8x8 Inc (EGHT) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the 8x8, Inc. fourth-quarter 2015 earnings conference call.

(Operator Instructions)

As reminder, today's program is being recorded. I would now like to introduce your host for today's program, Joan Citelli, Director of Corporate Communications. Please go ahead.

Thank you, and welcome, everyone, to our call. Today, I'm joined by 8x8's Chief Executive Officer, Vik Verma, and our Chief Financial Officer, Mary Ellen Genovese, to discuss our results for 8x8's fourth quarter of FY15, ended March 31, 2015. 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 limitations, 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 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'll turn the call over to Vik Verma, Chief Executive Officer of 8x8.

Thank you, Joan, and welcome everyone to 8x8's fourth quarter and FY15 year-end earnings call. 8x8's record fourth quarter capped off a very strong FY15. We achieved the revenue growth and profitability objectives we laid out a year ago, and introduced many new features and capabilities to our service offerings, which extended our lead in the market.

Total revenue for the fourth quarter of FY15 grew organically 22% year-over-year to $43.5 million, while service revenue increased 23% year-over-year to $40 million. Our non-GAAP net income results for the fourth quarter of FY15 were also strong, at $4.9 million, or 11% of revenue, compared with $3.3 million or 9% of revenue for the same period last year. This is the 20th consecutive quarter in which 8x8 has generated non-GAAP net income, alongside increasing revenue, and we remain committed to profitable growth and strong cash flow.

In addition to our solid financial performance, we made significant progress during the fourth quarter of FY15, achieving the objectives that are core to our growth strategy. First, we continued to successfully penetrate the midmarket with our differentiated cloud communications, contact center, and analytics service offerings, while at the same time maintaining a healthy and growing small SMB business.

Service revenue from midmarket customers increased 34% year-over-year, and now represents 43% of total service revenue, compared with 39% in the same year-ago period. Examples of some midmarket wins during the quarter included one of the country's largest dental support organizations, with 150 affiliated dental practices in eight states, an independent nonpartisan policy research center with over 400 employees, and a UK-based executive agency that provides civil and criminal legal aid and advice in England and Wales.

Our combined virtual office virtual contact center solution remains a strong differentiator, bringing us larger and larger deals. Two examples of new customers subscribing to our integrated offering include a leading publicly-traded lifestyle company for yoga, fitness, and wellness products, and a fast-growing London-based online designer furniture retailer.

On the SMB side of our business, we are continuing to see productivity improvements within the sales group, as they steadily add new customers with an emphasis on larger SMB and smaller midmarket deals. With the acquisition of these customers becoming more and more of a low-touch process, we're able to invest more time and resources in securing larger midmarket and enterprise business.

Second, we significantly enhanced a solution set for the midmarket during the fourth quarter, with a slate of new products, service quality, and professional service introductions. These include: one, the deeper integration of our virtual office and virtual contact center solution, which seamlessly ties telephony, unified communication and contact center users across the enterprise with a single sign-on, shared directory, and shared presence over a common underlying platforms. Two, our industry-leading service level agreements which establish 8x8 as the first cloud UC provider to guarantee the highest level of availability and voice quality over the public Internet.

Three, our virtual office analytics suite of services, which leverages it 8x8's internal big data infrastructure to enable customers to transform their business through actionable insights into their communication trends and activities. Four, our Elite Touch professional service offerings, designed to ensure the swift and successful deployment of our cloud communications services across an enterprise entire organization. And five, the establishment of our ISVforce partnership with salesforce.com, that provides our customers with tighter integrations with sales cloud and service cloud.

All of these core communication capabilities and value-added services have been bundled in a new Virtual Office enterprise suite offering, that layers critical capabilities and performance assurances on top of our Virtual Office cloud telephony solution, to ease the decision-making and oversight CEOs typically engage in when making changes into their IT or communication infrastructure.

Third, we expanded our channel partner program during the quarter through new relationships with leading vendors including Intelisys, Arrow Systems Integration, and CDW. These partnerships are already bearing fruit with collaborative wins such as a provider of mental and medical health services to correctional facilities across the US that employs more than 3,000 clinical, management and support staff nationwide, through a network of 20 regional offices. Overall, the productivity of our channel is increasing, with 3 of our top 10 wins during the quarter coming to us through our reseller partners.

Fourth, our global reach initiative continue to unfold, with the launch of our service platform in a Sydney, Australia data center, and new partnership with Entrust ICT, a provider of wholesale communication technologies to system integrators and service providers, who is now offering our virtual office and virtual contact center solutions to the Australian market. With our new presence in Australia, 8x8 now maintains nine data center operations throughout the world, giving us the ability to provide superior service to a multinational customers.

Examples of multinational midmarket customer wins during the quarter included a leading customer identity management company with six international offices and over 300 employees. And a Silicon Valley-based marketing automation software company with offices worldwide. We also unveiled our new Virtual Contact Center global solution, the first cloud-based contact center solution that seamlessly connects an organization's international agents over a single platform with integrated presence, multilingual chat with automatic translation, call routing, reporting, and management.

Fifth, we rounded out our executive leadership with the appointment of Puneet Arora as Senior Vice President of Global Sales in the fourth quarter, and two other key executives in the prior quarter. We enter FY16 with a full senior management team on board, along with the technology, product portfolio, global presence, channel network and financial resources to aggressively and profitably pursue the expanding midmarket opportunities we see across the globe. These fourth-quarter achievements conclude a full year of progress across all of the key segments of 8x8's business.

We demonstrated our ability to win very large midmarket accounts, and rapidly deploy our services across multiple locations. The strength of our communications solutions and the value of the midmarket customers was validated by new relationships we forged with key channel partners, along with the high marks we received from industry-leading market research firms including Gartner, IHS Infonetics, Frost & Sullivan, and Synergy Research Group. The awarding of our 100th patent underscored the Company's ongoing technology innovation, which was evidenced by the slew of new products, service quality enhancement, and expanded global capabilities we announced during the course of the year.

Looking forward to FY16, we are issuing our guidance for annual revenue of between $193 million and $197 million, with non-GAAP net income as a percentage of revenue in the 6% to 9% range. With the senior management team now in place and our enterprise cloud communications suite launched, we plan to continue investing in our business in FY16, in sales, marketing, demand generation, channel enablement, global expansion and acquisitions, to capture our fair share of the largely untapped midmarket and enterprise segments.

With that, I'll now turn the call over to Mary Ellen, who will provide you additional detail on our financial results.

Thank you, Vik. As Vik noted, financial results for our fourth quarter of FY15 were strong, with a 22% year-over-year increase in organic revenue to $43.5 million, and a 23% increase in service revenue to $40 million.

Gross margin for the quarter was 73% compared to 70% for the same period a year ago. Service margin was 81%, an increase of 200 basis points from the year-ago quarter.

Non-GAAP net income for the quarter was very strong at $4.9 million or $0.05 per share, representing 11% of revenue, compared with $3.3 million or $0.04 per share, representing 9% of revenue in the same period a year ago. In addition, we took a GAAP charge for $1.2 million for a loss contingency reserve in the quarter. This is not included in our non-GAAP net income.

For FY15, revenue grew 26.3% to $162.4 million, and service revenue grew 27.1% to $148.2 million. Gross margin increased to 72%, compared with 71% in FY14, and service margin was 80%, compared with 81% for FY14. Product margin was negative 12%, compared with negative 27% in the same period a year ago.

Full-year FY15 non-GAAP net income was $16.2 million, or $0.18 per share representing 10% of revenue, compared with $14.1 million or $0.17 per share representing 11% of revenue. Service revenue from midmarket customers now accounts for 43% of the Company's total service revenue, compared with 39% in the same period last year and 42% in the previous quarter. Average revenue per customer across our entire customer base was a record $320, up $33 or 11%, compared to the same period a year ago.

Monthly business service revenue churn also improved significantly in the quarter to just 0.5%, compared to 1.2% in the same period a year ago. As forecasted previously, our net customer additions were lower this quarter compared with our historical results, primarily due to the end of life reduction of previously acquired single line of iTel accounts, and an emphasis on the part of our SMB team on selling larger deals.

Cash, cash equivalents, and investments totaled $177.1 million in the fourth quarter of FY15, compared with $178.4 million in the same period last year. Cash flow from operating activities was $21.2 million for the year. We spent $19.4 million during the year on our stock repurchase plan, and to date, we have repurchased approximately 2.5 million shares, at an average price of $7.72 per share.

Capital expenditures were $1.3 million in the quarter, 3% of revenue, and $5.8 million or 3.6% of revenue in FY15. We continue to invest in our core network and equipment to upgrade to the next generation 10-gig infrastructure to support our future growth. We expect this trend to continue as we invest in upgrading our back office systems to accommodate the additional complexity of serving our midmarket and enterprise customers.

Sales and marketing expenses increased sequentially in the fourth quarter of FY15 by approximately $1 million, due to higher commissions and fringe benefits, especially related to the employer portion of Social Security tax. In FY15, our sales and marketing expenses increased on a GAAP basis by 32%, primarily due to the acquisition of our UK subsidiary, an increase in headcount in both deployment and sales engineering teams, and the development of a new customer success team. These investments paid off, as service revenue from midmarket customers grew 34% year-over-year in our fourth fiscal quarter.

Our UK operations is doing very well, selling our 8x8 products in the UK and Ireland, and we saw approximately a year-over-year increase of 90% in new MER from this team. We expect our UK revenue to grow greater than 25% in FY16, when measured in local currency.

Our deployment engineering team has enabled us to move upmarket, and win large distributed enterprises with the ability to rapidly deploy customers with 1000-plus users in three to five weeks. Our customer success team has built a solid relationships with our top customers with a favorable impact on upselling and revenue churn.

We expect our investments to continue in FY16, as we remain intensely focused on expanding our penetration into midmarket and enterprise customers as the lifetime value economics of these customers is approximately 40 times that of a small business customer. With the hiring of our new SVP of Sales and our new CMO, we intended to invest in our enterprise direct teams, our channel enablement, and demand generation, to continue to capture high-quality, midmarket and enterprise customers.

In addition, we made great progress in R&D this year, delivering many new products and features, such as Virtual Office Analytics, which were very well received by our customers. We will continue to invest in this the team in FY16, and bring additional new products and features to market. We are still very much focused on our SMB business and saw a 38% increase in productivity from our SMB sales team in fiscal Q4.

As we mentioned previously, this team is moving upmarket and closed a number of deals that were greater than 1,000 MER, with a no-touch approach. In fact, the team closed a 5,000 MER deal without ever meeting the customer face-to-face.

As Vik indicated, we are issuing our guidance for annual revenue of $193 million to $197 million. And we expect our non-GAAP net income as a percentage of revenue to be between 6% and 9% for FY16.

This concludes my prepared remarks. I now turn the call over to Vik.

Thank you, Mary Ellen. In summary, we had a very strong quarter to cap off a year of significant internal achievements and milestones, and I'm now committed to focusing our resources on expanding our brand awareness and market share.

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

(Operator Instructions)

Nandan Amladi, Deutsche Bank.

Thanks for taking my question. So the ARPU trends are clearly very strong, the share of revenue from the midmarket is also very strong. As we model our FY17 and -- FY16 and FY17 views, how will the ARPU trend, how should that pace versus the overall revenue growth and the share of midmarket revenue? What are your expectations for that?

So, I mean, I think thanks, Nandan, and a couple of quick thoughts. I think as you can see, our midmarket is growing in a very nice way. The ARPU in this particular quarter was significantly higher than I would probably model. Part of it has to do with just generally the cleaning up of our smaller customers, we are also introducing new upsell capabilities such as VO Analytics, et cetera.

I would still model historical $5, $6 of sequential increase through FY16. Starting 2017, I think you'll start to see that number move up, because we're starting to see the larger customers become a bigger and bigger share of our revenue, and as the midmarket starts to crossover and starts to get close to the 50% point of our revenue, you'll start to see that ARPU number climb, but that'll be in the FY17 timeframe.

Thank you and a quick follow up, if I might. At the Enterprise Connect show, large incumbents who have had a big footprint in the traditional PBX business, they've all launched cloud offerings and the marketing messages are very similar to yours. What has been the impact of that to the quality of your pipeline and your ability to close?

So a couple things. One, do you remember the long, long time ago, I guess I'm dating myself, but that Apple commercial where Apple welcomed IBM into the market for PCs? That's how I feel, because suddenly, people are not asking whether they should go cloud or on premise or this, that or the other, it literally is, we're going cloud let me pick. And our pipeline for larger deals has literally grown off the charts.

I mean where, when you and I started talking 18 months ago, maybe a few $2,000, $3,000 type MRR customers, a few $5,000, $6,000, $7,000, $10,000. Now suddenly you almost get a whole bunch of customers are in the $8,000, $10,000, $20,000, $30,000, as much as $150,000 type MRR that are starting to approach us. Where we think we are different is we have this really integrated solution, where if you think about what we have done, which I think we've done it in a very systematic manner, we are the world's best when it comes to VoIP.

I'm very confident about that. Our call quality is unprecedented, our reliability is unprecedented. We've then layered on multichannel. We have then layered on the whole customer engagement piece, which is Contact Center, and we own all our own technology and have done a very tight integration between the two. We have then added on the back office integration with NetSuite, Zendesk, salesforce.com, and now we have layered on the analytics.

I think some of the larger players are coming with piece parts, and they are trying to think about it as a volume game. I think we're trying to become more and more of that one-stop for these large enterprise, where we're turning communications into actionable information. I think that positions us, as I think the leader, and as I said, I'm quite pleased with where we are, and the pace into the midmarket is definitely accelerating.

Thank you.

George Sutton, Craig-Hallum.

Thank you. Vik, as we look at your midmarket success, and you are talking about it in a suite format, can you give us a sense of what's driving that success within that suite, is it simply having the breadth of functionality?

Combination of things. I think, George, you and I have had these conversations, it's very easy on a flip chart to say, we are SMB, we will become global, and we will become midmarket. It's much harder to do.

So if you think about how we went about it, putting together a world-class sales engineering and a deployment team is one of the first things we did, so you really understand the customer's problem, and more importantly, are able to come up with solutions that tightly integrate to their various back office systems, as well as tightly integrate into the various views that we want. So we think that's a key competitive differentiator.

Having essentially the equivalent of a Chinese menu of products, so you can literally say, enable this, enable this, disable this, they need this particular stuff. That, being able to provide that customized solution out of the box, I think is a key differentiator. And then, as I said, the fact that we have put so much emphasis on reliability, security, compliance, I think makes it very unique for us also, so we think that's what really bringing the market to us.

I think the good news for us is that as we become more and more positioned for the midmarket, these are very discriminating users. They're not interested in a price war. They are interested in making sure that they partner with the right company. The fact that we have a strong balance sheet, the fact that we have had 20 consecutive quarters of profitability, the fact that we have built all of the various capabilities that we talked about, the fact that we have 100 patents, that we own all of our own IP, that tends to be a massive differentiator. So the market's moving to us, which you always hope it's going to move to you when you start making some of the investments that we made, so I'm pretty happy that's happening.

You just brought up the strong balance sheet, and obviously relative to most of the competitors in this space you're pretty cash heavy. We are in a clear consolidation environment. Can you give us an update on your thoughts relative to your plans for M&A?

Yes. So again, I think you know us as a management team, UK, there's a very -- UK was the last -- Voicenet Solutions, which we acquired about a year ago. We are thrilled with that acquisition. I think Mary Ellen kind of alluded to the fact that their new MRR grew 90% year-over-year, in terms of bookings. In addition to that, we have had no turnover at the senior management ranks of that entity, and we've learned a lot about how to integrate this acquisition, and make sure you do it in a seamless way, so it doesn't impact your core business.

Stay tuned on the acquisition front. That's a key element of our strategy. Globalization is a key element of our strategy. Adding additional features, particularly analytics to our core offering as we go from the plumbing much more towards a knowledge solution that can help you transform your business, is a key element of our strategy, and M&A is going to play a very significant role in that.

Great. One quick clarification point. You mentioned a 3,000 employee organization in a deal that you won. Were you suggesting that was 3,000 seats or was that just a partial deployment?

That one is a -- started off as a partial deployment, but the intent is to keep going all the way out.

Okay. Thanks.

Nikolay Beliov, Bank of America.

This is Joyce Yang for Nikolai. Hi, Vik. Just a quick question. Have there been a changes or improvements in the sales and marketing strategy since the new executives have come on board?

No, more refinement. And I think we chatted a little bit about it, we have been very pleasantly surprised that we have been able to move our SMB team to larger and larger deals. I think Mary Ellen alluded to the fact that we signed a $5,000 MRR deal without ever meeting the customer. And the number of, I believe $1,000-plus deals grew 80%-ish year-over-year by the SMB team, which is phenomenal. Basically it says that the SMB team can start to do the lower end of our midmarket.

So on the enterprise team, Puneet and Vikas Bhambri, who is also joined us from LivePerson, both of them, and a whole series of others, Enzo Signore, who came to us from Avaya and Cisco, these folks have a very good understanding of how to attack both channels as well as the enterprise. So we are starting to head a larger and larger up.

So in essence our midmarket team is starting to go to larger and larger deals, and our SMB team is also starting to go into larger and larger deals. Our SMB team is a pure inside sales team model, our enterprise team is essentially more of a territory-based model, so it's more a refinement as opposed to a radical change. Everything is just starting to move upmarket for both our sales teams.

Yes. Got it. Just a follow-up to that, so I guess what percent of the business now is driven by the channel, and how much do you imagine that to grow three to five years from now?

So with regard to -- we don't break out channels separately. But what I can tell you is, I am very excited about channel, and again, you saw that one line, 3 out of our top 10 deals are from channel. And I think, I don't know if you and I have chatted about it, but I know Nikolay and Kash and I had chatted about it a long, long time ago we used to have a lot of channel partners, and this has been addition by subtraction. We have gone to less and less channel partners and we've seen the productivity of each channel partner go up. I believe channel is going to be by far the fastest-growing segment of our sales strategy.

Thank you.

Greg Burns, Sidoti & Company.

Just a follow up on the M&A commentary you gave earlier. One of your competitors has been pretty active rolling up the BroadSoft provider space. I know your UK acquisition, that was a BroadSoft provider that you layered on to your platform. Is that something that you might look to do domestically with these BroadSoft providers?

No. We are familiar with what some of these competitors have been doing. We are not -- we would do that for geographic expansion. Not just to get customers. We can get customers on our own, so we don't need to go get somebody else's platform, and then combine them out here.

The main rationale for Voicenet was it gave us a presence in the UK which we think is a very fast growing market, and had a complete sales team, support team, a customer support team, deployment team, et cetera, and the fact that they happened to be on a BroadSoft platform that we then started to migrate towards ours was a happenstance. But going after domestic BroadSoft platforms is not of any interest to us. We are looking for technology acquisitions domestically that add to our capability and that extend our lead.

This is about some really cool stuff. What you have the ability to do, when you have that plumbing done well, which is the whole omnichannel communication, you can start to layer on some very cool analytics, you can start to layer on some additional capabilities. We're looking for those kind of capabilities, as opposed to just buying customers domestically.

Internationally, we'll keep an open mind, because internationally, what you're looking for is geographic presence. So essentially, that's -- at a top level, that's our strategy.

Okay. Thanks. And just hoping to get maybe a little bit more color on the complexion of your customer base. What percent of your customers would you characterize as midmarket customers, and I know the demarcation line is like $1,000 in monthly MRR but I guess what's the average MRR of your midmarket customers?

About $3,500, I believe. Yes.

$3,500.

About $3,500 is our -- the average size of our MRR of our midmarket customer.

And the percent of your customer base of that you would consider midmarket?

So I wouldn't break it up by number of customers, so in terms of total revenue coming from midmarket customers versus others, 43% of our revenue comes from customers that are spending more than $1,000 MRR on us.

Okay. Thank you.

Catharine Trebnick, Dougherty & Company.

Nice print. Thanks for taking my question. Can we go back and discuss your channel partners? You signed three in the last quarter. And you had said 3 of the top 10 new customers were from these providers.

It seems like they ramp pretty fast. From my understanding most of these partners were signed late in last quarter? My question is, they must have a very mature inside salespeople and have -- how much training have you done with each one of the partners? Thanks.

Yes. That's a great question, Catharine. So surprisingly the ramp has been faster than I would have anticipated. Now, obviously, we like to think we're very good at training, and we have come up with some very good training material. We've assigned people to work with our various channel partners, but we're seeing a lot of pent-up demand from channel partners, and we are very excited with the channel partners we have signed.

They're smart, they have a great sales team, they're driven, there's been a good synergy with them, and it's amazing. and I think there's also a trend of the market which is you are spending less time trying to persuade somebody to go to cloud. You're spending a lot more time talking about how they can benefit from the cloud. And so, I think that's why the ramp has probably been faster than I would have anticipated.

Now, are you planning to go after any more large Arrow type agents? Or is that part of the strategy going forward in 2016 also?

Yes. On a case-by-case basis. I mean, I'm a big believer in, and I think you saw this in our SMB team also. Big believer sometimes it's addition by subtraction, the productivity of our SMB sales team went up, I believe Mary Ellen, 38%?

38%.

38%. So the headcount is less than what it was at the beginning of the year, and they had their best quarter ever in Q4 in the history of the Company. So I'm of that same ilk on partners. Make sure we get the right partners, make sure they share our values, make sure we invest heavily in training, make sure we're able to give them the full attention. One or two more we will add, but again, it will be on a case-by-case basis.

All right. Thank you.

Michael Huang, Needham & Company.

Good afternoon. A couple questions for you. First of all, obviously the bookings in the midmarket channel were very strong in the quarter, which is great. Was there anything that actually was one-time in nature that helped drive that performance? Or I guess my question would be, is the type of close rate that we saw in Q4, is that sustainable through the year, or maybe just some color around what we should be seeing from those close rates, from a booking standpoint?

No, but I think, Mike, hopefully what you are seeing with us is quarter by quarter, we've been trending up. So I actually think it's sustainable. I think we're going to turn on the gas a little bit, because if you think about how we have gone about it, and I think you and I have spent quite a bit of time on both products, I wanted to make sure that we addressed every area of the product whenever we thought that we had holes, add enhancements, et cetera.

Then we brought in this deployment team that did a great job, because deploying midmarket customers is painful. Brought in a sales engineering team so that they really understand what we are deploying and how it fits into the customer's problem. Customer success team brought churn down to a very manageable level, so you're not just getting customers in and they're flying out the door, and so 0.5% churn, I would model less than 1%, which I think on a consistent basis, 0.5 % was good, but we will clearly, I think we're modeling 1% and less consistently is good.

And then you are seeing just step-by-step, everything's trending up. So I don't view it as any one-time event, it's a culmination of a whole series of little things that are starting to go in our favor.

Great. Okay. With respect to competition, so obviously one of your PBX competitors is launching a contact center offering in connection with another cloud contact center solution out there. It certainly seems to validate your position there, but I was wondering from your sense, what -- how do you believe this could impact your sense around competition and maybe, just give us some general thoughts around that announcement?

We expect that people are finally coming to the same place we were about 2.5 years ago when we bought Contactual. Right? So you and I talked about it, where if you remember, several of these folks used to say, these two technologies don't go together. Contact center and telephony are two different markets, they need to be sold separately, dot, dot, dot. Well, that seems to be changing.

I'm a big believer in owning the technology, so then you can evolve towards a common platform, you can share the development, you can ensure that you can price appropriately. It's not two companies. It's one company owning one core technology, one engineering team, so the validation, I like.

The fact that they are heading in that direction is good because it helps to validate the market, so we're spending less time trying to convince people that those two technologies belong together, and I like the fact that we own all of our own technology and we finally start to get it more tightly integrated, so game on. I'm looking forward to it.

Great. And I guess last question is, and I don't know if you have specifics around this, but maybe you could share, some [qualitive] thoughts on when you look at the midmarket channel deals that were done in the quarter, what percentage included both virtual office and contact center, and then maybe you could offer a direction on where that is headed?

I think maybe a third to half. I can't remember offhand the exact number, but at least a third. I would say more than a third, probably less than half, in that ballpark is what included both, and typically tended to be the larger deals. So as I said, we are seeing that -- we are seeing great validation of two things.

And we've been saying, I think both for some while, one is, you had a whole bunch of people saying, well, large enterprises will never go cloud, they really are premise. That seems to be changing pretty dramatically with pretty much everybody who was saying no, no, no, premise solution is it, starting to come up with their own cloud offerings.

The second one, if you recall, people kept saying that VO or virtual office, or cloud telephony and contact center are two different technologies, two different products, sold to two different sets of buyers. We're seeing increasing those two things are coming together and people are buying an integrated solution. Those two things as you recall, are key tenets of our strategy.

And the third element, which I think is just as important, is we are seeing a big push towards global. More and more of our customers are looking for one common global push, or global vendor. That's another area that as I said we I think it did it ahead of everybody else.

And the fourth area we are seeing is increasingly important is security. That's another area we architected our solution to be that.

And then the fifth area is analytics, where you are basically taking communications and turning it into actionable intelligence and actionable information. That seems to be also a trend that customers are increasingly growing towards. I kind of like the trend in the market we have to execute, but the fact that everybody else is starting to figure that all out is good. We just have to continue to execute.

Great. Thanks so much.

Amir Rozwadowski, Barclays.

This is Arindam on behalf of Amir. Just one question on the margins. Margin guidance in fact. You are guiding to the 6% to 9%. I wanted to see, just get your thoughts on, as you continue to see increased penetration in the midmarket, how should we think about the margin upside from that growing penetration, and when do you anticipate perhaps getting the leverage from that model? Are you still in the investment phase, and is that going to be the case for most of the next 12 months? If you could just share your thoughts on that, that would be very helpful.

Yes. That's good, Arindam. So go back to one year, if you remember, the guidance I provided you in the beginning of FY15 was 6% to 9% non-GAAP net income, and at the top line, we said we would grow inorganically around 25%. As you know, we ended up at 26.2% and we ended up at 10% non-GAAP net income.

Correct.

So we were very good stewards of our shareholders' money, because in essence what we did is we said don't spend money willy-nilly like drunken sailors. Start very systematically. Invest first in making sure you have a good deployment team and a good sales engineering team.

Second, make sure that you have a good customer success team, and put all the infrastructure together so your churn comes down. Third, make sure you improve the productivity of your SMB team and turn that increasingly into a cash cow. Fourth, start to get the velocity of products up.

And then you invest a little bit in sales and marketing, but I kept a lot of my powder dry because I wanted to bring in the right leadership team for both sales and marketing. So therefore, I told you guys 6% to 9%, came in at 10%. This year, I feel pretty confident that now is the time to turn up the spigot, because a lot of the foundation has been laid, and that now the investment can bear the kind of fruit that we are looking for.

So we were able to achieve all the objectives we set out for you, with a whole lot less investment. We think this is the time to invest. We're at a 10% stage in the market that just seems to be taking off, and guess what? It's no longer a midmarket play. The logos that we are seeing in our pipeline are enterprises, which is fascinating for me. I mean, we literally have seen people doing $20,000, $30,000, $40,000 MRR type deals, and they're not even considering premise, they're coming right to cloud. So we think this is the time, and it's prudent to do it.

We've also factored in the fact that we may make an acquisition or two, so we want to make sure we anticipate, as you know, we like to make sure we set your expectations. I know we try to make sure we are consistent with telling you and being very transparent about it, so we baked in the fact that we may do an acquisition or two that won't necessarily come in with a lot of profitability into that guidance.

Okay. Makes sense and then just one quick follow up on the M&A comment, as well. You talked about how the fact that you can offer a global platform, differentiate yourself as offering, you did a successful acquisition in the UK. A time when the dollar is where it is, do you see this as an interesting time to perhaps do some more acquisitions internationally, or is the focus more in the domestic market? To the extent you can discuss, of course.

Stay tuned.

All right. Okay. Thanks.

Mike Latimore, Northland Capital.

Hi, great quarter there. Just on the contact center side, across your contact center customers, what's the average [seek out], and what's your largest contact center customer to date?

I don't think we want to disclose -- let's just -- our largest contact center customer is probably six figures. Yes. I don't want to disclose the details of our customers, but yes, we've got -- our range of customers is pretty large. They range anywhere from five seats all the way up to 500, 600 seats, in terms of contact centers.

We are increasingly finding that we built it right. In other words, the knock against us had been our reporting, et cetera, and we're finding now with the introduction of our VCC analytics and some of our reporting, and then the fact that we have come out with this global follow the sun contact center model, I'm pretty confident we can take on anybody on a contact center alone basis, and beat them. And I'm increasingly feeling better about the fact that most contact centers also like the integrated telephony, and omni-channel, and chat, and all of the other stuff all built-in. So we think we can start to go more upmarket.

Great. And then, I guess your comment on ARPU, you talked about I think $5 or $6 increments here. So this $320 is the new baseline, is that the way to look at it? And you kind of build from there?

Yes.

Oh, yes.

But it'll be more than that. Yes.

Okay, great.

I am hoping you saw, Mike, every metric, margins, gross margin, churn, everything was up and to the right systematically, consistently, step-by-step.

Yes. For sure. And then just last implementation timeframe. How are you feeling about that for your midmarket? Has that been consistent? Is that room for improvement, or are you where you want to be?

Always room for improvement coming down. I am so proud of what we call it sales engineering and deployment services, which is an integrated team. I cannot tell you how proud I am of those guys, it's been consistently coming down. We have kind of modeled two to six months, and over time, we are starting to see it head more towards the two as opposed to the six. So we're not there yet. There's always room for improvement, and part of the goal is to keep increasing the velocity of deployment.

Great. Thanks a lot.

Dmitry Netis, William Blair.

Yes. Nice quarter, and good to hear your voice, Vik, since the end of that March quarter. It's been a long wait.

Yes. You're right. It's been a long wait.

A couple of questions. I hate to belabor the channel issue again, but this is by far the major catalyst of growth going forward. So is it going to be a metric that you can provide us -- I don't know whether that happens when you reach 10% of your revenue, or maybe you're already there, but how do we track that success or performance in that channel? And you have about six master agents now that you have signed, three in the last quarter. So want to make sure we track that and measure your success as you roll in revenue into that channel.

Yes. Okay. Fair comments. Let me think about it. We have typically bundled midmarket and channel together, and lump that growth rate up together, but let me start thinking about how we start to break out channel. May not happen next quarter, but very shortly thereafter.

It's something we will definitely start to do, because you and I are aligned on the fact that channel is going to be an increasingly bigger part of our growth story, and I can't tell you how excited I am on that. I mean, we are far from -- I always like to tell you, we are a work in progress, and we hopefully learn day in and day out, and we'll keep making mistakes, but we are starting to feel good about the formula, and we are starting to feel good about the traction in channel.

So we'll come up with some way for you to get color on it. We'll hopefully give you a little more color on our analyst day. I'm not yet sure what metric to provide, and I'm not ready to break it out just yet, because one quarter does not a channel make. I want to show it to you over three, four, five quarters, and then I can start to feel like okay we're there. But it's showing the right trend.

Okay. All right. Excellent. And on the other important I guess driver would be this virtual office analytics suite, and I hope to learn more about it at your analyst day. But anything you can give us, as far as the traction of that product? The number of users, or I guess the better way to look at it is maybe a percent of your customer base that this would apply to. Is it 10% of your customer base? 50% of your customer base? How would we define a market or the upsell opportunity of this virtual analytics suite?

It could be virtually our entire customer base over time. The traction has been great. So in the sense, literally two months of, and we introduced it, if I remember right, late January, early February, we've already hit $30,000 of MRR in two months. We're not going to break it out separately because it's an add-on.

But this is telling me something. Right? It's telling me what you and I have discussed in the past. We are transitioning -- VoIP is just the start. Right? So you start with VoIP, you add the omni-channel, hallelujah. Next, you add this customer engagement and this complete solution. Great. Then you ensure that you are tightly integrated with the various applications so you have context, but then you start to layer on analytics.

And it has been very interesting how many people are using our analytics to try and understand how their communications are happening, how many calls are coming in, who are they coming into, dot, dot, dot. So we think this is going to be an increasingly bigger part of our strategy.

Okay. Great. And I wanted to venture out into international space, I would say I want to focus on Canada real quick. I know UK you had already mentioned good performance there, and that's good to see. But Canada, you had some channel partners from the past Contactual sort of presence. Now that you are fully integrated, is there much to write home about in that market segment?

Yes. It's starting to happen, to the extent that I believe we finally opened a Canadian subsidiary. So and we've got a couple of employees that are in Canada. The Canadian channel is also starting to go in the right direction. So yes.

Okay. And then, I want to leave one for Mary Ellen. On the G&A, that was up a little bit this quarter. Can you explain what were the drivers, and what's the go rate on that line is going forward?

The increase here is almost entirely due to legal fees, and then we had mentioned that we took a loss contingency reserve. That's at $1.2 million, that in our G&A number.

Got it. So it should presumably come down in Q1 time?

Yes. We would expect that to happen, yes.

Very good. Very good. Vik, one more for you if I may.

Sure.

Coming from Enterprise Connect, a lot of chatter about Skype for business, now that you are moving upmarket, wondering if you are seeing -- are you bumping heads with Microsoft yet, Office 365 suite et cetera? How are you feeling? I know voice is still probably maybe six to nine, maybe even a year away, but it's certainly coming together, and they're guaranteeing quality of service and all that good stuff. So I guess what's your perception there, what's your view, and how you're seeing the market unfold, as they bring the heat on?

Yes. So we're not seeing them yet, so I don't think they are -- they're not in the place that we're playing in. And as I told you, the thing I'm more and more convinced about is if you are a single -- if you're a one trick pony, then eventually the big guys can give you a hard time.

But in our case, I'm more and more convinced that the fact that we have this integrated solution, where you've got customer engagement, the VoIP, the omni-channel, tied in with back office integration with NetSuite, Zendesk, salesforce, and then being able to layer on all these analytics so that you can really be customizable to a large enterprise, to help them solve their business problems, I think that's going to be hard for somebody that's a pure volume player to just to play in, so I like our competitive position.

We haven't seen them yet. But if we do, again, hallelujah. I like to think the completeness of our offering gives us a non-trivial edge.

Mike Crawford, B. Riley.

Thank you. So Vik, but for that $1.2 million charge, your G&A would have been the same, $4.6 million you had last quarter, and you don't see a lot of change there, at least initially, before you turn up your spigot. You also have these 80% service gross margins, which I don't think you're expecting to deteriorate in the near term.

You talked about maybe potential acquisition. I guess that would be a technology acquisition? Because I don't think you include acquisition revenue in your guidance. Is that correct?

We've included some expense associated with it, but it would be primarily technology acquisitions. And then also in some instances, it may come with some revenue, but more often than not, they'll come with some loss also.

But there's no revenue --

There is no revenue associated with an acquisition in our guidance.

Yes.

Because it -- so basically it would be M&A that would, is just about the only way I think that could get you down to the low end of your target pro forma guidance, which as you mentioned, was something you exceeded handily last year.

Yes. No. But I think part of his I'm starting to ramp up in order of priority -- engineering, I'm continuing to ramp up. That's an area that I think we've had incredible productivity for a company that spends what, 8%-ish on engineering compared to competitors that spend 20%. We are going to start ramping that up, as I indicated, so that's a non-trivial increase in expense right there, while at the same time, making sure we don't lose that productivity. I think we get more productivity per engineer head than anybody else that's out there, and I think we want to have that number increase in terms of keep the productivity the same but have the overall number increase.

Second area, demand generation, particularly at the enterprise level, we want to really start to put some money into. We are starting to see a bunch of larger companies go in this direction, and we want to increase our demand generation activity, want to increase our branding activity, want to increase our channel-enabled activity and training for channels, et cetera, et cetera. And then on top of that we want to build up this enterprise sales team a little bit more, keeping SMB essentially flat.

So when you start to add it up, those are three areas of nontrivial investments that we will be making that will be faster than revenue. And then layering the fact that a couple of acquisitions that we are looking at, one that may come with no revenue but great technology, one that may come with some revenue but losing a little bit of money, so wanted to make sure that all of that was baked in.

Okay. Thank you. That is helpful. And then just slightly different, your customer success team, I think, has been primarily a middle market effort. But is that -- are you applying similar techniques to the SMB market?

Not yet. I mean, that's actually a great question, because what we're finding -- I'm heading slightly different direction for the SMB market. We're putting greater emphasis, this goes back to really leveraging our own tools.

So we have our own VCC, being able to provide a level of personalized support where when you call in, we know which number you called in from, your record is automatically pulled in, doing skill-based routing, so we can basically have all our various call centers. So if one has excess call flow, automatically routes to the other, adding in knowledge tools so that you can essentially do a lot of self-help, creating chat sessions, so you can answer questions coming up with FAQs. I'm trying to figure out a way to make SMB more and more automated, and have the customer success team more and more focused on the midmarket, as well as enterprise, where there's a lot more hand-holding involved.

So that's the way we are evolving, which is why I'm so pleased with the fact that our SMB team is starting to sell larger and larger deals. I mean, those guys have transitioned -- is not easy to start to have an SMB team that suddenly starts selling $1,000 MRR type deals on a consistent basis, and these guys have done it. And now, we're trying to make sure that the support organization is able to support the larger and larger customers with less and less touch.

Great. Thank you. And then final quick question is, as you are upgrading infrastructure to 10 gig and the like, does that mean that we should expect an increase in CapEx this year as well?

Yes. Yes. We are continuing to invest, not only in our infrastructure, but also in our back office systems.

So $8 million?

I don't -- no I don't think it'll be that much. No. We're actually -- we're CapEx light compared to other SaaS companies, but we are moving up as a percent of revenue. So I wouldn't expect it to get as high as $8 million. No.

Okay. Great. Thank you.

You're welcome.

This does conclude the question-and-answer session of today's program. I'd like to turn the program back to Vik Verma, CEO.

Thank you, folks, for joining us today. For those attending or listening via webcast we look forward to further discussing 8x8's vision and strategy at our upcoming analyst day on June 4, 2015. Again, look forward to it, and thank you very much. Bye-bye.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.