8x8 Inc (EGHT) 2010 Q2 法說會逐字稿

Good day, everyone and welcome to the 8x8, Incorporated second-quarter 2010 earnings results conference call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to 8x8's Director of Corporate Communications, Ms. Joan Citelli. Please go ahead, ma'am.

Thank you, and welcome, everyone, to our call. Today I'm joined by 8x8's Chief Executive Officer and Chairman of the Board, Bryan Martin, and 8x8's President and Chief Financial Officer, Dan Weirich, to discuss our results for 8x8's second fiscal quarter ended September 30, 2009.

If you have not yet seen today's financial results, the press release is available on the Investor's tab of 8x8's website at www.8x8.com. Following our comments, there will be an opportunity for questions.

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 limitation, 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 10-K, in our quarterly reports on Form 10-Q, 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, except as required by law.

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, Chief Executive Officer and Chairman of the Board of 8x8.

Thank you, Joan, and good afternoon, everyone.

Today, I'd like to provide some commentary on our financial results, followed by an outlook on what we are seeing in the business communications market and an update on some recent advances in our technology and service development efforts. Dan will then provide a detailed look into the metrics and trends we monitor in our financials, and then we will end the call with any questions you may have for us today.

The second fiscal quarter validated 8x8's business model and value proposition, as we resumed our top-line growth and generated record levels of operating income and operating margin. We are increasingly confident that 8x8 is well positioned to continue generating operating income during the second half of this fiscal year.

8x8 posted GAAP net income of $1.3 million for our second fiscal quarter. The second fiscal quarter was ended September 30, 2009, and that GAAP net income was up 223% sequentially from the $414,000 of net income reported in the June quarter and up approximately 30 times the $44,000 of net income we reported in the same period a year ago. Our operating income of $1.4 million and operating margins of 9% are both the highest since the Company went public in the summer of 1997. We have consistently stated that we are nearing an inflection point, and that margin on new revenue will notably expand, allowing more contribution to the bottom line. We began to see that in this quarter, and this success reinforces our confidence in the Company's business model. We are on the right path.

The solid performance in the second quarter enabled us to further strengthen our balance sheet. The Company's cash position grew by $636,000 during the quarter to $16.1 million. We were able to grow our cash even as we invested in the growth of our business, relocated our corporate headquarters and repurchased 282,376 shares in the open market at an average purchase price of $0.75 per share during the second quarter. We believe in this recessionary period that our balance sheet represents a key strategic advantage. Our strong cash position and ongoing free cash flow enables us to invest in growth, price our offerings more aggressively to capture market share and expand our marketing initiatives.

We maintained a consistently low overall churn rate for business customers for the third consecutive quarter, though the percentage of our total churn resulting from financial and economic hardship issues for our small business customers spiked to be almost one-half of our total churn. It appears to us that if the economic climate for our small business customers were ever to improve, this would likely result in a substantial improvement to our overall churn number.

Our competition for new business customers continues to come, almost exclusively, from AT&T and Verizon, with the very small business of 1-2 lines looking at single-line solutions from Comcast and Vonage as an alternative to our full-featured business functionality. Our value proposition continues to resonate, however, and businesses are increasingly realizing that with 8x8 they don't need to sacrifice functionality for expense, as our full-featured Virtual PBX solution is priced competitively with these lower-tier, bare-bones offerings.

In terms of our business outlook, we continue to see a trend towards signing up and servicing larger business customers. Lines and services per new business increased to 9.8 for the September quarter, vs. 9.6 in the June quarter and 7.7 in the year-ago September quarter. We believe that the disruption caused by Nortel's bankruptcy in the market, the business VAR channels not getting paid for telecommunications solutions requiring large capital expenditures, as well as a renewed focus on voice-over IP and hosted service provider solutions, are all contributing to a trend of larger businesses becoming more comfortable with alternative telecommunications solutions and providers.

With the return of regulatory introspection into net neutrality and broadband communication applications on the agenda of the new leadership at the FCC, voice-over IP technologies are again regularly being featured on the front page of the Wall Street Journal and in the mainstream media. We believe that this renewed attention on voice-over IP technologies bodes well for our sales efforts. During the September quarter, we announced our largest SIP trunking customer to date on August 6. This business customer carried more than 8.6 million minutes of voice traffic over 8x8's services during the quarter. We also began deploying phones to our largest business customer to date during the quarter, which will total approximately 1,000 extensions when fully deployed. This customer is ramping up to full deployment, with more than 400 phones deployed in the field thus far.

We are also seeing, for the first time ever, a markedly increased interest in hosted business telecommunications solutions from the federal government. As we announced on October 1, 8x8 and Level 3 have executed a teaming agreement which enables us to jointly bid on hosted voice services within the federal Networx program, administered by the GSA, as well as the Washington Interagency Telecommunications Services, or WITS3 program.

To date, 8x8 and Level 3 have submitted two proposals, one to the Department of Justice and the other to the Federal Maritime Commission. We have been notified that we have been awarded the Federal Maritime Commission bid, which will initially result in the deployment of approximately 155 Virtual Office extensions at the Maritime Commission in Washington, DC. With large businesses and segments of the federal government adopting state-of-the-art voice-over IP telecommunications technologies, it is clear that the trend toward lower-cost voice-over IP solutions is accelerating.

Now, regarding our technology and service development efforts, we launched the 8x8 Virtual Meeting service on September 1st, and we ended the quarter with 227 paid subscriptions to that service. This quarter, we will be conducting a trial of our new unified communications services for businesses with production launch currently scheduled for January 2010. We are looking forward to capitalizing on a new regulatory position to allow iPhone 3G data services to be a conduit for voice-over IP traffic. And we are also conducting significant R&D right now on high definition voice within our IP phone endpoints, which is a service enhancement we are looking to introduce to our current business customers soon.

With that update, I will now turn the call over to Dan Weirich, the Company's President and CFO, who will walk you through our detailed financial results and provide additional information regarding our business. Dan?

Thank you, Bryan.

This quarter, we began to see revenue grow again, increasing 3% sequentially after declining for three consecutive quarters. The revenue growth is due to the success of the marketing initiative instituted in March which involved increasing subsidies on hardware. The service revenue stream associated with this program is now contributing to our top-line results. Revenue from business customers represented 74% of total revenue in the second quarter of fiscal 2010, compared to 60% of total revenue in the same period of fiscal 2009. Revenue from business customers grew 10% sequentially and 21% compared to the same period a year ago. Residential revenue declined 13% sequentially and 34% compared to the same period a year ago. We ended September with 18,199 business customers.

Gross margin was 67% in the second quarter with service margins of 76% and product margins of negative 42%.

Management continued its focus on controlling operating expenses during the quarter. Research and development expenses were $1.3 million in the second quarter, a $34,000 reduction compared to the same period a year ago. SG&A expenses were $8.2 million in the second quarter, a $1.5 million, or 15.6% reduction compared to the same period a year ago.

The primary reason for the significant decline of SG&A expenses over the past year is a shift in the Company's sales focus to primarily selling direct rather than through third party. We ended September 2009 with 72 quota-carrying sales executives in our direct sales force, compared to 43 quota-carrying sales executives on September 30th of 2008, a net increase of 29 sales people. Keep in mind that our sales personnel are responding to leads of interest in our service. This is not cold calling or prospecting, so an increase in sales personnel reflects our expectation of increased demand through our marketing initiatives.

Gross new business customers added in the second quarter was 2,609 compared to 2,907 in the first quarter, and the sequential net increase in business customers in the second quarter was 933. We believe the growth in business customers has validated the strategic shift to direct sales. In the third quarter, we intend to modestly increase marketing expense and increase the subsidy on the equipment to accelerate the gross number of sales to new customers and the conversion rates on sales opportunities.

The average monthly service revenue per business customer increased to $201 compared to $196 in the first quarter. Business service gross and contribution margins remained strong at 82% and 63%. The cost of acquisition was $638 per business customer in the second quarter of 2010 compared to $1,174 in the second quarter of 2009. The payback in the second quarter, which is the cost of acquisition divided by contribution margin, was five months.

Cancellations due to financial hardship in the quarter represented 45% of total business customer cancellations compared to 35% in the previous quarter and 34% in the same period a year ago. Even with that change, total churn from business customers declined from 3.1% in the second quarter of 2009 to 2.7% in the second quarter of 2010.

The Company's reported $1.3 million profit includes reductions from operating results of $249,000 due to employee profit sharing, $192,000 of move related expenses associated with the relocation of our corporate headquarters, $69,000 of stock compensation expense, and a $91,000 noncash expense to account for the change in the fair value of our warrant liability resulting from the volatility and stock price appreciation of our stock price during the quarter. Depreciation during the quarter was $252,000.

Cash outflows during the quarter included approximately $380,000 related to one-time expenses incurred during the relocation of 8x8's corporate headquarters to Sunnyvale, California and $212,000 spent on the Company's stock repurchase program.

Capital expenditures for the second quarter were $441,000, 2.8% of revenue. $188,000, or 1.2% of revenue, of the capital expenditures in the second quarter relate to relocating our corporate headquarters. In the third quarter of 2010, we expect to spend approximately $120,000 of capital expenditures related to the relocation.

Working capital increased to $9 million from $7.4 million on March 31, 2009. Stockholders' equity increased to $10.8 million from $9 million on March 31st of 2009 and our current ratio was 1.8 to 1.

As of September 30, 2009, total shares outstanding were 62.8 million, and total shares fully diluted were 75 million. 1.6 million warrant shares with a strike price of $3.61 expired in September of 2009. The only remaining outstanding warrant shares are 1.8 million warrants with a strike price of $3.00 and an expiration date in December 2010.

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

Thank you, Dan. For your reference and convenience, we have posted a transcript of our prepared remarks, including the Virtual Meeting presentation slides that were shown today, on the Events & Presentations section of 8x8's Investor website at investors.8x8.com.

We will now be happy to take any questions you may have.

Operator, please open the lines for any questions.

Thank you. (Operator instructions.) Mike Crawford; B. Riley & Co.

Thank you. First, could you talk about this CallFire trunking agreement and what the importance is of that to you? You referenced your August 6th press release in the call.

Yes. So CallFire is a company that -- you can look them up at callfire.com, but they essentially do like voice-broadcasting type services. And so this is [one] to where we do -- it's called a SIP connect. So they just connect to one of our IP addresses and then send us traffic. And so this is something that, as Bryan noted, at 8.6 million minutes in a quarter, can be a pretty large customer in a very short period of time.

And so -- but can you put that in any numbers? Like what does that -- what do those 8.6 million minutes of traffic translate down to in terms of revenue or profitability for you?

Yes, so --

In broad brush.

Yes. Okay, exactly, so a customer like this is going to generate in the neighborhood of $30,000 to $50,000 a month in revenue. And from a contribution margin basis, it's probably running closer to 50% rather than a 60%-ish range.

Okay, great. And then you mentioned another large customer, I believe the largest one you ever had, which is ramping up from 400 phones deployed to over 1,000. Is that -- is there anything more you can share about that large customer?

We cannot share the name of that customer, but I can just say it's a Fortune 100 company and it's a distributed solution. So effectively, every location is a separate location.

Okay, but does -- how does -- doesn't that tweak your number of lines per subscriber, given you've got one customer with 1,000 lines and you're selling 9.8 per business customer? Does that -- do you pull an outlier like that out of the averages, or no?

The way that we put these numbers together is that, like on this 1,000 line opportunity, this is not all booked at one time, but it's booked essentially on a daily basis. New orders come in and so the opportunity size will end up at 1,000 lines, but over the last five months, they've booked roughly 400-plus lines, so it's an average of about 100 lines a month, something like that.

But, Dan, when you say that you're signing up, it looks like nearly net 400 Virtual Office customers a month, is that one customer counted as one, or is that counted as a series of those customers?

In that instance it's counted as one customer.

Okay. Great. Also, so one -- I think yours -- our thesis here has been that you have this base of fixed costs that are kind of covered by about $60 million in revenues. Is that -- and then anything on top of that kind of layers in at a near 65% contribution margin. Is that still a pretty good way to look at this business?

Yes.

And you invest $0 in residential. Some of that kind of trickles in on its own, but that's not anything that you're investing in. It's pretty much it's all the sales and marketing efforts are pushed towards Virtual Office. Is that correct?

Yes. So in this quarter that we just reported, 100% of our marketing dollars were on acquiring business customers.

I think in the past you've given some kind of close rates on leads. Have those remained high, given that you're subsidizing some of the fixed cost of opening an account for a customer?

Yes. So if you notice, our product margins have -- they were negative 75% in the first quarter and they were negative 42% in this most recent quarter. So we subsidized a little bit less and our close rates declined. And so what we've determined is, is that we're going to start subsidizing a little bit more to boost the close rate, because what we're seeing is that the conversion on the close rate even more than offset the increased subsidy.

I mean, that should be some fairly simple math, right? I mean, your churn has been consistent at 2.7%. You've got a monthly phone bill of $200, so you can run that out two to three years, versus you get paid back in five months. It seems like a no-brainer, is it not, to subsidize?

Yes. Yes. We would agree with you.

Okay. Could you talk just about competition a little bit. You mentioned AT&T and Verizon. What about other, more mom and poppy start-ups like, say, a Vocalocity or something like that?

So, Mike, this is Bryan. I think, you know, Dan and I do a lot of these customer meetings, especially these larger customers. And I can just tell you that most of the time we're running into AT&T here, Verizon or Qwest if you're in that territory. And a lot of our businesses have been in -- are not starting up fresh. These are businesses that have been in business for quite a while. And so I think those incumbent carriers just, by the law of averages, tend to be resident in that account. And it's up to us to convince the owner to go through the process to kick them out.

I think where we see the most competition coming from some of the smaller start-ups is the barrier to entry to get along side us on a Google search for business phone service is very low. You just write a check to Google and you can start appearing on some of those places. And similarly, there are IP communications and voice-over IP specific lead generation sites out there, who will sell their leads to multiple bidders. And so I think our smaller competitors are primarily able to join in on the quoting process if they generate a lead through one of those kind of communal sources.

But I think what we're finding is that the brand recognition of the service and the fact that we've been in retail for a couple of years now and that our referral program continues to go very strong is helping us out quite a bit. And I would attribute some of this large opportunities to kind of that approach, and some of the successes we've had there. So the smaller players are all still there, but I don't think the -- if you ask me who we're competing with most of the time, the answer's going to be the incumbent carriers and not the small start-ups.

And then I think I also made a reference, Mike, to if it's a one-person or a two-line kind of business, you can certainly run most of those businesses off of a single-line solution from someone like Vonage, but as soon as you get more than two employees and you have a lot of inbound calls and you have to transfer the calls and you need to have ring groups and an auto attendant, you quickly outgrow that solution. But we see a lot of customers that are using a four-line RCA phone and they've got four analog lines plugged into each phone and that's their phone system. And you make a single IT connection to our device, using a line that's already connected to your computer and office, and you've got a lot more functionality and flexibility and expandability and capability. And at the end of the day it costs a lot less. And that's primarily the people we're selling to in most of these accounts.

Mike, I've personally been on a number of sales calls right around our office here in Silicon Valley in the last couple of weeks, and every single one of them is -- they're considering us or an AT&T solution. And we've won 100% of them.

That's just because Dan's making the sales call.

A couple of other quick questions if you don't mind. So one, Virtual Meeting, what kind of traction are you seeing?

It's -- I think we're pretty pleased so far. It's pretty early. We rolled it out with the press release and kind of the meetings with the press, and launching it at the IT Expo convention that we were at on September 1st. And so we gave you a number today of how many paid subscriptions we have 30 days later. And I think our sales cycle kind of kicked in -- it didn't kick in exactly on September 1st. We were doing some training and getting every sales agent up to speed on how to use it and how to use it in their demonstrations and so forth. But, I think the number is fine. I think we'd like to see that accelerate in the third quarter. And hopefully we'll see that.

But I'd say the product is working very well and we haven't run into any of the kind of compatibility or bug-fixing types of issues that you would worry about with a new service like that. I think the reviews have been across the board very positive. And the customers that have subscribed to it -- some of those subscriptions are actually annual subscriptions, so they tried it and then immediately prepaid for a year. I think that bodes pretty well for us.

Okay. And I guess we'll see some more Unified Communication products and you rolling out in the future. But you mentioned in your script also high-definition voice. So what is that exactly?

Yes. So all of our services today, typically we'll use some form of voice compression. But they all use the basic 3 kHz sampling rate that modern telephony has always used. Our IP phones, the three versions that we're selling today -- 53i, 55i and a 57i -- all support in the hardware a high-definition mode where you actually use something closer to 16 kHz, kind of stereo sampling. And the best way to describe it -- you really need to experience it, in person -- but the best way to describe it is if you're an audio aficionado and you've gone to one of these Bose demonstrations at a Fry's or something where they play a regular stereo and then they play the Bose speaker system stereo. And you get that much fuller spectrum, a lot more base response and just a much clearer, full-bodied kind of audio stream or audio experience.

That's what we do over the high-definition mode. And we can enable it today with just a Firmware upgrade that can be done right over the Internet to any of our IP phone customers. So we're getting ready to roll that out. It will only affect calls that stay within your enterprise. So typically, you have a phone on your desk and you dial an extension to reach someone's phone somewhere else in the enterprise. And for those calls we will automatically switch into high definition mode. If you call back to the PSTN or you receive a call from the PSTN, that's still going to sound the same as this call sounds right now. But within the enterprise is where we can enable this much higher fidelity voice. And we're just in the final stages of finishing that QA and the development and getting that turned on to some of our customers.

Okay. Thank you. And then, final question is you talked about some of the incumbent carriers and maybe start-up mom and pops, but with you now demonstrating the ability to provide solutions to not just 10-line customers, but to 1,000-line customers, you start to get into kind of a bigger pond where you have Intertels or Advisor, even Cisco. So is that -- what can you say regarding competing against those bigger players?

Yes, I would say that's true. And I think these larger accounts, what we're -- we only have a handful of them, so it's not like we have a large number of these customers today. But they certainly require a lot more investment up front. They require us to typically travel to the customer and get to know them and make some presentations, and probably do a lot more of the evaluation type of things, and do head to head demonstrations against whatever else they might be looking at what they might have.

But I'd say the encouraging thing that we've found with the handful that we've got turned on right now is they require, obviously, a lot more work initially to get the installation done and get the training done, but once they're up and running they're actually requiring less effort to support on an ongoing basis than one of our typical smaller kind of 7-to-10 employee customers. And I think some of that just has to do with the fact that they typically will have an IT department and they can kind of handle a lot of the low-hanging fruit.

And so, we're still looking at the numbers on what the return looks like, but it appears to be quite favorable because that customer over time actually costs less to support. And we're also finding that they're churning at a much lower rate than a large customer. We've had -- of the handful of these large customers that we've gotten into production we've only lost one of them. And we lost that customer because they went bankrupt, not because they turned the service off and went to something else. So if you exclude that case, which is a financial hardship issue, we have yet to lose one of our large enterprise customers that we've gotten into.

Okay. Well, thank you.

J.D. Abouchar; GRT Capital.

Hi, guys. Thanks for taking my question. Nice quarter. You had a slide in there on voluntary versus involuntary churn, the economic churn. Can you talk about that a little bit more? Is there any economic impact in terms of bad debt or anything like that? And have you seen any trends there where maybe the economic side is peaking as the economy at least flattens out here?

Yes. So we just put this chart up on our Virtual Meeting presentation. But yes, we saw a big step-up in cancellations due to economic reasons. It's bounced around, and roughly a third of our total cancellations for roughly about a year, and then it moved up to about 45%. And so I don't have any sense on whether it's peaking or not. Month to date, it's actually looking like it -- month to date of October it looks like it's stabilized a bit. But I don't think --

(Inaudible - multiple speakers.)

-- it's [abating] a lot yet. I don't think it's getting a lot worse, though. But definitely it's a real issue and it's something that -- fortunately we've improved our cancellation rate of things that are under our control quite a bit. And overall, churn is flat, when we've got this thing that's effectively out of our control is moving upwards.

And is there an initial subscription period that people are now going for, sort of prepaying the year or things like that? Has there been any trends there?

We offer -- we call that an annual plan for our business customers, where they can pay a year in advance. But we are not -- it's an extremely small percentage of our sales are on that plan. And we're not seeing that increase or change in any manner.

Okay. You mentioned the 78 sales people and you sort of bring them in in classes or waves. What are the plans for new sales hires here in calendar Q4?

Yes. So we grew from 65 to 72 quota-carrying sales people throughout the quarter. The new people that we brought on, we brought them on in the late August and September time frame, because we actually moved locations in late July and early August. So we kind of waited to move to a new location to get these ramped up. So most of these people were not producing during the quarter. And we're continuing to expand our sales force in kind of the measurable growth that we've done over the past year. And we're just continuing to monitor it and make sure that we can keep the close ratios and things of that nature in line.

Okay. And final question is, do you have a sense if there's any seasonality in the business in terms of sub adds?

Yes. So this is a perfect quarter of kind of negative seasonality for us. And so typically July is our worst month of the entire year. And so we did have seasonality this quarter on gross adds and we had seasonality issues last year at the exact same time. Typically we see July is slow and then it picks up in August and then it ramps significantly in September.

And the thing that was interesting about this year was that July started off very slow as usual and it ended fairly good. And August was kind of on track with what we were expecting. But September began extremely slow. And the only thing that we can attribute it to is that Labor Day was on the latest day it could possibly be of the year. And we were actually in New York on September 8th and 9th and we saw all the children were going back to school that day. And all of a sudden Wednesday afternoon, the Wednesday after Labor Day, sales picked up. So it was almost like we had a kind of a July 4th beginning to the beginning of September. And so that kind of messed up our September targets. But we've actually seen sales kind of get back to norm and what we had been expecting in October month to date. So things are looking pretty good.

Great. Thanks, guys.

Brian Horey; Aurelian Management.

Thanks. I had a few questions. Can you just maybe give us a little more insight into what's driving the government agencies to be interested in hosted solutions? I mean, when you think of the government accounts, you think about generally larger accounts. You would think that -- wouldn't necessarily be interested in a hosted solution. So maybe if you can just give us a little insight on that, that'd be helpful.

Yes. This is Bryan. I think it's a very good question because, as I noted, this is a -- for us at least in our exposure to that type of account -- it's a very relatively new and different behavior. And so it seems to fit -- to the extent that they'll accept hosted services, obviously we can save a lot of money. So I think it makes sense that some of our bids should be very successful here. I don't know whether to attribute it to, you know, the government is facing the same budget tightening cycle that the private community is and thereby just needs to save money. The up-front investment you need to make in our hosted solution is obviously going to be a lot less than putting in a physical type of system where you've got to set up the core switching architecture and buy all of that gear and get it installed and service it over time. And so I think the whole cost of ownership and total cost of ownership for a government agency makes a lot of sense.

We're also seeing a lot of mobility requirements and what I like to refer to as the distributed enterprise application within these requests for bids and information. And so it does seem that with the bid that we just won, obviously we're starting by installing one building in Washington, DC. But if you think about the Federal Maritime Authority, they have ports all over the US and they have offices all over the US. And they need communication services that can address a distributed enterprise environment. And so the hosted solution works very well there, where you can -- your moves, adds and changes and your ability to address employees anywhere that they have high-speed Internet access fit into our service perfectly.

But it's very surprising to me the number of requests we're seeing for specifically the hosted component. And that's being a requirement in the type of voice service that's being asked for. And that's what led us to team up with one of our carriers and really put a lot of effort behind pursuing these. We think there's potentially some very large opportunities there.

Have you guys been able to scope the size of the government opportunity to any fine grain degree?

No. I don't -- I mean, I think it's -- to the extent that the bids are there, which they appear to be, I think the opportunity is large. Obviously, as one of our earlier questions alluded to, there's a lot of large competition there. So, again, we're going to be seeing kind of the same old folks, the AT&Ts and Verizons and Ciscos going after this business as well. And we'll have to rely upon our technology and our pricing structure to differentiate us.

Right. Okay. Can you talk at all about the kind of subscribers you're seeing for Virtual Meeting so far and kind of what segment of the market do you seem to be appealing to?

Yes. So far our Virtual Meeting customers are predominantly our existing customers. And we didn't sell too many to non-Virtual Office customers, so it's just our typical customer. So we did a customer study prior to rolling this out. And roughly 60% or so of our customers had used a web conferencing type solution more than one time in the last quarter. So it's just very -- it's our customer base is very wide ranging. We've got small customers and we've got some larger customers and -- but we're seeing it kind of evenly purchased by all of them.

Okay. And what neighborhood are you in with RPU on that product?

Roughly about $30.

That's per seat per month?

Yes.

Okay. And then, can you just go over again what you said about the iPhone and the regulatory situation and the -- it sounded like maybe you guys were thinking about exploiting the iPhone opportunity. Can you just repeat that so that we're clear on that?

Yes. So we've had a service that's been in the market for roughly 18 months that we call 8x8 Mobile Talk. And it's an outbound USA to the world kind of international dial-around service. The iPhone -- we support approximately 450 smart phones with that software. And so if you're a business person or you have relatives overseas and you want to be able to call them off your cell phone in the car it's a great way to do it.

The iPhone version of that application has always been kind of a very ideal platform for us, because the iPhone is really the only phone in the market where it's a requirement that the user has a data connection. And so you've always got data available, whether WiFi is available to the user or not. But, as you may have read, the -- it's been very difficult to send voice traffic over that data network because of the positioning that AT&T put on that.

And so we were anticipating a couple of months before this change occurred that it was starting to look likely that this could become part of an FCC action. I'll tell you, we were very surprised at how quickly the 3G network opened up to voice-over IP. And so we were anticipating something more like 12 months from now, and it actually happened within a matter of weeks. And so we were already in process with some products that were moving in that direction, to be able to support a 3G voice connection on the iPhone. And we've obviously accelerated those efforts since that announcement occurred two or three weeks ago.

Okay. So can you put any bounds around when you think you might finish those development efforts?

I think we're trying to include that application with the Unified Communications service that we talked about, that we'd be going into beta with this quarter. And Unified Communications we were targeting January of '010 and I would just say, to have the full solution, including 3G, we'd anticipate the first calendar quarter of '010, something like that right now.

Okay. Thank you.

Jim Gentrup; Ceiba Equity Research.

Good afternoon, gentlemen. Just wanted to ask you a couple follow-ups, actually. The operating margin -- I appreciate you guys showing us what kind of margins you're capable of in this business. Can you talk about the sustainability and just -- in other words, are we going to -- is this going to bounce around a little bit as you guys continue to maybe tweak on the marketing side, the marketing spend? Can you just talk a little bit more about where these margins are headed?

Yes. I mean, these margins will bounce around a bit. In some respect, we're a victim of our own success in that if we subsidize the equipment a little bit more and gross adds are a little bit higher, obviously it can impact margins in the period of the sales activity, so back in that result and some kind of bouncing around. But from a one-time like benefit and things of that nature in this quarter that were effectively nothing, but we did move and we had expenses and I kind of laid out what those expenses were, one-time items.

And so I think that is -- what we're going to need to do, is to grow and to grow faster, we need to invest more. And so obviously you can see sales and marketing and potentially subsidies increase. But we definitely intend to continue to generate kind of meaningful positive operating income.

Okay. All right. And then, you talked about the large enterprise success lately. Can you -- what kind of approach are you -- what is the sweet spot? Obviously, most of your business is still small enterprise. But what are you -- can you tell us a little bit more about the future, about where your focus is going to be? Is it going to kind of morph into the more large enterprise or both? Or, how are you going to attack that area?

Yes. So to date, most of our -- the wins on the kind of larger systems -- and when I'm referring to larger systems, I'm talking about customers that are 50 to 100 extensions and above. On those have been more kind of reactive type sales, so the prospect contacts us and things of that nature. And as we kind of confirm and validate that these are profitable and highly profitable customers, we're in the midst of kind of working on a kind of more proactive approach, to going after these types of opportunities.

We do really well when there's a distributed need. So if someone has multiple locations, it's where we differentiate ourselves a tremendous amount from the other solutions in the marketplace.

Okay. And then my last questions is that -- just talk a little bit more about the revenue recognition, because you add -- I didn't get the add number, the net add. If you could repeat that, I'd appreciate it, this quarter. But how long do these new net adds take to -- before they start impacting your -- I'm just trying to get a better idea of the pattern and what to expect in the future, future revenue. If you don't mind just spending a little time on talking about that?

Sure. Okay. So we have two components of our revenue. We have product revenue and we have service revenue. The product revenue is roughly 7% of our total revenue and it's the equipment, or the telephones, that we sell to our customers. And that is recognized at the point of shipment. And the service revenue is recognized in the period that the service is provided to the customer. And so typically the service revenue starts kicking in between 30 to 60 days following the point of sale. So the product revenues kind of lead the service revenues by 30 to 60 days on average.

Okay. Thank you very much.

And there are no further questions in the queue. At this time I'd like to turn it back to Mr. Martin for any closing or additional remarks.

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That does conclude our conference for today. Thank you for your participation.