8x8 Inc (EGHT) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the 8x8, Inc. Fiscal Year Third Quarter 2011 Earnings Call. (Operator Instructions.) And now, I'd like to turn the call over to Joan Citelli, 8x8's Director of Corporate Communications. Please begin.

Thank you, Operator, and welcome, everyone, to our call. Today, I am 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, 2010. If you have not yet seen today's financial results, the press release is available on the Investors 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 reflect 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 Factors 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 again, with that, I will turn the call over to Bryan Martin, Chief Executive Officer and Chairman of the Board of 8x8.

Thank you, Joan, and good afternoon, everyone. I'm going to provide an overview of the quarter, and then update you on several accomplishments and programs that made significant progress during the quarter. Dan will then provide a detailed snapshot of our financials and their trends. After that, we'll open the line for any questions you may have.

8x8's business services continued to grow in the third quarter of fiscal year 2011, which ended December 31, 2010. Revenue for the quarter totaled $17.8 million, a 2% sequential quarter-over-quarter increase and 12% increase year-over-year. This revenue number again established a new high for quarterly revenue in the history of the Company. Net income was $1.5 million, or $0.02 per share for the quarter, a decline of $473,000 compared to September, due primarily to a $625,000 charge that was accrued due to the settlement of a wage in our class action lawsuit that the Company announced on November 12. The Company expects that no additional expenses will be incurred related to this matter. Excluding the one-time charge, the Company generated $0.03 in EPS for our third fiscal quarter.

Most of our operating metrics were at comparable or better levels to those that were reported in the September quarter. During the December quarter, we added 1,084 net new business customers who purchased on average 10.5 lines and services from us. Over our entire customer base, our average number of lines and services per business customer increased to 7.8 from 7.3 lines and services a year ago and from 7.7 in the September quarter. Average revenue per business customer was flat sequentially versus September at $209 per month, as was our business customer churn of 2.2%.

New monthly recurring revenue booked during the quarter totaled $535,000, consisting of 90% from our business voice direct sales team, 6% from our managed hosting sales team, and 3% from our enterprise and government sales team. The balance of new recurring revenue sold during the quarter resulted from customer up-sells on our website.

Cash, cash equivalents, and short term investments peaked at levels not seen since fiscal 2006 at $20.5 million, or approximately $0.32 per share, as the Company received approximately $2.3 million of cash generated from warrant and stock option exercises. 293,281 shares of the $3 investor warrants that expired on December 19, 2010 were exercised, bringing in $879,843 of cash. The remaining 1,492,433 warrant shares expired unexercised.

During the December quarter, the Company also repurchased 539,159 shares of EGHT stock on the open market at a total cost of approximately $1.24 million. Between January 1 and January 25, 2011, the Company repurchased an additional 818,537 shares at a total cost of $2,223,990.

Now, I'd like to provide some updates on ongoing technology and business programs. Throughout the December quarter, we have continued to see the benefits of our previously launched Simple Activation software and provisioning to simplify and accelerate our service implementation process. For several months now, the abandon rate of business customer calls into our call centers has essentially been 0% with an average time to answer those calls of less than five seconds. We have seen initial customer satisfaction rates increase, and quicker and more productive installation calls with all of our new customers. We believe this is reflected in the continued all time low churn rates we reported this quarter.

During the December quarter, we launched two new customer centric updates to our services that accomplish two key initiatives. First, we enhanced, simplified, and automated the local number porting process our customers must complete in order to move existing phone numbers onto our services. Second, we allowed small business customers with fewer than five extensions to place their orders directly on our website without speaking to an 8x8 salesperson. This new ordering process would not have been possible without the previous enhancements we have made to the provisioning processes in our services.

We have also identified additional processes in our offerings that are being simplified and enhanced in order to benefit our customers. During the first half of this year, we expect to complete much of the work on streamlining and redefining the administrative web portal, which is used to globally manage a business customer's entire set of services from 8x8. With this new administrative portal, customers will have even greater control and reporting capabilities for their overall phone system organized in a new easy to understand web interface.

We expect this enhancement when launched midyear will reduce our maintenance and support calls further along with churn, and also allow us to more easily up-sell additional services to our existing customer base. It will also give the business owner or office manager greater control and visibility of their overall phone system with easy controls to make both global and individual extension level changes to the phone system and associated services they buy from 8x8.

The next topic I'd like to address is our new partnership with Polycom and the successful production ramp with their IP desk and conference phones we accomplished during the December quarter. We started selling one model of Polycom IP phone on October 12 and added two additional IP phones and a conference phone on November 9. Through December 31, we sold more than 8,600 Polycom devices to customers and have received nothing but positive feedback from these customers.

Dan will cover the details around the product revenue and margins that we are seeing with this new mix in just a moment. But I want to say overall that we are very pleased with the results of this production ramp and are excited to be collaborating with Polycom on supporting additional devices and service offerings that will be rolled out in calendar 2011.

We are also working with Polycom's federal sales team in Herndon, Virginia to supplement their sales of Polycom IP communications equipment with 8x8 hosted services to government customers.

The next update is that on December 22 we announced that we had hired a new government sales executive based in Washington, D.C. who is focused on expanding opportunities for the deployment of our hosted voice and cloud computing solutions with federal, state, and local government agencies. The data center space that we announced on September 29 is fully functioning with new customers and services running out of that facility on the East Coast. During the month of December we won a third government contract with a federal agency for our managed hosting services and have already provisioned and turned up these services this month.

Finally, during December, 8x8's referral program for new customers crossed the $1 million mark in total referral fees paid out by the Company. The millionth dollar referral was paid out to Nervus Consulting, LLC, who referred a three-line business and generated a $300 referral fee. To express our appreciation, the Company tripled Nervus' referral fee in honor of the event. We signed up more than 200 new business customer referrals during the month of December and are very pleased to see our improvements in customer churn, customer satisfaction, and loyalty translating into these referral results.

With that, I'm going to 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. Total revenue for the nine-month period ended December 31, 2010 was $52 million, an increase of 9% compared to revenue of $47.5 million for the same period of fiscal 2010. Net income for the nine-month period ended December 31, 2010 was $4.5 million, an increase of 62% compared to net income of $2.8 million for the same period of fiscal 2010. This is the 12th out of the past 13 quarters that we have generated net income.

Gross margin was 68% in the third fiscal quarter with service margins of 77% and product margins of negative 65%. When we added Polycom phones to our product mix in the quarter, we found that the most popular Polycom IP phone was the entry-level Polycom telephone. In the past, when we were only selling telephones from one manufacturer, our most popular telephone was our midrange phone. The primary reason for this is the entry-level Polycom telephone is a very good telephone that is feature rich, including high definition audio and a full duplex speakerphone and meets the need of a majority of our customers.

With more than half of our telephone sales in the quarter being this entry-level telephone model, it resulted in lower revenue per phone and a reduction in product revenue, compared to the second quarter of 2011 and the same period a year ago.

Product revenue represented 6% of our total revenue in the December quarter, compared to 7% in the September quarter and 8% in the same quarter a year ago. Product margins declined to negative 65% in the December quarter, compared to negative 57% in the September quarter, although the absolute dollar loss on product sales declined by $9,000 sequentially. We expect this mix of more than half of our phone sales being the entry level phones to continue and may result in lower product revenue in the fourth quarter of 2011 as it will be the first full quarter marketing the Polycom phones.

Sequentially, cost of acquisition per new business customer declined to $768 from $826 in the September quarter. Cost of acquisition declined sequentially, primarily due to an increase in the close rate of our sales that resulted in advertising representing a smaller portion of our cost of acquisition in the December quarter. The close rate increased due to the addition of Polycom telephones to our product mix and the promotional pricing on the entry level telephone.

Average monthly service revenue per business customer was $209 in the December quarter, up from $204 in the December 2009 quarter. Our advertising expenditures totaled $1.3 million for the quarter versus $1.3 million in the prior quarter and $1.3 million in the same quarter a year ago. The Company's $1.5 million of net income for the quarter includes a $99,000 stock compensation expense and depreciation and amortization of $361,000.

Capital expenditures for the quarter were $811,000. Capital expenditures were 4.6% of revenue, which is significantly more than our historical spend. Approximately $320,000 of the capital expenditure is a one-time expenditure related to bringing up our new East Coast data center, and approximately $25,000 is a one-time expenditure related to bringing up our new managed hosting data center in Santa Clara, California.

In the third quarter and the nine-month period ended December 31, 2010, 8x8 generated $2.7 million and $7 million of net cash from operating activities. In the nine-month period ended December 31, 2009, the Company generated $1.5 million of net cash from operating activity.

As of December 31, 2010, total shares outstanding were 63.3 million, compared to 62.6 million at September 30, 2010. There were approximately 8 million unexercised stock options and unvested stock awards as of December 31, 2010, compared to 9.8 million at September 30, 2010. During the December quarter, 924,000 stock options were exercised, 503,000 stock options were canceled or expired, 144,000 stock options were repurchased by the Company, and 108,000 stock awards were canceled. The 924,000 stock option exercises generated $1.4 million of cash invested into the Company.

The Company's fully diluted share count, including shares outstanding, unexercised stock options, unvested stock awards as of December 31, 2010 was approximately 71 million shares, compared with a peak of 82 million shares at September 30, 2008. The 82 million fully diluted share count as of September 30, 2008 includes shares outstanding, unexercised stock options and warrants. As of December 31, 2010, the Company did not have any warrants outstanding.

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

Okay. Thank you, Dan. I knew we threw a lot of numbers in there, so for your reference and convenience we have posted a transcript of Dan and my prepared remarks on the Events and Presentations section of 8x8's website at Investors.8x8.com.

This quarter we have a Midwest Road Show in Detroit, Milwaukee, and Chicago scheduled for the week of February 7 and we will be presenting at the Northland Capital Markets Growth Conference in New York City on March 3 and at the Wedbush Securities Technology Media and Telecommunications Conference in New York City on March 9. We will also be sponsoring and attending Team Polycom, which is Polycom's annual conference for their worldwide staff and channel partners, which will be held the first week of April. We look forward to seeing you at one of these events.

So with that, we'll be happy to take any questions. Operator, if you can please open the lines.

Thank you. (Operator Instructions.) Our first question is from Mike Latimore of Northland Securities. Your line is open.

Mike?

Hello.

Hi.

One moment, sir.

Can you hear me?

I can hear you now.

Mr. Latimore, your line is open.

Great. Just on the churn, you guys are at stable, you're doing more work to improve that over time. Is -- well, what's your general view? Do you think we're kind of at the bottom where churn is, or can you continue to improve that?

So, Mike, this is Bryan and I think we've gone into a phase here where we're definitely seeing the positive feedback and results from the improvements that we've been rolling into the services and everything from how we sell the services on the front end to how we get them installed, and then some of these other processes that I described. And we're very excited that we've been able to kind of translate the work that you do upfront into meaningful improvements. And the churn rate I think reflects it. But we track some of these internal customer satisfaction studies and so forth and we see constant improvement there. So again, I -- we're not providing forward-looking guidance, but I would say we're very optimistic that we can continue to improve this churn as we go through calendar 2011.

Okay, great. And your gross subscribers and net adds are very strong again in the quarter. What -- just kind of as you look -- as you think about your strategy, marketing, and advertising sales strategy over the next 12 months, are there any kind of key initiatives that we should think about there?

Yes, there are. Number one, I think our sales team is executing quite well and we're just very aggressively and very efficiently converting the leads that we've been presenting into that group. And the leads didn't really grow, but I think we're just converting a few more of them. We have initiatives in place that we're going to be rolling out in the next quarter around some of our unified communication offers that we think will broaden the appeal of that product line and broaden the available market there.

And then, we continue to be very optimistic about the growth in our enterprise sales, our government sales as part of that, as well as the sales on the managed hosting and cloud computing side of the house. There's still very small numbers of our total new revenue that we bring in. I think I said 90% of our sales were through the direct sales team.

But if you look back just a few years ago, our direct sales team was this sort of size and doing kind of this sort of magnitude of numbers. So we're very optimistic again that in the next one to two years we should be able to grow the sales contribution from enterprise and managed hosting quite meaningfully.

All right. And can you -- how do you see the -- kind of the pricing environment there -- out there overall? Is there -- I know you're adding more services with UC and so forth, but anything different in the quarter from a pricing competitive standpoint?

I don't think so. We do a lot of aggressive promotions. We do it every year from Thanksgiving to the end of the year just because it's that much harder to kind of stay on top of an office manager's list of things to finish before they head out for the holidays. But I don't think we really did anything different or more aggressive. We did talk about the appeal that the entry level Polycom phone is kind of seeing across the board. And I think certainly having that brand associated with our service has been something that's made it easier to sell. But we really haven't from a competitive standpoint seen anything different.

And the good news for us is that the incumbents that are out there continue to raise their prices every six months. I know I got notices from my cable companies and the company uses AT&T fiber here, and those prices continue to appreciate, which I think helps our competitive position with the relative cost of our services.

Great. And just a last question. On CapEx, what -- it's kind of sort of 400,000 or so a quarter. Is that a reasonable run rate?

Yes. I think anywhere in the $400,000 to $500,000 range is a pretty reasonable figure.

Okay, great. Thanks a lot.

Okay. Thanks, Mike.

Thank you, sir. (Operator Instructions.) The next question is from Mike Crawford of B. Riley and Company. Your line is open, sir.

Can you hear me?

I can hear you, Mike.

All right. So the service revenues I think were stronger than expected. And you see the greater discount on your endpoints, which to me seems to point to the fact that you guys are subsidizing your phones by closing more of the leads that are coming in. So I'm wondering if you are able to tie that correlation together any better or if there were any changes during the quarter that affected the way that all played out?

Yes. So we started to -- as Bryan just mentioned, in the mid-November timeframe started to more aggressively price the entry level Polycom phone. And it had a material improvement in our close rate, which is just defined as number of new customers booked divided by the total number of leads that we get in. And so, we have been running at close rates kind of in the mid-teens. And since we made that change our close rates increased in the November and December timeframe to kind of the upper teens percentage. And so, that had a -- that was the primary driver in the reduction in our cost of acquisition, because our advertising related expense, which is effectively a sunk cost became a lower percentage of overall cost of acquisition expense.

Right. So I mean, the net result was that you had the largest net increase in business customers of the year and the lowest subscriber acquisition costs of the year. So given now that you can -- I presume there is no reason you would discontinue this practice since it seems to be quite effective. But given that you're doing that now, isn't it fair to assume that there's still -- there is room for further reduction in that SAC in following quarters?

I think that it's -- possibly. It's kind of hard to comment. I mean, because if you look at the absolute dollar amount of the range that we've been in over the past couple of years it's -- I don't think that the range has been more than $200 and we've kind of been in a range of plus or minus $50 for quite some time. But I mean, we definitely are seeing that since we added the Polycom product line that even though we're seeing a lower percentage standpoint of product margin, we actually saw less subsidy.

So if you look at our Q2 numbers, our subsidy was a little over $730,000 and if you look at our total subsidy in the third quarter, it was a little under $730,000. So the percentage worsened, but the absolute subsidy was $9,000 less, which has been reflected in reducing cost of acquisition. So presumably, if we have a full quarter of Polycom sales, it could result in lower cost of acquisition.

Okay, Dan. Thanks. And then, maybe I'll try it a different way. So if your close rate had been in the mid-teens and now it's the upper teens, does that mean that it might be worth increasing the net that you're casting in terms of [paid]surge referrals, partner programs, to get more of these in, since you know -- you have a pretty good sense that you might be closing more of them, so it's now economic to cast a wider net?

So the challenge that we've had for a long, long time on growing the overall lead base is -- I'll just give you an example -- is search engine marketing, which is predominantly Google, is that when we increase our spend it results in a few more leads. But those leads end up costing a tremendous amount of money and we never make money on those.

So our challenge has been kind of getting out of this range of -- we've been in a range from like 4,500 to 6,000 leads or 6,500 leads for a long, long time. And anytime we've increased the advertising expense in specific periods based upon any type of additional advertising or doubling down on various things, the next portion of leads costs a tremendous amount of money and have resulted in I would say significant increases in the cost of acquisition.

So I think -- Mike, this is Bryan. I think that the way we're thinking about it is we're -- if suddenly magically we can increase leads and cast a wider net, as you're saying, with what we've done on the just kind of basic voice services, obviously we'll do that.

But I think where we see the opportunity to meaningfully grow the net is doing a little more marketing and getting a little more aggressive on some of these what we call unified communications or virtual office pro services, and then certainly continuing the growth in the small success we've gotten so far out of the enterprise side and the managed hosting.

But that's kind of the battle. It's -- we can't just pull out our wallet and magically have another 1,000 qualified leads per month rolling in the door, at least, historically have not been able to do that. But we do think that the conversion -- that the kind of conversion metrics that we've discussed and the improvement we've seen there will apply directly to our efforts in some of these other areas like unified communications.

And so, Polycom is actually helping us in expanding the net a bit to some more exploratory lead generation efforts and they're facilitating in just kind of new ideas as well as financing some of these.

Okay, thanks. And then, last question relates to mix. So the virtual office or business revenue part of your business has been growing fairly consistently for several years and in fact quite impressively. Now that growth has been masked by a decline in kind of older iteration of the model where you had some of these -- this residential customer base, which I presume now is down into maybe a low single-digit millions run rate overall. But are you able to break out at all around what that level of business is now or is expected to be next year and whether indeed next year is going to be the last year of that or maybe there's just a slight tail beyond that? Because it's still partially -- I think that it's still partially masking the growth of what's really the core business.

Yes. So the residential business today it's representing approximately 10% of our total revenue. The decline on our residential base has slowed significantly. We -- a year ago we were having extremely high decline rates in our residential base, and it was predominantly driven by competitors who were offering free calling to 100 international countries or something to that effect. And the vast majority of those people have left us. And today, we're actually at a pretty decent steady base of 40,000 or so residential customers. And it is declining, but the decline rate has reduced quite a bit.

Okay, thank you.

Thank you, Mike.

Thank you. Our next question is from Brian Horey of Aurelian. Your line is open.

Hi. Thanks for taking my question. Just a few follow-up questions. Dan, was there any expenses for the warrants, kind of the mark-to-market this quarter that you've had in the past?

No. The [last six], it was actually income, but it was in the second quarter.

Okay.

I believe it was roughly $9,000.

Okay. And then, on the CapEx kind of going forward, do you guys have any thoughts about where that levels out? And I mean, is it going to be at a little bit higher level going forward given that you've got the hosting business now in the mix? Can you just give us some sense as to kind of where you think that settles out?

Yes. So prior to having this hosting business, which is more capital intensive, we were in the 1% to 2% of revenue range. And the bulk of the work of kind of moving data centers and things like that from a capital perspective has been completed. The migrations in some of these are still going on. So we do have duplicate expense there that we should be done with at the middle part of calendar 2011. But from a CapEx perspective, I would expect it to be in the 3% to 4% of revenue range.

Okay, that's helpful. And then, I was wondering if you could just give us some color on the progress that you've made on the enterprise side. How many reps are you up to? Are there any -- can you give any color on the accounts that you've signed and what the pipeline looks like? And do you think you're at the point where you've got kind of a repeatable sales process that you can measure and project and scale? Just any kind of additional color you can give on that would be helpful.

Yes. So we ended the quarter with total sales people of 67 sales people. 55 of those sales people are in our inside sales group. We have seven in our enterprise and federal group and five in our hosting division. And if you look at total revenue from our enterprise and hosting initiatives in this most recent quarter, it represented 6.8% of service revenue. And we -- in the quarter we added five new accounts on the enterprise side, which equated what we did in the second quarter. So we're --

And also up-sold to existing enterprise customers quite a bit.

Yes. So what we're seeing is the enterprise customers are in almost all instances getting bigger. So if you look at our new monthly recurring revenue coming from our enterprise efforts, roughly one-third of it was from new business that we booked and two-thirds of it was from up-sells and add-ons from our existing base. So I would characterize it right now as we're in the position to where we definitely have everything down so that we know how to provision, install, bring these customers online. And we're kind of in the mode to where we can start leaning on it and start to get some more traction on the number of gross adds per quarter.

Yes. And I would say we're also improving the cycle time of getting those customers brought into the services and making sure they're successful and satisfied on day one, which has been a significant improvement over the last 12 months from some of the enterprise accounts we brought on this time last year. So yes, I think I'm feeling good about the -- again, like I said, everything from the pre-sales to the sale process to getting the provisioning done and getting the services in, and then the relationship that we get with them from an account management position to make sure that we--our services spread within their company. So we will be leaning on it much harder, as I said in my remarks, Brian.

Okay. Can you give us a sense as to in terms of number of seats per account, at least the initial sale, what that -- the range that that tends to fall in?

Yes. It's -- there's a wide variety of kind of deployments. But a lot of them will start with just five or six phones because our services enable you to just bring a few phones in on day one and start trying our services. But I would say the initial opportunity is something in the neighborhood of anywhere from 100 to 300 or 100 to 400 seats. But then, the long-term opportunity obviously is much greater once we're successful with that initial deployment.

And do you have a sense at this point, if you bring on somebody say in January over the next six or 12 months how many seats you can kind of expect them to add on as you go through time?

Yes, I don't know if we have that off the top of our head. But I would just say that the amount of repeat business and expansion business we're getting from these accounts is very -- we think that's very positive, obviously. And we think that it just reflects that once we get in we become kind of one of their go-to suppliers when they need to add offices or employees or different types of services. So I think it's a great trend to have that.

Okay. Thanks for the color.

All right. Thanks, Brian.

Thank you. I'm showing no further questions or comments at this time. I would like to turn the call over to Mr. Bryan Martin for any closing remarks.

Okay. Thank you, Tyrone, and thank you, everybody, for joining us today. If you are not already a customer, I encourage you to sign up for any of our business services by visiting 8x8.com. And if you're interested in collecting a portion of the next $1 million in referral fees we're going to be handing out, as we said in the call and a recent press release, please join our business referral program by going to our website at 8x8.com/resources/referralprogram. With that, we will conclude today's call. Go ahead, Tyrone.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.