consumer markets. But again, I think what's significant to me is that more than half of our new order receipts are coming from the business segment.

And in that sense, you know, we want to really stress that we think line count, relative to this new business model - and that the strategy that we've been putting in place the last couple of quarters, is really, - you know, lines, to us, are much different and probably much more valuable than lines in other consumer reporting things.

And I think it's kind of gotten out of whack with where our business is going. I'd much rather see you looking to someone like SeeBeyond as a comp for us, than someone like Vonage, because I think the companies that are in the consumer segment that continue to tout giant line counts, are probably trying to hide the fact that other areas of the business model may not be working as well as the growth rates.

But I can tell you that total lines did increase. It did increase less than the amount that we increased last quarter. So, we are seeing the growth rate slow a little bit but, again, the fact that we're able to add more of those business customers, you can tell from the bottom line and the other fundamentals that that's having a net positive, I believe, on our financials. And, that's why we're doing the shift here this quarter.

Okay and at your shareholders' meeting, you guys, I think, gave out some more options. And I think you just mentioned now that fully diluted you have a share count of 79 million, vs., I think, approximately 60 or so today.

What's the time frame for bringing some of those shares actually into the share count and, do you have an idea where we'll be from the share count perspective, exiting the fiscal year?

Yes. I think the shares outstanding has been a pretty steady number, at least for the last, say, three quarters. And I would say total outstanding, if anything, has probably come down a little bit just because we've had some employees leave the company. There's a big chunk of the difference between outstanding and fully diluted that's tied up in warrants.

And these warrants tend to be at the $3.00 a share level that were part of all these past financings. We've raised $60 million to date to fund Packet8 and there's a big chunk of that.

Do you remember the employee stock option component?

Employees are roughly about 10 million shares and the balance are warrants.

Okay and then, last question and then I'll come back and circle around. It looks like, from a gross profit standpoint, you had over a 200% contribution, which is great. Going forward, to get to free cash flow positive by the first calendar year of '07, is that primarily going to continue to come from reducing your gross margin - excuse me, your cost of goods sold? Or are we going to see a significant improvement as well in things like SG&A?

So, with the SG&A, I mean, we - as a percentage of total revenue, it's been trending downward. And it's probably not going to continue at that aggressive a rate, but it's definitely going to continue in that trend, you know, along with gross margins. I mean, we had a massive improvement in gross margins. And, everything so far is still looking very good in that respect.

Yes, I think the other thing to really state here, there's not - you know, product margins certainly had a huge impact on total gross margins. But, we see that the business model and the metrics really improving across the board. And, I think Dan, in his section, mentioned a lot of those customer service costs are improving. The cost of our products, obviously is improving greatly.

Our network costs are improving, so there are big components that are driving that but I want to stress that across the entire business model, we're seeing better metrics as we scale the size. And certainly, as we add more of these companies, it just gets better and better.

I mean, we're not having to add one employee for every so many extra customers that we get. I mean, that multiple is increasing, so that's looking very good, month-over-month.

Okay. Congratulations, guys; thanks a lot.

[OPERATOR INSTRUCTIONS]

Our next question comes from the line of Mike Cody, with B. Riley and Company. Please proceed.

Thanks, good morning. Looking at the gross margin, I know you said that you don't - at the beginning of the call - you don't like to talk about forward guidance. But I'm just kind of trying to get a sense of that 29% product margin. And, if you were to look at your business, I mean, could you break it out in terms of what the Virtual Office product margin is, such that if you were to [out rate] of 50% revenues coming from Virtual Office, what your product margin might look like?

I don't think we can break it out but I want to stress we don't think it's a one-time event. There wasn't anything special this quarter so we like making money from the equipment. It's certainly a smaller margin than the network margins and the network margins are what really drive the business model. So, our focus is really on continuing to improve those.

The business services, clearly we're able to sell the equipment at kind of higher prices. But the other component that's part of this is we started charging activation fees across all of our channels, including consumer. So, we've got a box that we give away when you sign up for consumer service but you also pay a $30 activation fee to get service started on that box.

And so, activation fees across all of our channels are contributing a lot to that as well, Michael.

Right and I wanted to touch on that as well. When did you start with the activation fees and how have those been received and is that any reason why the growth in consumer lines has slowed?

We started charging $29.99, again, for consumer activation on July 1st and we charged it all throughout the quarter. And in the previous year before that, for about 10 of 12 months, we did not charge it.

And then, on the business side, we've actually always charged it. But we just became a little bit more selective on when we offered a more aggressive deal to certain customers. But, primarily, the increase in activation is related to the consumer side and, yes, it did have a negative effect on gross line sales.

Free is always better.

Right, right. Okay and -

I think you can see that from the cost-of-acquisition improvement. The portion of that is driven by the consumer side but another portion of that is driven by our business cost of acquisition, which is starting to look pretty good. And we have a lot of customers that buy from us and then they add services on. And, many times, when they're adding services on, effectively, the cost of acquisition is zero or it's actually we're making money on it if they're paying for more services because they don't even call us or contact us. They just add on.

Okay, sounds good. And then, I mean, obviously, we'd like to SG&A - or, it needs to come down significantly as a percentage of revenues. As you ramp revenues, I'm sure that'll happen.

What do you attribute the decline in absolute dollars, in SG&A, and R&D, over the last couple of quarters? Especially given the increase and expense in stock options and yet, still, in June it was down from March and again, down in September.

The primary driver between the last quarter and this quarter for the sales and marketing component is that we just reduced some advertising on the consumer side. And, as I stated in the script, advertising expenses dropped by approximately $700,000, quarter-over-quarter.

Okay.

And then, one other item to note, though, when you state that on R&D, R&D, since the fourth quarter fiscal of - the quarter ended March and then the quarter ended June and the quarter ended September, it was actually flat. We had our vice chairman leave the company in January and, in that quarter we took a $450,000 charge.

I see.

So, if you [jack] that out of that quarter, it's pretty much - you know, we're deemphasizing R&D investment.

Got you. All right; thanks. Good job in the quarter and good luck getting to profitability.

Our next question comes from the line of Eric Buck, with Brean Murray. Please proceed.

Thank you, good morning, guys. The first thing I wanted to do was kind of reiterate Colby's point on the line counts. In reality the number of [inaudible] 250 lines, I think if you were to continue to give VO lines and residential subscriber lines, we could differentiate you from Vonage and say beyond. But just thoughts from this end.

The second thing, I was going to ask about the churn. I think you said it was 3.7%, and if I remember on the prior quarter, it was 4 and change, but you had indicated that if you x'd out people that you had intentionally gotten rid of, churn would have been closer to 3. So if you can talk a little bit about the churn factor, I would have expected that number to have come down with higher VO sales.

Yes, so as Bryan noted, the churn on the business side is our lowest of our three product sets; and when we talk about three product sets, we're talking about consumer voice, Virtual Office, which is a business service, and then the video piece. So the way that churn stacks up is business is the lowest, video is fairly close to it, and consumer is quite a bit higher. And so the reason that it moved upward is primarily related is actually entirely related to the consumer churn increase.

So the consumer churn itself increased, it must have been fairly dramatically in the quarter. Anything you would attribute that to?

Well I think, I mean part of our strategy here as we emphasize the business side of what we're selling is, we're not competing head to head with some of the more, I would characterize them as nonsensical offers that are out there in the consumer market. There's free services, there's very low cost for a year, all sorts of offerings that I think these consumers, in all the research we've seen, are mainly motivated by price, they don't embrace the features as quickly, which is very different from a business customer.

And so I think it's just a natural -- as we add activation on, and we've certainly had to add some charges this quarter related to 911 and universal service and so forth. I don't find it actually that surprising.

And then finally on the product margins, if you X out the activation fees, which actually I'm kind of surprised you would count that as cost of goods anyway.

Well I wouldn't do it, but our accountants make me do it.

Okay. But if you looked at the actual hardware itself, and looked at margin X those fees, is there a significant delta between the VO and the residential, and is there a significant delta between where those are today versus where they were prior to your change in the activation fee?

And let me just comment, I'll let Dan answer that, but the reasons the accounting is there is if you look at it, and the way the accountants would look at a sale; we've got this box going out the door and it's free, and yet here's this $30 charge. And that $30 charge looks a lot like you're buying the box, and that's how the accounting literature makes us treat it. So Dan, do you have a number there?

So what happens is that since we've subsidized the price of the consumer box, because we actually market it for zero, we have to, there's an accounting rule that we actually have to take a bit of the service revenue and allocate it up to product revenue for the equipment. So there's a component of that that we move up there, and so if I pull that number out we still have positive margins on the equipment side.

And on the consumer piece we literally make a couple of dollars per unit on the margin. When I say that it's just like activation less what we pay for the equipment. And on the business side it's a bit more than that, but it's not a large number.

They're still thin margins.

Yes, pretty thin.

It's really the service margins that are net driver of long term business.

I mean the way that we modeled this is that if we essentially it's neutral, that's good. And anything above that is just gravy.

Okay, thank you.

Thank you Eric.

Our final question comes from the line of Brian Quarry with Aurelian Partners; please proceed.

Thanks. I heard what you said about not adding, or not reporting on per line statistics, but given the focus on the business side, the business customers, can you give some stats on a per account basis? In other words, revenue per account, cost to acquire an account, those kinds of things that business has some more focus, from an analytical standpoint?

I don't think we're prepared to break that out today. But I certainly, I'm hearing the parade of feedback on our change in disclosure practices. And so I think going forward what we may try to provide is, in future calls, some more guidance on what one of our business customers, on average, looks like in terms of the services we provide and the results that we get from that customer. As we continue to report the number of businesses that we're adding and the growth in that channel, I think that will guide you in that direction.

I do think, I mean we've provided metrics from a top down perspective in terms of percentage of revenues resulting from this; the average number of extensions per business, and that sort of thing. So I think there's some analytical information you can use to derive some numbers. But I do hear the criticism and we'll look at what we do in the future on that.

Okay, and on the activation fee; you're able to recognize all of that up front as opposed to amortizing that revenue and recognizing it over, kind of over the life of the contract, is that right?

Yes. We have one product we sell that's a consumer product called a Freedom Annual plan, and that's one where you pay $199 and you get the service for one year, we amortize that over the life of the subscriber, or over the one year. But since we are effectively subsidizing portions of the equipment, we take the activation as revenue in the current period. And we do defer some of that, because we have a return right for 30 days. But yes, we do take it in the current period.

Okay, thank you.

Thank you. I would now like to turn the presentation over to Bryan Martin.

All right, thank you everybody for listening. If you're not already a customer or a business that's using our services, I encourage you to sign up today. You can do so at our website, www.packet8.net, and that's the end of our call.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.