8x8 Inc (EGHT) 2010 Q3 法說會逐字稿

Good day, everyone and welcome to the 8x8, Incorporated, third 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 third fiscal quarter ended December 31, 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. Thank you for joining our call today. Despite the ongoing effects of the current economic climate, 8x8 business customer revenue grew 7% sequentially quarter-over-quarter, and 19% from the same period last year.

ARPU per business customer increased to $204 per month, and lines and services per business customer over our entire business customer base increased to 7.3. Overall business customer churn, excluding economic-related cancellations, set an all-time record low at 1.4% per month for the December quarter.

However, the economic headwinds impacting our business customers have not improved since our last call. In fact, cancellations related to economic hardship and nonpayment of outstanding business customer bills represented 49% of total business customer cancellations during the December quarter versus 45% of total business customer cancellations in the September quarter. This set an all-time record, as 810 business customers cancelled service for financial hardship reasons in the December quarter of the total 1,659 business customer cancellations during the quarter overall.

Fortunately, the absolute number of business customer cancellations for all other reasons, or those within 8x8's control, fell to its lowest level since the December 2008 quarter despite the fact that we have increased our business customer base by more than 4,700 business customers since that time. These business customers and revenue growth results were offset in the December quarter by the largest drop in residential revenue in two and one half years since the quarter ended June 30, 2007. Residential revenue decline quarter-over-quarter by $890,000, and our residential lines and service dropped to 56,547 lines at the end of the quarter.

The decline in our residential business does not appear to be slowing as our base of total residential customers gets smaller. Customers we surveyed during the December quarter that canceled residential service stated that they were leaving for lower price offers from bundled residential voice data and video service providers and free international call offerings from a competitive residential voice over IP service provider.

None of our survey customers indicated they were leaving due to any issues with the quality or feature set of our residential service and only an insignificant number of customers were leaving because they were cutting their residential wireline cord completely and going purely to a mobile phone provider.

We confirmed that the residential voice exodus was driven purely by price, which we are not interested in competing with given the unique, higher-margin, and sticky business customer services that accounted for 79% of our total revenue for the December quarter. These higher-margin services should only be buoyed by our announcements last week.

Last week we greatly enhanced the functionality of our small business offerings and rounded out the competitiveness of our distributed enterprise offerings to larger businesses by introducing a full suite of hosted mobile unified communication offerings under the Virtual Office PRO brand. Together with the high-definition, or HD, voice service that we announced earlier this month, the 8x8 business phone service experience is now going beyond a simple replacement for a PBX or business phone system. We are now offering a better, more productive environment for our customers' business communication needs. We are taking the functionality of business phones to new places with higher-fidelity voice and mobile access via any Web browser, iPhone, or iPod touch and making our business services easier and more productive to use with the new unified communication services.

Using 8x8's IP phones with Virtual Office Pro is as simple as pointing and clicking in any Web browser or iPhone, much like reading or sending e-mail or using a social network to communicate. Virtual Office Pro is bundled with a Web calling platform. The 8x8 Virtual Office app for the iPhone, voice mail, chat, fax, 8x8's Virtual Meeting Web conferencing service, which now supports video of Web participants, as well as remote desktop control for Help Desk or collaboration applications.

It also supports call recording with online archiving and integration with other Web, data, and hosted applications such as Facebook. Our new Virtual Office Pro unified communication services make the 8x8 business phones a quicker and more productive tool for any business user. I have personally been using the new service as a beta tester for several months before the product launched, and I can tell you that it has greatly increased my phone productivity. I use my 8x8 phone service more often now because it is available on the iPhone in my pocket or in any Web window on my laptop.

Also, accessing another person or my voice mails or my call recordings or faxes or virtual meetings from any location, whether it is from my desk phone, my laptop, or my iPhone, is now a simple point-and-click or touch away with the new directory services and user interface provided by Virtual Office Pro.

With the launch of our initial suite of unified communication services, we are now pursuing separate technology roadmaps tailored specifically to enhance our small business offerings and our distributed enterprise offerings for larger customers. Many of these new services are software-based applications with functionality that we expect will increase our total monthly ARPU per business customer, as well as the margin contribution for each business customer line.

We launched our Virtual Office Pro service at a bundled price of $49.99 per month, which includes an unlimited virtual office phone extension. We look forward to updating you next quarter on our progress with these new services.

Lastly, I wanted to update you on the status of our first government contract implementation at the Federal Maritime Commission in Washington, D.C. All of our equipment was installed in December, and a cutover of all of FMC's contracted telephone numbers occurred in January 14th. The installation and training went smoothly, and FMC's Washington office is now fully up and running on the 8x8 Virtual Office Enterprise platform.

FMC also happens to be the very first customer of our next-generation IP phone, which includes a gigabit network interface and some other exciting new capabilities.

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

Thank you, Bryan. Our revenue from business customers was in line with our internal forecast. But, as Bryan mentioned, our revenue from residential customers was significantly below our expectation. As we stated in our October call, we increased the equipment subsidy and advertising spend to attract new business customers in the third quarter compared to the second quarter. This resulted in 275 more net new customers added in the third quarter compared to the second quarter.

In the fourth quarter, we intend to keep the equipment pricing and subsidies consistent with the third quarter. We ended December with 19,407 business customers.

Gross margin was 68% in the third quarter with service margins at 78% and product margins at negative 59%. Service margins are at an all-time high since revenue from business customers continues to be a greater percentage of our revenue.

We ended December with 75 quota-carrying sales executives on our salesforce compared to 56 quota-carrying sales executives on December 31 of 2008. Services sold per new business customer continued to be strong at 9.5 compared to 7.4 in the same period a year ago. The average number of services per business customer for our entire customer base was 7.3 in the December quarter compared to 6.6 in the same period a year ago.

We are seeing continued adoption of our services by businesses that are larger than our historical norm. Business service growth and contribution margins remain strong at 82% and 64%, respectively. Cost of acquisition was $749 per business customer in the December quarter compared to $933 in the same period last year.

Cost of acquisitions in the first and second quarter of fiscal 2010 was $638. 55% of the increase in cost of acquisitions from the second quarter to third quarter relates to increased subsidy, 31% is due to increased marketing expense, and the remaining 14% is due to a $38,000 write-off of legacy inventory associated with our talking services.

The Company's $1 million of net income includes reductions from operating results as $70,000 of stock compensation and a $255,000 noncash expense to account for the change in the 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 $236,000.

Capital expenditures for the third quarter were $269,000, just 1.7% of revenue. Approximately $125,000, or 0.8% of revenue were capital expenditures in the third quarter that were related to the relocation of our corporate headquarters.

Working capital increased to $10.5 million from $7.4 million on March 31 of 2009, and stockholders' equity increased from $12.1 million -- or -- increased to $12.1 million from $9 million on March 31, 2009.

As of December 31, 2009, total shares outstanding were $62.9 million, and total shares fully diluted were $75 million. The warrant shares related to the $265,000 noncash expense have a strike price of $3 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 on the Event and Presentation 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 & Company.

Thank you. Could you go into some additional detail on the mobility features you are offering subscribers with who have an iPod or an iTouch or maybe even, in the future, and iPad?

Yes. So -- how are you doing, Mike? The basic idea across all of our different unified communications offerings is really to extend the functionalities that a subscriber has on their desktop business phone to the device that we are supporting the unified communications on. So as an example, this is true for whether you're using the iPhone and iPod touch applications or you're just accessing our unified communication services for a Web browser on a different platform.

You have the ability to place and receive calls, and the people you're calling will think they are either calling you at your desk phone, or it appears that you are calling them from your desk phone. You have the ability to instantly check whether or not you have any sort of messages -- whether they're voice mails, faxes, recordings of past phone calls, that sort of thing. You have the ability to change some of your configuration settings. You have more configuration options available on the Web than you do on the iPhone right now, but we're certainly increasing the capabilities of the iPhone in a release that we're readying for the near future.

And you have the ability to unify all of the experience, especially in the Web application right now in terms of being able to schedule a meeting, modify a meeting, pull up your corporate directory. So that, you know, I don't necessarily remember Dan's extension because I'm so used to just pulling up the corporate directory on my IT phone and selecting "Dan" and calling him. But on these applications, it's just as easy as I type "Dan" into a search box. All of the "Dans" in either my corporate directory or my outlook contacts are available, and I can simply click on of the phone numbers, and the application will call that person.

And there's a lot of communications tools that are out there that enable call management and the ability to change some of your configuration options. There are very few that are flash-based in a Web application. It actually enables you to place or receive the actual call right within the Web platform. And our services enable that. And on the iPhone, right now, we're limited to wi-fi hotspots due to some contractual issues that are, you know, hopefully, going to be resolved but we, certainly, in the lab, we have a version that works over 3G, and it works very well.

Okay. Do you think by the end of the year, the calendar year, 8x8 subscribers could expect to use a service without even getting an IP phone?

Yes. I think the capability really exists today, so we have mainly some call center customers that are already customers that are using a soft phone platform that we introduced two or three years ago. And so they physically don't have any phones. They just use their laptop as the telephony environment, and the -- if you look at the feature set that we have in the new Web environment that forms the base of this unified communications offering, you actually have more features than we have in the soft phone environment because fax and meeting and recordings and all sorts of other corporate and contact directories are incorporated. So today you could run your business just off of our unified communications platform.

Personally, I believe that businesses will prefer to still -- your receptionist at the front office is going to have a hard phone maybe, unless you're -- again, if you're in a call center environment, you might take a lot of calls. But I think the businesses, the vast majority of our customers today, also want to have a phone on their desk, but they also want to be able to access it and use it from a lot of other places. And so I think the trend will slide that way.

But the capability exists today and Dan, personally, put his desk phone in his drawer for the month of December and ran his office off of our UC platform. So you can certainly do that right now.

Okay, great. And then -- and it's only been a week or so, but is there any meaningful data you have from the bundle -- from the Virtual Office Pro bundle?

Yes, so we launched it one week ago, and we've actually had pretty good sales since then. We've added, roughly, 350 total accounts to the bundle, and approximately 400 mobile subscriptions, and these are all paying subscriptions.

In one week, that's good. Great, and then, Dan, so the churn is great on Virtual Office as are the takeup of accounts, but what about the subscriber acquisition cost? Is that something you expect to stay in the mid-700s? Or it's hard to tell, it depends on close rates? What do you think that's going to be, going forward?

Yes, I mean, we -- it's bounced around a little bit, and I think I've said in the past, it will be in the 600 to 800-ish range, and we expect it will be somewhere in that range. It tends that when we advertise a little bit more, there's a delay in the conversion, so you have that cost [to zonk], so we spent a little bit more and some of those sales are occurring in the month of January, months like that. But I think it will be in that range.

Okay, great. And then last question from me is regarding the residential subscribers. So do you think that you're going to see attenuation there? Or do you think it's going to just drop off at 500,000, 600,000, 700,000, 800,00 a month and be gone in 18 to 24 months?

Yes, so Dan and I have been debating that question quite a bit in the last quarter. And at the present time, we just do not see any attenuation as the base gets smaller, and it's the reason that we went out and actually surveyed these customers as they were canceling, to really understand what is the dynamic. And so I guess we could guess that in the absence of all of these unlimited international calling plans -- call India for free, call Haiti for free, $40 cellular unlimited international calling, $5 unlimited international calling, and the bundle deals -- which a lot of our customers told us they liked our service, but the cable company finally got so cheap that they just couldn't stay with 8x8 anymore. And they knew that the cable offer is only good for 12 months, and they literally said that, number one, "I'll probably be back signing up for your service again next December," and, number two, "I hope the cable service is half as good as your service has been."

And so we're just losing them due to price and we've made the decision that we're not going to chase them because of price just to preserve the revenue. And so if you just do a straight line on the absolute number we lost on the revenue, I think, in four quarters you would say that revenue is zero. I actually think it will be more like 6, 7, or 8 quarters from now, it could be at or near zero.

But I think it's still an open question over whether it levels off here at some point, and net adds equals net declines. But we have just not seen the attenuation yet, Mike, which is why we spent so much time kind of explaining the dynamic on the call, because it caught us off guard, as well, this quarter.

(Operator Instructions) Brian Horey, Aurelian.

Thanks for taking my question. I'm wondering, on the Virtual Office margins, when you've had a nice contribution and service margin now, it's been pretty steady for the last four quarters or so. Do you guys feel like you're kind of at the optimal range there, or do you think there's some more juice to be squeezed out of the orange?

Yes, we've been in the 82% service margin and 63% and 64% contribution margin for quite some time. If we get the traction that we've had in the last week on this unified communication solution, it's an extremely high-margin product in excess of 82% margin. And it's just layering on top of an existing revenue stream or new revenue streams coming in that in terms of new customers, we could get some margin expansion there. But I would say that, at the moment, it's still a little bit too early to tell.

Okay. And then on the churn, I mean, you guys have done a great job of bringing that down over the last year, year and a half, in terms of the non-economic. Do you think that there is more opportunity there? Or do you guys think you're kind of getting close to the limit in terms of where you can push that?

There is definitely more opportunity for us to do a better job at retaining customers. So I think that, presuming that the economic churn stays constant or actually improves, you know, we definitely could improve churn.

Okay. And is there any color you can add to the -- in terms of the economic churn, in terms of region of the country, size of account, vertical market, that stand out?

Well, on size of account, it's typically in our smaller customers. So people that have three or less services from us represent a substantial portion of the cancellations. So it's definitely on the smaller side.

On the verticals -- we don't really have huge concentrations in verticals. We are pretty much -- just been small business across the board. But if you look at it, we have a higher percentage of cancellations today in the real estate sector from title companies, just all of the businesses that are associated with real estate continue to be impacted. On the flip side of that, some of our new customers are in the debt collection and debt restructuring side of the business. And so that's where we see from a vertical segment.

And then on the geographic side, it's pretty much across the country, but we definitely see concentration heavier in areas like Ohio, Detroit area, and some of those locations, yeah.

Okay.

So I think it's fairly comparable to, like, nationwide unemployment rate. I was going to say, if you overlay unemployment percentages, it will probably match pretty well with our churn rates.

Okay. You mentioned FMC getting turned up. Can you comment on other trends in the larger account area and what you're seeing there and, you know, are there any particular verticals there that stick out? And also whether you've tweaked your selling process in some fashion to go after that opportunity?

Brian, this is Bryan. I don't know that it's really a vertical, but the application that we do very well with is if the enterprise has their workforce distributed into multiple locations. And, quite frankly, the more locations the better for us from a competitive standpoint. The competitors are different, so every account is basically we're bidding against either Cisco or Avaya or both. And it's just Cisco and Avaya all day long. And the reason our services are designed for a distributed environment, they're plug-and-play. We can walk into an executive meeting and plug a phone in and actually demonstrate the phone live and leave it with the decision-maker. And what we're finding is neither of those competitors I mentioned seem to be able to do that very easily. And so they can actually try a live phone versus listening or watching a PowerPoint about what the other companies' phones might do.

On price, if there seems to be a trend that these large deals are just focused on the up front capital expenditure that's going to be required to buy one of those two competitors' equipment. And they seem to have no idea about what the ongoing monthly operating costs of getting dial tone and long distance and maintenance and software upgrades and training and all the other things that go into the total cost of ownership of a phone system. And I don't have a real hard rule of thumb, but I can tell you, in the accounts I've been personally involved with, you know, for the most part, we can provide all of the equipment that the large distributed enterprise needs to buy from us, as well as between three and five years of all-in phone service for a lot less than the up-front capital cost that those two competitors are quoting just to buy their phones and the associated equipment.

And so, from a price perspective, I think we have a significant amount of leverage there. We do have a different group of people within the Company that are focused on these accounts. It's a very small team right now. It's an ad hoc team, so Dan and I are both contributing some time to these efforts while we're still trying to bring in full-time resources to displace us.

It looks like our ROI in terms of getting the payback back from the customer, our service margins and so forth, are all very consistent with servicing the smaller customers. So we're very optimistic about the opportunity there, because it looks like the numbers work very well for us.

Okay. Just two other questions -- Dan, you mentioned on the account acquisition costs, there were three factors, and one was marketing cost, and the other was a writeoff. What was the first one, I missed it?

Okay, so the first one was related to the increased subsidy, it was 55% of (inaudible).

Got it. Okay, and then the last question -- I realize you haven't been selling the unified package that long, but can you give us some guesstimate as to what the penetration rate do you think that will be on new sales?

I don't think that we know yet what it will be, but the early indications where it was in the neighborhood of 15% of new business coming in the door, and (inaudible), obviously, were upselling our existing base as well.

I think it's real tough on seven days of data, Brian, to really (inaudible). So that's very preliminary.

Got it.

But I would say that this is a product that has been very well received by our sales team, and they are -- it's priced right, it's very feature-rich, and they are very happy and excited about it.

Is it skewing to any particular kind of customer in terms of size or vertical or anything like that that you can tell?

No, no.

(Operator Instructions) J.D. Abouchar, GRT Capital.

Hi, a couple of questions for you guys. The first one was, we've done a great job on bringing the churn down after the 30-day trial period. What efforts are we doing on that 30-day trial period on the installation to get a higher take rate, because, obviously, that is a huge benefit if we can get that number down as well.

What we're doing now is we're doing a lot more work on pre-qualifying the customer, making sure that when the sale is booked, the customer that definitely we can install and will be successfully deployed. And then once they actually become a customer, we spend approximately an hour on the telephone with the customer at a later date, typically, a few days later, going through an hour install with the customer.

And we've been doing this in earnest for a little over a year, and we've refined it a lot. It's getting a lot smoother, and it's -- in excess of 80% of our customers are going through this. And so I think that, to bring the 30-day cancellation figure down is just a combination of the factors, just doing them a little bit better will result in continued reduction in the number of customers or percentage of customers that cancel within the first 30 days.

What is the typical reasons they do cancel? Is there any one factor?

In the first 30 days, it's very --

(inaudible).

No, they're just distributed for wide variety of different reasons.

Okay. Then you talked a little bit about taking the unified messaging back -- the new product back to the existing customer base, which you could talk a little bit more generally about, sort of, upselling all of the newer services back to the existing sub-base.

Yes, so we have -- our sales team has just been recently reorganized into two separate groups. One group is a group who closes new business. And so when we have sales opportunities coming in the door, they are closing companies who have not done business with us before.

And then our other side of our sales group is called our account manager group. And these are people that have a group of accounts that are existing customers, and they nurture these accounts, and call them and start building relationships with these customers, and work on upselling our additional products as add-ons to existing physical telephone lines or if the business is expanding by adding employees or adding another location, they work with the customer from that standpoint.

So we have a dedicated team in place that is working this upsale process and getting referrals.

Great, thank you.

And there are no further questions at this time. I'd like to turn the conference back over to management for any closing comments.

Okay. Thank you, Anthony. Thank you, everybody, for dialing into our call today and listening. We appreciate the ongoing interest in our company. If you are not already a customer, and you want to try some of these new services that we talked about today, I encourage you to sign up today. You can call us at the number that's on our website or order right through the website, www.8x8.com. Go ahead, Anthony.

Thank you. Ladies and gentlemen, this does conclude today's conference call. We thank you for your participation.