8x8 Inc (EGHT) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to 8x8 third quarter fiscal 2012 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference call may be recorded. I would now like to turn the conference over to Ms. Joan Citelli, Director of Corporate Communications. Ma'am, you may begin.

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 Chief Financial Officer Dan Weirich to discuss our results for 8x8's third fiscal quarter of 2012 ended December 31, 2011. 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" section of our annual report on Form 10-K and 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.

Thank you. And 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'd like to begin by providing an overview of our third quarter fiscal 2012 results which will be followed by Dan's discussion of the financial details. We will then open the lines for any questions you may have. 8x8 performed exceptionally well during the third quarter of fiscal 2012 as we continued to experience escalating demand for our cloud-based business communications and computing services.

Revenue for the December quarter was $23.3 million, a 31% increase compared to the same period last year, and our net income grew 73% year-over-year. Revenue from business customers grew 42% versus the same period last year and 21% sequentially and now represent 93% of total revenue. Cloud data services comprised 3% of total top line revenue. During the quarter, we also continued to see increased interest from larger customers ordering 25 or more services. Average services per new business customer increased to 14.1 in the December quarter, up sequentially from 12.4 in the prior quarter.

This is a trend we are very pleased to report as it underscores the competitiveness of our hosted offerings against equipment vendors and service providers who sell on-premise solutions to these larger businesses. And at the same time this increased interest infuses our customer base with businesses that are less likely to churn. New monthly recurring revenue sold in the third quarter was $756,000 compared to $641,000 last quarter and $535,000 in the same period last year. Average monthly service revenue per business customer increased during the quarter to $239 up from $207 last quarter and churn improved to a record low of 2.0% compared to 2.1% in the prior quarter.

We were also pleased to see an improvement in our product margin for the third consecutive quarter, from negative 45% in the September quarter to negative 24% in the December quarter. This is a result of our continued focus on selling higher quality, full featured IP end points at higher price points to larger customers. The ultra-small prospects or business prospects who purchased fewer than five services were most negatively impacted by this change in our product pricing strategy, but in the long run we believe this will result in a further improvement in revenue and churn as we concentrate on these larger business opportunities. The number of new gross services sold during the quarter increased from 39,514 for the September quarter to 40,057 in the December quarter, and we ended the December quarter with 27,677 business customers.

The channel program we announced in June last year continued to make progress. We ended the quarter with 54 distribution partners including three strategic telecommunications providers who were previously partnered with Contactual and are now distributing our call center services under the 8x8 brand. These partners are SaskTel, Bell Canada and CenturyLink. We also announced a new distribution partnership with AT&T Mobility on November 8 for AT&T Call International, a new service that we developed with AT&T and now operate on their behalf. Excluding AT&T Mobility customers, we closed 83 new end customer deals from channel partners in our fiscal third quarter and quarter-over-quarter new revenue sold by channel partners grew 37%. Our absolute channel numbers are still a small percentage of new sales, but the increase in revenue from these partners is encouraging and our recruitment efforts continue to gain momentum and traction with new partner prospects.

On the technology side, we announced several important new product and service launches during the quarter. We rolled out our redesigned Account Manager web portal and have received extremely positive customer feedback on the new interface, especially from our smaller customers who lack some of the internal IT expertise that is present at our larger customers. We also announced the development and launch of the Call International mobile app and service with AT&T and a new wireless deck solution for cordless enterprise telephony in conjunction with Polycom. Two weeks ago, we announced certification of our services by Cisco along with the addition of Cisco phones and hardware for small businesses. On the cloud data side, we introduced Windows Virtual servers and completed the stand-up of our Vblock service. In December, we provisioned our first cloud data customer on the Vblock infrastructure.

During the December quarter, 8x8 was awarded its 79th United States patent. We continue to believe that owning all of our software technology enables us to deliver better, more innovative services to our customers which will result in higher recurring service margins to our shareholders. 2012 appears like it will be a banner year for 8x8, as the virtualization and outsourcing of back office information technology and communications to proven service providers continues to gain popularity and it's becoming more of a best practices methodology amongst IT professionals and larger enterprises.

We intend to position ourselves at the forefront of this growth in 2012 by continuing to invest in M&A, R&D, customer support and channel development initiatives that will allow us to capitalize on these emerging opportunities with our industry leading turnkey solutions. We continue to believe that 8x8 offers the most complementary set of hosted communications and data solutions to the SME and distributed enterprise customer. With that, I'm going to conclude and I'll turn the call over to Dan Weirich, the Company's Chief Financial Officer, who will walk you through our detailed financial results and provide additional information regarding our business. Dan?

Thank you, Bryan. All of the key indicators of our business were record or near record setting this quarter. Hosted service margin remains strong at 77%, our 11th consecutive quarter with hosted service margin greater than 75%. These service margins are at the upper end of the Software as a Service universe of service margins ranges and more than 1,000 basis points greater than the highest gross margin for premise-based PBX vendors.

GAAP net income was exceptional at $2.6 million or $0.04 per share. Capital expenditures were at the bottom end of the SaaS universe range at 2.3% of revenue. Amortization, depreciation and stock compensation expenses were approximately $1.2 million in the quarter. We ended the quarter with just under $22 million in cash, cash equivalents and investments, an increase of $2.8 million for the quarter. Working capital of $13 million increased $3.3 million sequentially.

Cash flow from operating activities was strong at $3.2 million or 14% of revenue. The balance sheet was impacted in the quarter by a one-time payment of $625,000 related to a class action wage and hour lawsuit we settled in the same period a year ago and $500,000 in earn-out payment related to our June 2011 acquisition of Zerigo. These payments complete our earn-out agreement with Zerigo. Business customer average monthly revenue increased 15% to $239 sequentially. Business subscriber acquisition costs for service of $92 declined 9% sequentially and 7% compared to the same period last year.

Our reported churn was a record low of 2% with 51% of our cancellations due to business closure and economic environment reasons. Revenue churn in the quarter was 1.8%. The quarter's net income benefited from a one-time non-recurring engineering development fee of $150,000 and the relief of $161,000 accrual related to a sales and use tax audit that was resolved during the quarter. Our effective tax rate during the quarter was approximately 1.4%.

Shares outstanding as of December 31, 2011 were 69.5 million. That concludes my prepared remarks. 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 events and presentations section of 8x8's investor website at investors.8X8.com. With that, we will now be happy to take any questions you may have. Go ahead, operator.

Thank you. (Operator instructions) Our first question comes from Mike Crawford from B. Riley & Company.

Thank you from B. Riley & Company. On the channel, it seems like you're making some good progress there. What is that number of channel partners that you ended the quarter with, how does that compare with how you started the quarter?

Hi, Mike, it's Bryan. The -- we added approximately 14, we ended the September quarter with 40 and the number on this call was 54, which is including those -- the handful of strategics we picked up from Contactual plus the relationship with AT&T Mobility. Are you there, Mike? Operator?

Our next question comes from Mike Latimore from Northland Capital.

Great, thanks a lot. Very nice quarter guys.

Thank you.

Thanks, Mike.

I don't know if you're going to break this out going forward but roughly what was Contactual's contribution to the quarter?

Mike, this is Dan. We are not breaking that out for -- the primary reason is that the integration has occurred extremely quickly. We have integrated the billing systems very rapidly, and it's what's happening is that our inside sales folks have been selling the Contactual solution for many years, but after the acquisition closed we just got a lot more flexibility in pricing and feature capabilities that we could do on our direct legacy 8x8 sales side. And so those sales ramped quite a bit and those were always on our billing system. The Contactual folks have been starting to put in newer orders on the 8x8 systems, and then we have been migrating some traffic, when I say traffic, I mean like telephony revenue that was related to the Contactual customers. We have been migrating onto the 8x8 network, and so if you look at it, it -- the integration, the revenue is bundled in significantly already. And it's a figure that we've got some rough estimates but we don't have 100% actual figures as to what the revenue is, so we are just reporting it, what it is right now. We filed an 8-K on December 1 that provided all financials of Contactual through June 30 of 2011, and you have the figures as of the last two weeks of September of 2011 for Contactual, and the business is growing, it's very healthy and we are very happy with the results from it.

Great. And then how many of the 54 partners have gone through some sort of training process?

Mike, it's Bryan. I'm guessing it's about half of them. It's the typical lag we have from signing up a customer to putting them through in either an in-person or a remote webinar-based training.

And then last, obviously, really good progress on the product gross margin, how should we think about that? That can bounce around depending on product mix, obviously, but is this the new normal for product gross margin?

Yes, I think it's bounced around quite a bit over the years including, I remember one quarter when it was worse than negative 100%, and I had to ask Dan how he could possibly do that and he said free shipping. So I mean, our -- I don't know the answer. We are thinking about it as the new normal, I think that's a good way to put it. Hopefully, we will still be able to eke out some improvement, but if I were modeling it, I would flat line it around this level. And as I mentioned in our prepared remarks, it did -- we saw a reduction in sales to the fewer than five service businesses because we were pushing higher end equipment at higher average selling prices. But I don't think that's something to be concerned about, because as long as revenue is increasing it's going to result in lower churn, not having those ultra-small businesses on the service in the long run anyway. So that's how we are thinking about it. But it's still -- it's a volatile figure and until we put up two successive quarters at similar levels, let's just see where it goes.

Yes, it makes sense. Last question is what was the stock-based comp expense in the quarter?

Stock compensation was $418,000 in the quarter.

Great. Thanks a lot. Nice quarter.

Thank you, Mike.

Thank you. (Operator Instructions) Our next question comes from Mike Crawford from B. Riley & Company.

Hey, Mike.

Thank you. I was cut off. So, one, I'm glad to see the upgrade in industry expertise on the Board. Although I think there is a question whether the Contactual founder, who is now your Board member, is an independent director. Is that right? Is he allowed to sit on the audit committee or do you need to get another independent director?

Our interpretation of the rules is that he will not be independent for three years. He was drawing a small salary from Contactual which is now a wholly owned subsidiary of 8x8, so based on that interpretation of the rules and, again, I'm not a lawyer, he is not independent. We are actively recruiting, hopefully, some new additions to the Board that we will announce shortly.

Okay, great. Thank you. And then also in your prepared remarks you did mention that 79th patent that issued in the quarter, and I know you're a member of the Ocean Tomo 300, I'm just wondering if you've done any independent third-party analyses of what your IP portfolio might be worth or what might be the most valuable families within that portfolio, or if you can comment on such?

Yes, I think that's a good question, Mike. I mean, we have not commissioned any independent evaluations, but I think we have a pretty good idea. A large segment of the issued patents date from the era when 8x8 was primarily a video processing company and a lot of the video standard development that was invented here still resides in some of the compression and transport algorithms that are used on the modern entertainment and Internet video delivery mechanisms that are out there. And so I think the closest idea to an independent analysis we have is external interest that we have received over the years on some of that portfolio. We continue to have discussions around ways to monetize or add that to the balance sheet but, again, it just hasn't been a real focus of ours, but the interest is definitely out there.

But having said that, the patents that are issuing now to the Company are directly in line with our current business. Most of them are patents that we filed between 2002 and 2003 that have finally wound their way through the halls of the US PTO and they are finally coming out and issuing to us. I just got notice yesterday that another patent should issue in the spring and, again, that's one that has been just sitting there, from my point of view, doing nothing for many years and, again, we finally got it through the process. So I think right now we have more than a dozen of our patents that directly relate to the day-to-day business the Company is doing. We acquired one patent with the acquisition of Contactual, as well, and their engineering force. We are working on additional filings now that they have the resources to do that. So it continues to be a very core strategic focus of ours to work on the patents and protect what we are doing and, again, down the road I don't preclude that we could turn them into a hard asset on the balance sheet, but it's not our number one priority around here.

Okay, thank you. And then last question, back to the current business, I know you don't guide, but if revenues or account activity would continue to layer in as it has done for the past several years fairly consistently on the business side, I'm wondering if you can comment at all about the operating leverage in the business? What might happen to decisions you might make regarding R&D and how SG&A might be affected in that steady state increase environment?

Yes. So I think as you can see in the quarter that we just announced, that we definitely had pretty meaningful improvement in our operating margins relative to almost all the quarters in the last two years or so. If you look at our R&D spend and our SG&A spend relative to some of the models out there, it was a little bit higher than our actual figures, a little bit higher than the consensus figures on this, and we intend to continue to spend at or above those levels. And if you look on our website today, we are looking to hire a lot of people and the primary thing that we are seeing is that the market is starting to move our way. It's very early and as you can see in the significant increase in the new recurring revenue that we signed up during the quarter relative to the September quarter, as well as the year-ago quarter, that it moved up very nicely and we are going to be investing in growing more aggressively. So, therefore, you'll probably see a little bit of pressure on the operating income as a percentage of revenue, primarily because we are going to invest more in growth.

Okay. Thank you very much.

Thanks, Mike. We didn't cut you off either, just for the record.

Thank you. Our next question comes from George Sutton from Craig-Hallum.

Hi, guys. I wanted to understand the success you're seeing going into a larger and larger customer base. How much of that is driven by Contactual and can you summarize in a few bullets what's driving that improvement?

Yes, hi, George, thanks for dialing into the call. We've begun segmenting the -- what we call the larger or enterprise, distributed enterprise customer, 25 and greater number of services subscribed to. I would say virtually all of Contactual's existing customers when we acquired them, which is about 250 businesses, were of that size or in that category. And so I think Contactual has obviously contributed, their sales team had deals in the pipeline that closed this quarter, but I also see across the board on 8x8's existing services a lot of interest there. And just to give you some examples of wins we saw during the quarter, we signed up Yale University, we signed up CB Richard Ellis, Ball State University, Virco, which is a large school furniture company in two locations, one in LA, one in Conway, Arkansas, Brightcove, the Los Angeles Economic Development Council, the Foundation for California Community Colleges, Cogswell College, which is a local professional night school here in Silicon Valley, as well as the New York Health Club. So with names like these, you can see that we are really beginning to penetrate into businesses that would have historically adopted an on-premise hardware approach and these large organizations are openly embracing a software-based, cloud services approach to fulfilling their communications needs, and we are anticipating continued success at signing these types of customers up, both through our direct efforts, our inside sales team, as well as the new channel partners that are coming on board.

I will guess that's the first time Yale University, Ball State and Cogswell College have been on the same list.

(laughter) There's definitely an education vertical. There's a lot of K-12 requests that, because of the different funding mechanisms that both the federal and local governments are making available, there's a lot of school systems out looking to upgrade their ancient or aging [phone] systems, so we are seeing a lot of interest from that sector.

Can you give us a relative sense of the importance around the Cisco certification? What does that mean for you?

Well, again, number one, our focus is providing the best possible customer experience that we can and certainly the IP telephone, or in some cases IP video endpoint that's sitting on the desk is how an end user is interacting with our services. The Cisco certification, and we have rolled out Cisco phones across the board, both in our Channel partners as well as our inside sales force. They have some really nice new IP endpoints that have some unique capabilities around how the devices interact with Bluetooth appliances and Wi-Fi networks and things like that. So we've added some of those features to the feature set. Cisco obviously has a huge installed base and so there are customers that have Cisco installed and they want to continue deploying Cisco at the endpoint level and so we are now able to accommodate those requests. We also have channel partners that have joined up with us who are pretty much exclusively Cisco oriented shops and they are requesting to continue that relationship, as well. So I think it's significant. It took a lot of work to get certified. Cisco, I think, can open up a lot of doors in a number of different ways and we are glad to be a partner with them on the small business side.

Okay. Lastly for me, Dan, you mentioned, quote, the market is starting to move our way and I'm wondering, are you referring to that on a macro level or are you -- is that a VoIP specific or a cloud specific discussion point? Just curious exactly what you mean there?

When I say that, I'm just meaning twofold. One is that if you look at the average number of services across our whole bay that we are selling to customers, from the low point a few years ago to today, it's up almost 50%, so the size of our customers is getting to be a lot bigger. The brand of our customers are starting to get to be a lot bigger. So businesses of all shapes and sizes are getting much more comfortable and are jumping off old traditional systems onto cloud-based systems such as ours. And we are also seeing a lot of momentum on the federal government side. If you look on our website, we have a new presentation up there, and we have some new logos on there, and there are some pretty big names on those logos.

Perfect.

That's kind of what I mean, is that you hear the President of the United States is talking about the government needs to move toward the cloud and there definitely is a push and there definitely is action once it flushes through the organization.

Got you, perfect. Thank you.

Thank you. (Operator Instructions) Our next question comes from Patrick Lin from Primarius Capital.

Hi, guys, congratulations on the quarter. I want to especially highlight that six months ago I asked you when you guys are going to start seeing the inflection point in the flow-through to the bottom line and you said that it would be the end of the year or about six months lag. So I just applaud you for keeping your word in following through on that, and congratulations for the team. I wanted to ask you, in terms of your visibility and confidence level looking at 2012, given what's happened the last six months, can you talk a little bit about what it looks like from your dashboard and what's driving this and what you're most excited about relative to six months ago and a year ago, please?

Yes, thanks for the comments, Patrick. I think what we are seeing is across the board adoption of these services. If you go back a few years, it was the leading edge or the small business owner who was comfortable setting up their own internal networks and servers and they were the ones that were adopting these solutions. There's still a very extremely small penetration rate of IP communication access lines in the US business market, so I think we are still -- I don't think we have declared victory and think we are at an automatic tipping point. But I think the increased interest, the better knowledge of cloud concepts across the board. In my prepared remarks, I talked about how this is starting to become -- you're starting to see the white papers that encourage IT professionals to look to outsource these types of back office technologies to the cloud. And 8x8 is, obviously, a proven provider both in communications and as we get more air under our wings in the cloud data space. We are delivering similar results, enterprise class services in the cloud data space.

So I think the specific comment you're referencing about the second half of this fiscal year was we kept -- we were asked after we signed our first channel partner on April 29 what do you think we will see results from the channel program, and my comment was we don't think you're going to see anything we can quantify until the second half of fiscal 2012 and so this is the third quarter of fiscal 2012. We were able to quantify some results. We are certainly not satisfied with those results yet, but we do see some deal flows starting to happen, we see a lot of interest in channel partners. We see recruiting of those partners getting a little easier than it was when we first started, and we see better partners, in our opinion, coming on board including some of the names that I announced in this call who are now distributing our services for us. So we want to thank you for remembering the remark and, hopefully, we can quantify that a lot larger as we move into this calendar year towards the end of the year as well.

Great. Thank you.

Thanks, Patrick.

Thank you. Our next question comes from J.D. Abouchar from GRT Capital.

Congratulations on a great quarter.

Thank you.

I just wanted to follow up on the Cisco hardware with a couple of questions because one of the things that I think had been holding the Company back, if we look back a year or so ago, was not having name brand hardware and Polycom changed the game, and now it looks like we have Cisco as well. So is Cisco going to be on equal footing with Polycom and you -- how does that fit into your marketing strategy?

Yes, a great question. I figured either someone was going to call me on it on this call or Polycom would be on my cell phone by the time I got off the call. Our partnership and positioning of Cisco is in no way meant to diminish what we have done with Polycom and the results we continue to see with Polycom since we launched with them in October of last year -- October the previous year. I keep forgetting that we have rolled into a new year. We did an announcement, which I think was a very important announcement, which was really to announce a wireless enterprise grade telephony solution with Polycom during the quarter. That has already become our third best selling endpoint, behind two other IP phones that have the Polycom brand on them. So our top three phones that we are selling today are Polycom phones and there's been nothing to diminish our enthusiasm for that partnership. Having said that, there are millions of Cisco IP phones in the field. We have been asked since the beginning of time to support those and we are finally in a position to begin supporting IP phones and other devices that have the Cisco brand on them. And so our positioning is not to favor one or the other, our positioning is to listen to our customers and our prospects. I have my personal biases. I'm not going to tell you what phone is sitting on my desk right now because it will just get me in trouble with one or the other. But if you're a customer and you come us with a requirement we want to be in a position to meet that, and that's what we have achieved with the Cisco certification. I do think it's significant for that reason.

Got you. And then if we look back a year ago it used to be generating quality leads, we hit a ceiling and that there just were only so many you could get and the salespeople could chase down. It seems like there's been a shift now with getting more enterprise customers, with more lines of service per customer. Has the nature of the selling and lead generation changed and has that opened up some more runway, or maybe you could talk about how that's evolved?

So primarily what we have been doing on the lead side is expanding the reach of the products that we are looking to procure leads for, and so we broadened our product set massively in the past couple of years and today we are selling over 20 subscription-based services. And so our primarily goal is just to get a billing relationship with customers and then cross-sell additional services into them. And so we have been quite successful at that. If you look at the absolute number of leads each month, they are fairly consistent over the past couple of years, but we are just starting to convert them into much higher dollar amounts into average revenue per quarter, or per month.

Got you. Okay. And then finally, maybe an update on the internal enterprise sales/government businesses you embarked, about nine months or so ago.

Yes, so this is Bryan. That continues to go very well. We won a -- as a subcontractor to a prime contractor, the defense Nuclear Facility Safety Board contract during the quarter. We were just informed that we have won, with a similar relationship, a state government retirement system. We are continuing to submit bids on a regular basis and continue to work on our product and aligning it with the needs of these bids. So we are in the process, we have been working now for probably going on six months with IBM to obtain business certification on all of our cloud data services including our phone services out of our Ashburn, Virginia facility. We have hired a second full-time salesperson to track down the leads because we've got too many leads and too many bids coming in and continue to accelerate on that front. Vance was just out here yesterday for our in-person Board meeting and he's a busy man. So we are very optimistic on that front.

Excellent. Thank you, guys.

Thank you.

Thank you. Our next question comes from Michael Needleman from Preservation Asset Management.

Good afternoon.

Hi, Michael.

I came on a little late, so pardon me if I ask a couple of questions that were already answered. What was the number of channel partners that you had this quarter?

It was 54 as of 12/31.

And that's up from what?

40 at 9/30.

Okay, and you said that you've quantified a little bit of what came through that channel. Did you quantify it in terms of revenue?

No. We said 83 -- 83 deals, new deals were attributed to that channel.

Okay. And the SAC cost?

The cost of acquisition in the quarter was $92 per service and that is down sequentially about 9% and down about 7% compared to the same period last year.

And what's your average -- what's the average line doing now, in terms of revenue, so ARPU?

$239.

Yes, $239 is per customer and the average customer subscribes to 9.4 services.

And is that $239, is that also up?

Yes, it grew 15% sequentially. It was $207 in the September quarter.

Thank you so much.

Thank you, Michael. Good talking to you.

Good talking to you.

Thank you. I'm showing no further questions at this time.

All right. Thank you, operator. Thank you everybody for listening. If you're not already a customer, I encourage you as always to come to our website, learn more about our services. We have many diversified cloud services that can help your business or your investment fund and the website, again, is www.8x8.com. With that, we will conclude today's call. Go ahead, operator.

Thank you. Ladies and gentlemen, thank you for participating in today's call. This concludes our program. You may all disconnect and have a wonderful day.