8x8 Inc (EGHT) 2015 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the 8x8 first-quarter FY15 earnings conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host Ms. Joan Citelli, Director of Corporate Communications.

Thanks and welcome, everyone, to our call. Today I'm joined by 8x8's Chief Executive Officer, Vik Verma, and 8x8's Chief Financial Officer, Dan Weirich, to discuss our results for 8x8's first fiscal quarter of 2015 ended June 30, 2014. 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 Vik, 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.

Thank you. With that, I will turn the call over to Vik Verma, Chief Executive Officer of 8x8.

Thank you, Joan. Welcome, everyone, to 8x8's first-quarter FY15 earnings call. I would like to begin by reviewing some of our high-level financial results and business activities for the quarter. Following my remarks our CFO Dan Weirich will discuss the results and metrics in greater detail. We will then be happy to answer any questions that you may have for us today.

As you can see from our FY15 Q1 results, this has been a very strong quarter for 8x8. Total revenue for the quarter grew 30% year over year to a record $37.9 million and non-GAAP net income for the quarter was $3 million or 8% of revenue. This is the 17th consecutive quarter in which 8x8 has generated non-GAAP net income alongside increasing revenue.

Additionally, we continue to demonstrate accelerating penetration into the mid-market, our primary target segment, with new sales from a mid-market and channel teams increasing 94% from the same period a year ago. Revenues from mid-market now represents 41% of service revenues compared with 34% for the same period a year ago.

As we have discussed before, one of the primary drivers of our accelerating penetration in the mid-market is that these customers are looking for a single provider to deliver a broad range of communication capabilities that include cloud-based telephony, contact center, mobile apps and web conferencing. We see ourselves as significantly differentiated in this market in several key ways.

Number one, our position as the only cloud-based provider with a native UC and contact center offering. Number two, our ability to provide services globally through our global reach initiative. Number three, a leadership position in security and compliance notably HIPAA and FISMA. Number four, our proprietary technology that enables us to meet stringent security and compliance requirements with exceptional reliability and documented up time of 99.997%. Five, our out-of-the-box integrations to back-office systems such as Salesforce, NetSuite and Zendesk.

As a result of this differentiation more and more midsize and distributor enterprise businesses are transitioning to cloud-based communication services and are choosing 8x8 for the reliability, security, international scalability and breadth of services that are platform delivers.

In addition to our strong financial performance, we made good progress during the quarter on all of the strategic growth initiatives we had previously laid out. First, we're not only seeing greater adoption of our services by mid-market customers, we're also seeing the size of these customers increasing.

For example, in the first quarter one of our most notable new customer wins was a healthcare provider with more than 30 locations and 1,200 virtual office seats. We beat a very large premise-based supplier in this opportunity because one, our cloud-based solution delivered savings in excess of 70%, or $5 million over five years, compared to the premise-based solution. Two, our solution embodies all of the security compliances, notably HIPAA and reliability assurances that are critical to this companies day-to-day operations.

Second, we are seeing more and more mid-market customers subscribing to both our virtual office cloud telephony and virtual contact center solutions with their initial orders. Of our top 10 new customer wins this quarter, or new logos in this quarter, six subscribed to our combined virtual contact center and virtual office offering. Two subscribed to our virtual contact center solution and two subscribed to our virtual office solution.

In addition, many of our existing customers continued to supplement their initial subscription to one first of service such as virtual office with additional services such as virtual contact center or unified communications.

Third, our ongoing focus on security, compliance and reliability continues to work in our favor with the HIPAA certification we received last year playing a key role in significant customer wins, such as the 30-location healthcare provider I mentioned earlier and three additional top-10 customer accounts in the healthcare segment we won during the quarter.

This is a big differentiator for us, more than you might imagine, as the penalties for violation of this important privacy standard are beginning to be levied and many types of businesses are subject to these finds.

Fourth, our global capabilities are now essentially fully integrated and are increasingly being requested by our mid-market customers. Two of our top-10 deals this quarter chose us, in part, for our ability to locally serve the UK operations from our London data center. We can now provide services to our multinational customers throughout Europe and Asia from our data centers in London and Hong Kong. Beyond multinationals, we are making inroads into the foreign government markets with our recent acceptance as a supplier for the United Kingdoms G-Cloud V framework. G-Cloud is a UK government initiative developed to encourage the adoption of cloud services across the whole of the public sector.

Fifth, we are having very good success with our customer deployment efforts, as several of those that were pending last quarter have now been successfully installed. In general, the larger the customer the more complex the deployment tends to be with multiple locations, services and integrations involved. One such customer we deployed during the quarter is a national, student focused, financial services organization for whom we are providing 450 virtual office seats and 150 virtual contact centers seats complete with quality and workforce management capabilities, which were a vital component of this service requirements.

Given our strong first-quarter performance we now expect revenue to grow by at least 25% with non-GAAP net income as a percentage of revenue in high single digits, 6% to 9%, range for the fiscal year. In light of our strong cash generation this quarter and in FY14, our Board of Directors has authorized the repurchase of up to an aggregate of $15 million of our common stock.

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

Thank you, Vik. We started the year off strong with revenue increasing 30% compared with the same period last year. We are beginning to see acceleration in our revenue growth as we successfully sign-up and deploy larger customers.

Our 30% increase in revenue compared with a 29% increase in revenue for the fourth quarter of FY14. 41% of our service revenue in the first quarter was from customers who generated more than $1,000 in monthly recurring revenue or MRR, compared with 39% in the fourth quarter of FY14.

As Vik noted, our sales were robust in the quarter with record new MRR. Our channel and mid-market sales teams generated 44% of our new sales compared with 39% in the prior quarter and 30% in the same period a year ago. New MRR sold by our channel and mid-market sales teams increased 94% compared with the same period last year. This 94% increase in MRR compares with 47% growth in the fourth quarter of FY14 and 73% in the same period a year ago. All of our sales channels experienced an increase in MRR sold in the quarter.

Non-GAAP net income was strong at $3 million, which is $0.03 per share or 8% of revenue. Gross margin was strong at 71% with 80% service margin and negative 9% product margin. This compares to 70% gross margin with 79% service margin and negative 23% product margin in the fourth quarter of FY14. Cash, cash equivalents and investments were $182 million at June 30, 2014, up $3.6 million in the quarter. Capital expenditures were $1 million in the quarter, were 2.7% of revenue.

We ended the quarter with 39,340 customers, an increase of 1,407 in the quarter and 5,966 compared to the same period a year ago. Average revenue per customer was a record at $293, up $6 sequentially and $30, or 11%, compared to the same period a year ago.

Backlog increased approximate 20% sequentially during the June quarter. Approximately 50% of the backlog at March 31, 2014 went live in the June quarter and an additional 15% of the March 31 backlog has gone live since July 1. Of the backlog that went live in the quarter, the weighted average go-live date of the MRR was June 1, 2014.

We will not be providing backlog in the future, but have provided this figure the past two quarters to illustrate the impact to our service revenue recognition as we transition from bringing SMB customers that go live in one month to mid-market and distributed enterprise customers that go live in 2 to 6 months.

Monthly business service revenue churn was a record low in the quarter at 0.4%. At the moment we believe this is an anomaly and would guide you to modeling revenue churn to be approximately 1% until we have more consistency at sub 1% revenue churn levels. When looking at where our churn comes from, the vast majority is from our SMB customers, defined as customers with less than $1,000 of MRR.

We experienced exceptionally strong retention of our mid-market customer revenue in the quarter. Mid-market customers are defined as customers with more than $1,000 of MRR.

Contribution margin defined as service margin less customer service and billing expense was 64% in the quarter. Mid-market customers have a contribution margin of 63%, while SMB customers have a contribution margin of 65%. Mid-market customers' lower contribution margin is due to higher deployment and customer service expense. We believe that over time this expense will decline as a percentage of revenue.

As you are aware, over the years we have had an outstanding return on invested capital from our SMB business customers. What we are finding is that our mid-market customers, even assuming a conservative monthly churn rate of 1%, have a return on invested capital that is approximately double that of our SMB customers.

Finally, given the strength of our business and visibility into operating cash flow 8x8's Board of Directors has authorized the repurchase of up to an aggregate of $15 million of our common stock. The repurchase program is expected to continue until July 22, 2015 unless extended or shortened by the Board of Directors. As a reminder, net cash provided by operating activities for 8x8's fiscal year ended March 31, 2014 was $14.9 million.

As Vik indicated, we expect revenue growth of at least 25% with non-GAAP net income as a percentage of revenue in the high single digit 6% to 9% range for this fiscal year. We are building a Company focused on sustainable growth with attractive growth potential.

That concludes my prepared remarks, and I will now turn the call over to Vik.

Thanks, Dan. As evidenced by our results over the past two quarters, we're seeing more and more businesses transitioning their communications infrastructure from legacy, premises-based systems to cloud-based alternatives. As a result of our cloud-only focus since day one and the investments we have made over the years in R&D, engineering, security, reliability, customer support, sales and marketing, 8x8 has made great strides in this industry. I am looking forward to many more exciting years of growth ahead.

With that we will be happy to take any questions you may have for us today. Operator, please open the lines for any questions.

(Operator Instructions)

Amir Rozwadowski, Barclays

This is a Arindam on behalf of Amir Rozwadowski. One question was that it seems you're increasingly crossing paths with premise-based competitors. I just wanted to get some color in terms of what kind of competitive responses have you seen, if any, from them? What is your strategy going forward, because increasingly, I guess, you'll be coming up against them?

We are increasingly seeing premise-based guys, particularly in the mid-market space. The number one thing that makes us obviously very attractive is the fact that -- I used to one particular example of that medical facility where over a five-year period we saved this customer, which had approximately 1,200 VO seats, $5 million. That makes it a no-brainer.

Correct.

The typical response from a premise-based guy, is cloud vendors are not as secure. They're not as compliant. They have less up time or they are not HIPAA complaint.

We are HIPAA compliant and we have 99.997% reliability, so in essence we are able to be 70% or so lower than a premise-based vendor, and we can meet them on every one of those other functionalities. Then, on top of that cloud enables the level of flexibility in terms of basically being able to adapt your system, add to your system, subtract from your system. That's a competition we enjoy.

Okay. Just as a quick follow up.

How difficult or easy is it for your cloud-based competitors to secure the same kind of certifications, the HIPAA compliance that you talked about, from a security point of view, so that they can effectively compete with you? Is it a process that takes time or is this something that they can do pretty quickly?

It's a non-trivial process. You are basically signing BAA agreement, a business associate agreement. It's a lot of liability, so you have to really go in.

You have to third-party validation. You have to re-engineer systems. You have to make sure that you are able to have a level of reliability and compliance.

It is a multi-year process. It is something we have invested a lot of time and energy in.

Alright. Thanks, guys.

Catharine Trebnick, Dougherty.

Mine is more to do with your commentary on the mid-market. Could you give me an idea of how robust is the solution? Because you did mention that it has mobility and other extensions?

And I guess I would like to ask, since this is the first time I'm taking over the call, have a good feel for, is that a strong differentiator in winning against some of your competitors? Thank you.

Yes, Catharine, ultimately the real test of the robustness of our solution is twofold: one is churn rate and the other is adoption. Mid-market and channel year-over-year, in terms of new monthly recurring revenue, grew approximately 94%. That's pretty good.

Churn rate, as we also noted, particularly for the mid-market segment, was a record low. We increasingly see ourselves, that all of the money, time, energy that we have spent in building our systems from the ground up, making sure they're architected properly, making sure that we didn't cut corners on security, all of those things are ending up being non-trivial differentiators for us.

Okay. One more question on the healthcare market. You indicated that last year you were certified for HIPAA compliance, is that different than what I understand from like security, for voice over IP, etc?

Yes, there's many different types of certifications. Our accreditation that we received in the summer of 2013 for HIPAA was just one element of security, so it's a multi-faceted effort that took many, many, many years to get in place.

Alright. Thanks.

Michael Huang, Needham.

Good quarter, guys. First question for you, could you, drilling into the mid-market opportunity and what way you're seeing there, could you help us understand how much of what you're seeing in there is US? Which verticals are standout ones and how many of those are both virtual office and virtual contact center?

Michael, primarily we are seeing across the board. The vertical that we have seen a lot of interest in particular has been medical. I think we said three or four of our top four required some level, of our top-10 customers, required some level of HIPAA compliance.

Six out of our top-10 deals required both virtual contact center and virtual office. That is increasingly a differentiator. As I said, adoption across the board was strong, both here as well as in our Europe facilities. It is early days yet, but it just feels like mid-market is starting to tip over and the adoption is starting to happen in an accelerating manner.

Got you. How did your success that you're seeing right now in the mid-market, how was that impacting how you're thinking about sales ramp and distribution and so forth?

This plays back to our profit expectations in the 6% to 9% range. We have been investing heavily in sales and marketing, 100% of that investment has being going into mid-market sales and marketing efforts as well as the deployment side. Throughout this entire fiscal year we have expected ramps in all of those elements of our business.

As I noted in my prepared remarks, we are seeing a return on investment of our mid-market customers that is roughly 2 times, using the extremely conservative churn rate of our SMB side. We are very, very, very happy with the performance there, and we will continue to be investing on acquiring customers in the mid-market because they are extremely profitable and have an exceptional return, which is well in excess of things we have done in the past, which had phenomenal returns as well.

Great. Thanks, guys.

Nikolay Beliov, Bank of America.

Congratulations on a good earning and what looks like improving execution. Two quick questions for me. Can you provide us the organic business services revenue year-over-year (low freight) and also give us an update on the desktop? You were making some efforts last year, I just want to catch up on what you're doing there?

Nikolay, on the organic revenue we are starting to see an increase in the organic revenue growth. If you just compare to what we did last quarter, we had 29% revenue growth and in the quarter we just reported we had 30% revenue growth while we had increasing backlog during those two periods. Do you mind expanding a little bit on your desktop question?

You guys gave a front end for desktops (inaudible) or VMware is part of your platform, I'm referring to the SoftBank relationship. I'm just wondering what you have been doing, so some moe work around this area?

I think it's what I said in the last few quarters, our focus is on virtual office and virtual contact center. VDI is one of those deals where in essence we cut a deal with SoftBank and they are taking it to market. We are at the back end of that.

Think of it essentially as an option, SoftBank goes off and executes. We are off sitting at the background. That has not been an organic focus for us.

That is much more of a deal that we did with SoftBank that we have put in place and SoftBank is the lead. As SoftBank grows the business, they'll start to use more and more stuff. They're still at their minimums levels, but again, that's not been our focus.

Thank you.

Mike Crawford, B Riley & Company

The revenue churn performance was admirable. You're talking about 1% churn going forward is a good assumption. How low do you think it could possibly be in a sustainable basis? Probably somewhere between that 1% and that 0.4%?

I think that's probably a longer-term range that we could be within. It's what we're seeing is the vast majority of our cancellations in terms of revenue in the quarter were from our SMB customers, our customers that spend less than $1,000 a month with us. We had a little to no revenue churn from our larger customers.

A couple of things are happening. One is as we get a greater percent of our revenue from these larger, more established customers, history continues into the future, we will just naturally have lower revenue churn. Then, the other component is, is that we are seeing a tremendous amount of up-sell and add-on revenue from existing customers that contract at $100 and they end up spending $105 or so, which are benefits to the revenue churn component.

Thank you. Then the follow-up question relates to operating expense.

You guided to 6% to 9% pro forma net margin this year. You did higher, I believe, 26 people and issued 137,000 RSUs in the period. Is this a case where you are growing into revenue the base or do you expect to continue to grow operating expenses at a similar rate next year?

We're not commenting on FY16 yet, but the 6% to 9% as a percentage of revenue is what we guided for FY15, so this has not changed. We stated this range, and I have had some commentary that's kind of a large range, because there are certain variables such as hiring and various things such as that, that are hard to predict exactly when they're going to fall in the period.

We are seeing a phenomenal ROI from these larger customers. We are very excited about their long-term revenue potential. And so as we continue to have success similar to like 94% increase in sales from our two sales channels that attack this market, we're going to continue to invest.

Alright. Thank you.

Greg Burns, Sidoti & Company

Just a question on the product margins. Much less of a subsidy this quarter than in past quarters.

Is the handset something that you have to subsidize less in the mid-market? Is there anything different about the mid-market that is improving the margins on the products?

Secondly, I wanted to get your thoughts on wholesaling out the platform. Is that something of strategic importance or something that you are actively pursuing? Thanks.

It's Dan. I'm going to do the first question and then I think Vik will take the second one.

On the product margin, we are down to negative 9%. When you just take a step back and look at it from absolute dollar amounts, it's not huge dollars. I know we are in the negative 23% range in March, and we stepped down so you look at that delta from percentage standpoint looks huge, but dollars is not nearly as big of a number.

It's happening for a couple of reasons. One is, yes, mid-market customers are less sensitive to the price of the handset. Whether they're buying low-end or high-end phones, it's just not as big of an issue relative to the SMB side.

Two, we've had some improvement in pricing from vendors. Three, we kept it enhanced, controls in discounting, various things like that, primarily on our SMB side as we are really turning the shift to focus more on mid-market, going-up markets, on to larger customers. We're not cutting off signing up the one-line customers, but we're not running like aggressive handset promos to attract extremely small customers.

I think your comment with regard to, I guess you used the word wholesaling, which I assumed you mean white-labeling our system. I think what you found, our channel growth has been quite spectacular. What we're finding is there are a few people that like to white label our system, but generally what we have found is people want to co-sell with us or re-sell our system.

Part of the reason is because increasingly our brand name is starting to be synonymous with reliability and compliance, and so there is value in the brand name. We are rarely finding people pushing for, in that sense, white labeling our system. It's much more of a co-sell or re-sale arrangement.

Thank you.

Mike Latimore, Northland Capital.

Very nice quarter. The Voicenet or the UK operation, how much do they contribute to service revenue?

Mike, it's Dan. That's a number that we're just not disclosing. You can see the number in our 10-K for the fiscal year finishing 2014 and we're just not going to disclose that number going forward.

As Vik noted, two of our top-10 deals in the quarter included deployments in the US and in Europe and the systems are totally meshed together, and we're seeing some good success there. It's just something that, frankly, we don't look at internally as separate, and on our booking side just one P&L and that's the way we do it.

I got it. This dynamic of customers ordering more services or adding on additional services, how much of that dynamic adds to new MRR purchased or sold in the quarter?

I think you're talking about of sales versus new logos?

Yes.

It was approximately half -- half and half. We like both elements of it and I'd love to model it as half and half.

Approximately half of it should be bringing new logos and the other half should be upselling to existing logos, because the more you upsell the more they get tightly wedded to your system and the more integrated you are. That's less likely they're to churn. We are quite satisfied with the fact that it seems to be approximately half and half

Great. Thanks.

(Operator Instructions)

Dmitry Netis, William Blair.

Nice quarter, guys.

Thanks, Dmitry.

I wanted to get on the mid-market side again, dig in on that. How many customers do have in the mid-market that for example you're recognizing revenue from right now?

Mid-market customers are roughly 1,200 or so, customers in the mid-market. Our definition of the mid-market customer is just someone who is paying us a monthly service bill in excess of $1,000.

Got it. Okay, great.

Then on the backlog, I think you had 75 that were in the backlog last quarter. How many you have this quarter?

We have a greater number of customers in backlog today than we did at March 31. The increase in terms of recurring revenue in backlog has gone up 20% sequentially. We deployed approximately half the backlog of March 31 in the quarter and an additional 15% of that backlog at March 31 has been deployed the first three weeks of July.

Okay, great. Thanks. I guess to follow up on the Voicenet side.

I'm just curious, I know it's smashed, but can you talk about the international traction in general? Is it meeting your expectations? Is it exceeding your expectations? Is there more work to do? Can you just give us an overview what you're doing overseas and whether things are firing in our cylinders there?

Actually, I am increasingly pleased. In essence we bought a company, Novemberish timeframe.

It was operational on our system, and by that means selling our virtual office products, in the February/March timeframe. It's totally integrated. I think there are several deals that were cross-border type deals, where there was a US component, a UK component. There were two pretty significant deals.

I'm actually very pleased. We got a very good team out there; it's definitely exceeding expectations.

Great. What about the other parts, Vic, Latin America, maybe Hong Kong? I know you just began those data centers.

Right. As I indicated last quarter, Hong Kong is up and running and we're starting to put several folks in there. Latin America, we had not deployed, mainly because we were able to serve our Latin America customers, at least in the short term, through the US.

On a case-by-case basis we continue to deploy, but again what I try to do is make sure we have very good capacity and customers fill it up relatively quickly. We will continue to tell you about areas that we deploy as time goes on.

Any new extension data centers across the globe that you are thinking about and are willing to talk about it on this call?

Not yet. I think it's premature to talk about it.

The part I would emphasize is the UK deployment, on two levels, has been a great model for us and one that has worked out exceedingly well. First, we deployed a data center. Then, we acquired a company that leverages that data center plus use that data center for our existing customers, then transferred some of the ownership of those customers to our UK facility. That process has gone quite well.

Actually, as I said, it exceeded my expectation. As we continue to learn from it, we want to make sure we deploy all of the lessons learned so we can keep getting even better. Over time, we will continue to deploy, but again, we will do it in a very planned and optimal manner.

I am showing no further questions at this time. I would now like to turn the conference back to Mr. Vik Verma.

Thank you, everybody, for listening to our presentation today. I look forward to seeing all of you in the coming months at upcoming financial conferences and other industry events. Thanks again.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.