8x8 Inc (EGHT) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the 8x8, Inc Q3 2017 earnings call.

(Operator Instructions)

As a reminder this conference call is being recorded. I would now like to introduce your host for today's conference, Joan Citelli, Director of Investor Relations. Please go ahead.

Thank you, Charlotte and welcome everyone to our call. Today i'm joined by 8 x 8's Chief Executive Officer, Vik Verma, and our Chief Financial Officer, Mary Ellen Genovese, to discuss 8 x 8's third fiscal quarter of 2017 financial results for the period ended December 31, 2016.

The earnings press release which was issued today after market close is available on the investors section of 8 x 8'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 things 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 using the terminology may, will, believe, expect, plans, anticipate, 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 factor sections of our annual report on form 10k, 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. I would also like to note that during this call we will provide financial information that has not been prepared in accordance with generally accepted accounting principals in addition to our GAAP results.

Management uses these non-GAAP financial measures internally in analyzing our financial results and believes they are useful to investors as a supplement to GAAP measures in evaluating the Company's ongoing operational performance. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures.

This reconciliation has been provided on the financial statement tables included in our earnings press release. And with that I will turn the call over to Vik Verma, Chief Executive Officer of 8 x 8.

Thank you, Joan, and thank you, everyone, for joining us today. Our financial results for the third quarter of FY17 were strong with a 23% increase in service revenue to $60.1 million and a 20% increase in total revenue to $63.7 million. Adjusting for constant currency and the previously reported discontinued segment of our UK operations, service revenue grew 28%, and total revenue grew 24%. Non-GAAP net income was $5.8 million or 9% of revenue.

This is the 27th consecutive quarter that 8 x 8 has been profitable on a non-GAAP net income basis. Along with these solid top and bottom line results we have made very good progress during the quarter executing on the strategic initiatives we have outlined for continued growth. These include one, increasing adoption by midmarket and enterprise customers; two, building an effective worldwide channel organization; three, enriching our product portfolio with new features and services; and, four, and enhancing our global systems to support our multinational customers and partners.

First, looking at our progress moving up market, I am pleased to report that during the third quarter of FY17, service revenue from midmarket and enterprise customers grew 36% year-over-year and now represents 55% of total service revenue. We are now seeing a steady flow of midmarket customers adopting cloud communication solutions similar to what we saw in the SMB segment a few years ago, and enterprises are steadily beginning to come on board.

60% of the new monthly recurring revenue booked during this quarter came from midmarket and enterprise customers and our channel sales team. Our differentiated suite of integrated unified communication, contact center and analytic services combined with our superior deployment capabilities and reliable high-quality global network are the reason cited most often by larger customers who choose 8 x 8 over competitive vendors.

Of our top 20 customers, 15 subscribe to both our unified communications and contact center solutions, and 19 utilize our analytics capabilities to improve productivity and gain insight from their day-to-day communications activity. Also, we are now seeing the enterprise market moving beyond early adopters to more mainstream customers. These customers tend to use the same traditional procurement methods that drive other corporate buying decisions and are increasingly employing a land and expand deployment strategy initially committing to a subset of their organization and subsequently adding new locations and users.

For example, this quarter, we added to our enterprise customer list a division of a large well-known fortune 50 company that is a good illustration of this land and expand strategy. Brought in by our direct sales team, this high profile healthcare company selected 8 x 8 as a the vendor to transition over 400 offices of the various client medical practices it manages onto a single cloud-based communications system. Our selection followed an extensive 12 month RFP process involving more than a dozen vendors in a rigid proof of concept testing culminating in a master service agreement with this customer.

Under the agreement, 8 x 8 will provide virtual office and virtual contact center services to an initial set of designated locations, and we anticipate that the remaining locations will follow. 8 x 8 successfully went live at the first set of medical practices earlier this month, and we are currently finalizing plans to deploy a large practice with 12 locations consisting of 750 virtual office extensions and 60 virtual contact center seats in the coming month.

By becoming the chosen cloud vendor for this division, we were granted access to a captive market of over 400 medical practices and approximately 10,000 users. In addition, the division with which we contracted is one of many divisions that make autonomous buying decisions, but who tend to give weight to the buying decisions and previous vetting of vendors by other peer divisions.

We now have a proverbial foot in the door of what is essentially a new channel with a partner whom we expect to be a zealous advocate within the larger organization provided we execute to our abilities. The time and resources we invested to become the chosen vendor of one division was substantial, and the initial commitment was low. But the opportunity is large, up to $9 million in contract value for this division alone.

By comparison, many of our previous early adopter enterprise customers placed an initial order for most or all of their locations resulting in large initial bookings, but with gradual deployments generating revenue recognition over subsequent quarters. Although these recent enterprise customers have represented comparatively smaller initial bookings, and [numer] in this section -- sector was essentially flat this quarter, we expect them to deploy additional locations at a rate similar to other enterprise customers and do not anticipate an adverse long-term revenue impact.

We also continued to add sizable midmarket accounts during the quarter including a leading manufacturer of turnkey sorting and packing solutions for the fresh produce industry with approximately 500 virtual office and virtual office analytic seats and a provider of products serving the food service and food packaging industry with nearly 600 virtual office seats across 12 locations.

In addition to new logos being at a by our sales team we are seeing consistently strong expansion revenue each quarter with over 50% of new monthly recurring revenue coming from existing customers in the form of additional seats and services. Some examples of these expansive deals from the third-quarter of FY17 include Regis with an additional 15 virtual office and virtual contact center seat, Net Suite with over 500 virtual office seats, True Blue with over 400 new seats, Social Finance and Patterson Medical Products each with over 300 virtual office and virtual contact center seats and a leading media company based in Los Angeles with over 1100 additional virtual office seats.

Second, our channel continues to grow and perform well bringing us 5 of our top 10 deals in the third fiscal quarter. One of those deals is a rapidly growing enterprise retail customer that went fully deployed that encompass over 10,000 virtual office extensions in 3500 locations across 49 United States. This customer selected 8 x 8 because of our excellent reputation in the retail space, experience deploying large customers in an efficient and timely manner, deep analytics capability, and ability to provide service internationally as they expand outside of the United States.

The channel also brought us a combined virtual office and virtual contact center, a customer a cemetery and mortuary business with 700+ seats deployment. This customer chose 8 x 8 following a successful proof of concept trial deployment that demonstrated how 8 x 8's integrated offering would streamline communications and customer engagements across all of their locations.

Another combined virtual office and virtual contact center customer that came through the channel is a leading manufacturer and e-commerce retailer of point of sale displays. Our single unified communications and contact center platform, along with the customer's need to be up and running with all users in less than 45 days were two of the reasons they selected 8 x 8 for this 200 seat deployment. This customer is using mobile and cell phone only demonstrating the growing trend we're seeing away from physical desk phones.

We announced several new channel partners during the quarter along with our new partner, Connect Global Portal, enhanced sales and technical training and expanded channel enablement offerings including marketing and demand generation support. 8 x 8's global channel team has doubled over the past year with employees now in North America, Europe, and Australia.

Third, on the product innovation front our recent investments in the contact center capabilities of our platform including global tenant, analytics and quality management are beginning to show good results. Revenue from virtual contact center grew 32% in the third-quarter period last year.

A Q3 deployment of our virtual contact center solution for the International Red Cross by our UK office is a good example of how customers are able to easily deploy and utilize our powerful customer engagement solution. Completed in less than one week, this 70 seat deployment supported the Red Cross' serious request family of annual multi-day, multimedia fundraising events which recently focused on raising awareness of pneumonia. Due in part to the swift trouble free implementation of our solution and accompanying reliability, the campaign successfully raised nearly EUR9 million for this cause.

Our path and portfolio continues to grow with our recent notification of three new patents for a total of 120 awarded patents to date. In addition we continue to expand our resources and in Romania to supplement our existing R&D and engineering operations with dev ops, knock, and customer support professionals. We now have nearly 100 full-time employees working out of our Romania office and over 1000 employees worldwide.

With this expanded capacity we have a rich pipeline of new products and enhancements that we will start launching this coming quarter including open platform capabilities, new mobile and desktop apps and more out-of-the-box integration and real-time analytics.

Fourth, we made significant progress during the quarter expanding our global capabilities including ongoing investment in our back-office infrastructure. We have completed the transition of our global sales team to a single sales cloud environment, and we are in the process of implementing a major refresh of our ERP system to unify financial operations across all of our regions.

Additionally, we have completed the second of three phases to rollout service cloud across a global support team to enable seamless 24/7 support capabilities to our midmarket and enterprise customers. With these infrastructure projects, we are rapidly preparing our business for the next stage of global growth.

Finally, I am excited to announce the completion of a small technology acquisition earlier this month that will bring us some really innovative collaboration capabilities. We will be providing additional details about this technology and how it fits into our global communications platform and strategy in March. So stay tuned.

With that, I will turn the call over to our CFO, Mary Ellen Genovese.

Thank you, Vik, and thank you all for joining us today. Let's begin with some highlights from our income statement. Total revenue for the third-quarter of FY17 grew 20% to $63.7 million, and service revenue grew 23% to $60.1 million. On a constant currency basis, current total revenue increased 22%, and service revenue increased 25% year-over-year.

Further adjusting for the discontinuation of the non-core voice message broadcasting segment of our DXI operations which we announced last quarter, total revenue increased 24%, and service revenue increased 28%. We anticipate the continued depreciation of the British pound against the US dollar, and with the discontinuation of the non-core segment of our UK business to have approximately a 350 basis point impact on our GAAP service revenue in our fourth fiscal quarter.

On the product side, revenue declined year-over-year by 16%. As mentioned previously, we are seeing a trend whereby customers are shifting away from desk phones in favor of mobile and cell phone apps. This is good news for us and a trend we hope continues. Given the changes in customer adoption, we also anticipate product revenue in the fourth quarter to be comparable to this quarter.

Service revenue from our midmarket and enterprise customers grew 36% year-over-year. And it was 45% growth when adjusted for constant currencies and the discontinued segment of our UK business. 55% of our total service revenue is now coming from these larger customers compared with 50% in the same period a year ago.

My comments going forward will be based on non-GAAP results unless otherwise noted, and I remind you to refer to the tables included in today's earnings press release for a GAAP to non-GAAP reconciliation. Gross margin during the third fiscal quarter of 2017 was 78.5% compared with 74.8% in the same period last year. Service margin was 84.3% compared with 83% in the same period last year. The improvement in our margins this quarter is a reflection of several factors including the growth of professional services revenue which is increasingly becoming a standard component of contracts with larger customers.

Net income for the third quarter of FY17 was $5.8 million representing 9% of revenue compared with $4.3 million or 8.1% of revenue in the year ago quarter. On a constant currency basis, net income benefited by approximately 50 basis points or approximately $300,000. As Vik mentioned, this is 8 x 8's 27th consecutive quarter of profitability on a non-GAAP net income basis.

Sales and marketing expenses in the quarter were $32.9 million or 52% of revenue compared with $25.3 million or 48% of revenue in the same year ago period. As previously indicated this is one of the areas we have been increasing our investments to build out our channel presence and capture the growing market demand we are seeing.

The increase in sales and marketing expenses during the quarter was primarily due to an increase in salary and channel commissions to support our growth in channel. Also, continued implementation of our new internal system supporting our global sales and service organizations, and the build out of our global deployment team.

Moving on to some of the key operating metrics for the quarter, average revenue per customer was $414 compared with $359 in the same period a year ago. Average revenue per midmarket and enterprise customer grew to $4,412 compared with $4,017 in the same year ago period.

Gross monthly business service revenue churn on an organic basis was 1% compared with 1.2% in the same period last year. While the number has hovered around one half of a percent over the past few quarters, we generally see this take up a bit and the third fiscal quarter due to less usage over the holiday season.

Bookings during the third fiscal quarter for mid-market and enterprise customers and by our channel sales team comprised 60% of the total new monthly recurring revenue sold, 61% on a constant currency basis compared to 58% in the year ago quarter. Adjusting for constant currency and the discontinued DXI business segment, bookings from mid-market and enterprise customers and by channel sales teams grew 10% year-over-year.

In addition as Vik mentioned, we are seeing some of our large customers use traditional procurement methods whereby they buy in tranches from a pre-negotiated Master Service Agreement. We do not anticipate this buy in methodology to have an impact on long-term revenue growth.

Expansion revenue from existing customers comprised over 50% of the total new monthly recurring revenue booked during the quarter. This remained strong quarter after quarter and is a solid testament of the value our solutions deliver and the flexibility our cloud-based technology enables to support customer expansion and growth.

Cash, cash equivalents, and investments were $173 million at December 31, 2016 compared with $155 million in the same period last year. Cash flow from operating activities was $8.8 million in the third fiscal quarter compared with $8.3 million in the same period last year. Capital expenditures were $2.8 million representing 4% of revenue compared with $1.7 million or 3% of revenue one year ago.

We are maintaining our annual guidance for FY17 of revenue in the range of $251 million to $254 million and raising non-GAAP net income guidance to range of $18 million to $20 million representing non-GAAP net income as a percent of revenue of 7% to 8% from previously issued non-GAAP net income guidance in the range of $16 million to $20 million.

As a reminder last quarter increased our FY17 annual revenue guidance from a range of $249 million to $253 million despite headwinds of approximate $4.4 million from the discontinuation of the DXI voice messaging service and the continued decline of the British pound. That concludes my prepared remarks, and I will now turn the call over to Vik.

Thank you, Mary Ellen. There is no question that cloud communications adoption by the midmarket and enterprise market segment is upon us. From food producers to healthcare corporations, to mortuaries, 8 x 8 is favorably positioned to capture more than our fair share of this emerging demand.

What is even more exciting is the strategic value these companies are already placing on the communications as a critical component of business productivity, planning and growth. We recognized this trend several years ago when we began developing analytics tools from customers from our Big Data environment.

Now we are committed to taking this value proposition further through what we would believe would be an unprecedented move forward for the cloud communication industry. Stay tuned for more on this in March at Enterprise Connect. 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.

Good afternoon thanks for taking my question. Vik, as you expand your sales channels overseas, can you highlight some of the similarities and differences on how the channel works here in North America versus in other countries.

Slightly different. In the North American channel to a large degree is more like a referral network where increasingly what we are seeing with international channels is they are much more value added resellers. They tend to pick one or two vendors, typically one and then they build a practice around them. That is actually a much better approach because then you don't mind investing significantly and basically making that channel effective.

That is a decision we then tend to make on different locations. I want to make sure that I have people there that can enable the channel, provide them the support, help train them but to a large degree I don't need to have that many employees at different parts of the world because I can leverage the channel because they are essentially either exclusively or semi-exclusively selling us.

That has been one of the key areas that we see as an area growth and a way to get leverage and yet maintain our headcount relatively steady.

How does that impact your sales and marketing spend on a per unit basis if I could frame like that?

We plan for this. That was always our strategy. Over time I think we are starting to get to critical mass on sales and marketing. We will start to see more leverage out of the sales and marketing spend over time.

I do want to make sure we increase our brand recognition because I think we've now got the entire and comprehensive product portfolio. I have been somewhat reticent to go out and really do a massive branding campaign or anything else like that. I may start to tweak that up but as a percentage of revenue growth, I assume the sales and marketing growth will be consistent with or maybe slightly lower than revenue growth going forward.

Engineering I will continue to invest. From my perspective, through a combination of luck and hard work, the team has assembled three very core technologies all under one roof. We have got the essentially collaboration type technology. We have got the contact center technology. And we have got the whole virtual office technology, and they are all on a common platform, and we are starting to expose the APIs to a complete refresh on our UI and make sure we head towards much more of a micro services architecture.

I feel like that is a huge strategic weapon, and we will continue to invest in engineering faster than the rate of revenue, but sales and marketing will either stay at the rate of revenue or start to decline in terms of investment as compared to revenue growth.

Thank you.

George Sutton, Craig-Hallum.

Thank you. Vik, I realize now how to make you giggle. I need to mention cemeteries and mortuaries. (laughter)

That was hard to read.

I wanted to take what you just had relative to getting the critical mass on sales and marketing a little bit further and speak more competitively. You have been trying to build up your direct sales force more recently to try to get after more of the opportunities. Do you feel like you are getting to the point where you are seeing the vast majority of the opportunities, and then once you are seeing those can you just give us a sense what you are seeing in a win rate.

No, actually, we are not. That is one of the areas that I think I kind of make a comment. We are seeing a reasonable share of opportunities, but we are not a household brand.

We are fundamentally, I would take our technology put it up against anybody and I would say, we are awesome and the fact that we have it all integrated together makes us truly differentiated. We do need to get better as a company in getting our brand out there. And what has been going on with us is I think we have built up a very strong enterprise sales team, and we are seeing, I think as you saw, we talked about the whole concept of whales, our whole goal is to get a couple of whales and the next thing you know, 10, 12 whales all jumped on the boat.

From that perspective, we do need a bigger boat. We are starting to now put much more of a replicable machine together, because we are starting to feel like we understand which of the larger customers have a much more predictable buying pattern and buying behavior, and what we are trying to do is subsegment that market and then create much more efficient teams.

That is a work in progress, and I think we will be putting much more effort into creating this level of replicability, because we have had such a vast number of customers from the different parts of the industry that we can come up with a sense which ones go through what type of buying behavior, how do they buy, when do they buy and which ones are ripe for basically the quick wins because they all self reference each other.

And so we are going that next stage of evolution as a company.

You mentioned household brand name and I guess it depends on the household, but Avaya is a pretty well-known brand name out there, obviously just filed for bankruptcy. I wondered if you could address any potential opportunities you see for 8 x 8 through that situation.

If I had a Cessna that I could get it I was going to put a little sign on it that says 8 x 8 welcomes any potential Avaya customers and/or channel partners and fly it around Avaya headquarters. I see that as a logical evolution. You never wish anybody ill, but Avaya was traditional enterprise -- on premise and cloud is disrupting.

To use your phraseology I was actually also startled by some of the type of customers that you start to see now that are adopting cloud and just the way they adopt cloud. When you think about it you have the entire circle of life from food producers to healthcare providers, to mortuaries services.

You've got them all covered. They are all starting to move towards cloud, and I think that's going to accelerate. And also think about how much flexibility a system like ours gives to large companies. If you are adopting an Avaya system, a large on premise type system for a global enterprise, you have to buy the whole shebang or nothing works.

In our case you could literally start with two, three, four offices once you to negotiate the right service agreement and then keep adding rapidly over time. The flexibility then makes it that much more easy for enterprises to start moving. I think that trend is coming. I think we have to evolve towards the fact that we are now starting to see that next wave of enterprise.

These are not the techy geek type companies that really are comfortable with cloud. They view cloud as a business value and a way to move in this direction, but they are not necessarily that tech savvy.

So you have to build your support as well as your overall sales team to provide some level of education and then make it almost simple for them to use and that as I said, is the next level of maturation that is happening for us as a company.

Thank you.

Rich Valera, Needham & Company.

Thank you. I wanted to just follow-up on a question regarding the growth of your midmarket MRR, Mary Ellen. You had mentioned that I think past purchases from a Master Service Agreement had caused that to slow relative to historical rates. I was wondering if you could just clarify that and talk about how you see that growth rate trending in the future?

Good question, Rich. This quarter, as you know we booked a very, very large deal, a Fortune 50 deal that we are really honored -- very honored to win. We were up against a number of competitors and it was a one year process with a POC that ended up in a very long negotiated Master Service Agreement.

As part of that, there were a couple of offices that they booked this quarter. If you go back a quarter, or you go back to our third fiscal quarter of 2016, or even the fourth fiscal quarter of 2016, we had large whales that booked their entire enterprise, so they booked their entire enterprise.

A big deal, so all of GameStop, the 4000 stores in the United States was booked all at once. Movement Mortgage, 6000 employees booked all at once. Auto Europe, they wanted first just a contact center and then when they realized that the cloud savings would also help them pay for their virtual office, they wanted both at the same time.

You deploy those over a period of anywhere depending on the customer, anywhere from 6 months to 12 months to 18 months. So you have a big booking upfront but then you have deployed revenue over 6, 9 or maybe even as far out as 18 months. In this particular case it is different. You get a small number of dollars booked upfront, but then you deploy the same way.

They start to -- they have already started to release purchase orders. We have already started to deploy these offices. It will be the same we think over the 6, 9, or 12 months or 18 months we will get the same amount of revenue regardless of whether we book 100% of it upfront or whether we just get the small piece first, and then continue to expand. And it may be too early.

We have a number of customers that have done this. Maybe it is too early to call it a trend. But I wouldn't -- I think moving forward we are going to see more and more of our enterprise customers, more of these traditional enterprise customers book in that regard.

Got it. But your experience so far makes you think that the cadence of new customer additions under that agreement is likely to be similar to those customers that have historically booked the whole thing upfront.

Yes. And I think we are seeing that. It is quite interesting because where previously, as you indicated, early adopters tend to go out and it stretches out over 18 months. These guys will tend to spend a lot of time doing a proof of concept and making you either an exclusive or preferred vendor, with a well-defined Master Service Agreement and then that almost became [like] a catalog and then they start essentially adding addendum after addendum to the catalog and expect the deployment to happen in 30 days or 60 days. A very quick deployment.

Here's the contract. Deploy this office in 30 days from now, it is done, next; versus coming up with a large program plan for deployment over an 18 month period.

Got it. That makes sense. Just following up on the theme of investment. It sounds like both R&D and sales are clearly focused this year. But when you look at your annual guidance for net income, it would appear that the fourth quarter you would be down versus the average for the first three. Which seems a bit challenging assuming the revenue goes up a bit.

But I wonder if you just put a little color around that, what are some of the incremental investments in the fourth quarter that get you that pretty significant bump in OpEx that appears to be baked into your guidance? Thanks.

Thanks, Rich. Our fourth fiscal quarter typically is a larger investment quarter from the others for two main factors. One, is you start the security clock all over again. All of our employees are paying a higher fringe benefit. Second, is that we have a fairly big show at Enterprise Connect at the end of March which is a big show for us.

It's the biggest show of the year, and this year we expect to have a major launch of our new products. Those are two key things but in addition to that we want to also prepare for our FY18 kickoff in April. So we are hiring the team now that is going to be needed and required to meet our numbers for FY18. We want them to be up to speed and on boarded, ramped and being able to kick off a new year in a great way.

So there are those investments that we are kickstarting for the new year.

And as I said, what Mary Ellen kind of alluded to, we acquired a company in the collaborative space which we think is really innovative. We have also got a major -- we are using Enterprise Connect as a way to completely refresh our UI for all of our core products because that was one of the areas we put emphasis on. We will be introducing several new products into the US market that we have been getting ready to launch.

The idea is to just kind of, we think we have kind of built a critical mass across the board. We have kind of gone through our series of learnings, and we want to use as an opportunity to really go out and show the breadth of products that we have that are all now going to be integrated together with the next generation of UI.

So if you are at Enterprise Connect, we welcome you to join us. I think you won't be disappointed.

Thank you. Amir Rozwadowski, Barclays.

Good afternoon this is Matt for Amir. Just a quick question on the midmarket and enterprise customers. Obviously that has grown from 40% a few years ago to 55% today. Do you have a target mix in mind that you would like to hit over the next two to three years?

The number that I am looking for is ultimately our future is enterprise. We still have, we will continue to service our SMB customers. We love them. We think we can provide significant value for them, and remember we are a cloud vendor so anything we develop for the enterprise customer is basically provided to our SMB customers for that same low price.

So from that perspective, over time I would like to see 70% or 80% of our revenue base coming from midmarket and enterprise, because the main thing, and I'm becoming a big fan of this, because of the fact that we have such a comprehensive product portfolio, there is an unprecedented opportunity for land and expand. So once you go in and you build up credibility with a customer by providing them the core communication platform, the ability to add contact center becomes very, very, very significant.

And then you can add our Virtual Meeting product which essentially gives you a WebEx equivalent, a much lower end of that but basically gives you that type of functionality. And then you can add your quality monitoring which gives you speech analytics as well as the ability to do agent training. It allows us to do some of our sales analytics, too. So that -- midmarket and enterprise customers do that. And that is why you are to see land and expand become a bigger and bigger piece.

Second, as I said from a contact center perspective we are typically going to a customer with our virtual office, and then we bring in our virtual contact center, but that is an area we have been putting a major amount of push into, and as a matter of fact, I am going to keep accelerating the push into our virtual contact center, because that is a hidden gem.

I think you saw it this time where the growth rate for virtual contact center has gone from 16% a year ago to 32% this year. And I think that thing is going to keep moving up and then we've got our product in the UK which is a very low end contact center which is intended for nontraditional contact centers which we will be introducing into the US market in the March timeframe.

That whole concept of land and expand is increasingly more important to us and that is tailor-made for midmarket and enterprise customers so long-term a couple of years ago from now I would love for that mix to be 70% of midmarket enterprise, 20%ish to 30% as SMB customers.

And just a quick modeling question. I know Mary Ellen you had said that the pound is going to be 3 -- you're expecting 350 basis point of a headwind in Q4. Could you just help us reconcile how that compares to, I believe it was $4.4 million you gave us last quarter for the full year impact.

Right, the $4.4 million was a full year impact. So the 350 basis point was only for Q4. So if you look for instance as an example if you look at this fiscal quarter Q3, 23% was our revenue growth on a GAAP basis.

But then when you corrected for constant currencies, and you corrected for the discontinuation of that one business segment non-core business segment in the UK we are at 28%. On an apples to apples basis, we would have had 28% growth rate. That is about a 500 basis point. Next quarter we don't expect it to be as significant. It will be approximately a 350 basis point difference.

Thank you for taking my questions.

Dmitry Netis William Blair.

Thanks, guys. Just to [pound] on the last question you addressed, so 500 basis points this quarter. 200 of that was FX and 300 was discontinued operations, is that correct?

No. That is actually not correct.

Okay. Can you tell us exactly how that 500 split this quarter.

It was -- it was a 23% on a GAAP basis. 25% on constant currency basis and a 28%. That is a 300 basis point difference just on the discontinued basis and a 200 basis point for the constant currency. You were correct. Sorry.

And then 350 next quarter how much is FX versus continued discontinued operations?

That is a good question I didn't actually do it that way, but you could do the same percentage cut, if you will.

Okay. That makes sense. And then the midmarket service revenue growth up 36%, if you adjust what constant currency and exclude FX, what would that number look like? I think you might have mentioned it but I might have missed it.

Which question is that? Is that for he midmarket revenue growth?

Yes. Growth but what would it be on a constant currency?

45%.

45%. Last quarter it was 40%. Is that right?

Last quarter was 40%.

Okay. Excellent. And I guess, I wanted to also see the virtual contact center is spectacular growth. It is almost doubled from a year ago. It grew I think 32% year over year.

I just want to understand, is it as a result of competitive environment easing, or maybe additional product capability you added, and even all of the things? I would love to see your thoughts on that growth being sustainable going forward, and maybe the line of business product sales force analytics, if you can comment how that is doing in the market and whether that is going to add to growth or will retain that sort of run rate on the VCC side of things.

Our contact centers are a Goldmine. In essence, it is an area that we neglected in the sense that, that had not been the push for the Company because we had been getting such great growth from our overall core [BDX]. And over the last couple of years, I had come more and more to the conclusion that both virtual office and virtual contact center belong together and kind of build on each other.

And so over the last year, year and a half we started to put major investments into it. We have went through and created this whole concept of a global tenant and followed this on. We are doing a complete platform refresh. By the way, you have not lived until you go through and do a platform refresh and any remaining hair I had fell off.

What it allows us to do with doing this complete platform refresh changing [gooey] adding key features is more and more this product is starting to become a product that's standalone; can hold its own. It is not quite there, but we are getting very close, where what we have is, we will end up with best of breed products. I will put our VO product against anybody and I would be very confident in what it is.

VCC traditionally has been essentially one bubble off center, but over time we have started to now make it much more of a focus and I actually think that, that has huge growth. And I'm going to put more and more emphasis on it, because the more that I dig into VCC the more I see huge opportunities for that to be not just a standalone product but an additive product with VO.

And then we have a third leg to that which is our easy contact now or contact now product for UK which is essentially a try by and deploy contact center. You literally download -- not even download I'm sorry. You have your web. You log on and you are now starting to use the contact center; and can use it to do outbound dialing and you can take inbound calls and it is simple to use and it is completely seamless, no training involved, no professional services.

So for nontraditional contact center we think it can be very disruptive. We want to introduce all three of these products together. I expect contact center both VCC and ECN over time to be a very appreciable growth driver for us, and we want to make sure that those get the kind of attention and energy and effort that they deserve because in the past we have underinvested in those.

Will Power, RW Baird.

Hey, guys, thanks for taking my question. This is actually Charlie Ehrlich on for Will. I was wondering if you could tell us who specifically did you guys compete against for those two large customer wins this quarter, and how competitive was that process, and how do you ultimately think that you ended up winning that contract? Thanks.

I don't know specifically and the one was 12 vendors and I know one was a whole bunch of vendors. I'm not sure if we can tell you who, by I think, we all signed an NDA with the customer in terms of the process. What I can tell you and this tells you what is our strength and what is our weakness.

We always get brought into every deal late. I figured that part out and we have just learned to live with the fact that nobody knows our brand as well as they should. And our intent is to start to change that. Every deal we have is competed.

More often than not, the more complex the deal, global, virtual office, virtual contact centers, the more complex the deal, the more demanding the requirement with uptime reliability and stuff like that is very critical, we win. If it is pure cosmetics or simple application and UI is the key driver, that is not necessarily our strength. It will become our strength as I said. We are going through a complete refresh but we believe we can kind of compete on all levels but because we have captured the high ground which is our ability to compete for very complex deals where reliability, integration and the comprehensive on the solution is key, we win on those. I want to make sure our UI is world class.

Once the UI is world-class and you will start to see that around March timeframe I think it will be tough to beat. But the other part we have to do is more and more we have to start making our brand known. I think with the wins we have had and the kind of prominence we have had, with a complete [comprehension] of the portfolio that we have assembled and the gaps that we have that we have subsequently filled, collaboration being one of them. I think we have an opportunity to really be a one-stop shop.

So I think we will start to really raise our brand starting in the March timeframe.

Makes sense. Thanks.

Mike Latimore, Northland Capital Markets.

Thanks. Just on the ARPU is look like it grew about $5 in the quarter. It has been growing $10 or so. Any influence from the discontinued ops or generally, how do you see ARPU trending over time?

If you look at the midmarket ARPU, it is trending right in the same direction as it has in the past. It is a little lumpy from a percentage perspective. This quarter was 10%. Last quarter was 7%. The quarter before that was 10%. The quarter before that was 7%.

Within that 7% to 10% mark seems to be pretty consistent. On the total ARPU it was a little bit lower. It was 12% at this time. It was a 14% last quarter and 13% the quarter before that. I think we are in the ballpark. I would say 12% seems to the low over the last couple of quarters. Maybe 11% to 13% moving forward.

Great. Thanks. Professional services you sort of mentioned that. Can you gave a general sense of what percent of revenue professional services is today and what it was may be a year ago?

That is something that we started this year actually more actively pursuing especially with our larger accounts and professional services contracts to do deployment. Will don't really get any push. We get push back of course on the smaller customers but on the larger customers they are used to paying for deployment.

So this particular quarter was slightly more than 1% of revenue. It is still small, slightly above 1% of revenue. About a year ago it was maybe 0.5% of revenue.

Thanks.

Mike Crawford, B. Riley and Company.

Thanks. To only hit the high end of your guidance for Q4 looks like OpEx would need to grow about $4 million or $5 million from the pro forma $43 million in Q3, so would you be able to provide just a little bit more color on how much of that might be from a technology acquisition or how much of that is enterprise connect and how much of that would carry through into next year? Thank you.

A little bit it would be from the technology acquisition. Not a significant amount. We did hire a very capable team, but think of it very much like our Quality Rocket acquisition that we did a little bit more than a year and a half ago. It started out with a team maybe seven or eight individuals pre-revenue.

But the core of some phenomenal technology that we've been able to bring to market very quickly. That is the same situation here. In addition, we are ramping up our R&D as Vik has said. We were down year over year from 10.4% on a non-GAAP basis to 9.5%.

We really want to pull that up from a non-GAAP perspective. We will not be able to do overnight of course, but we are building a very solid team in our Romanian operations. We were able to get some of the best of the best university students as well as some folks that have 10 to 15 years of experience that can lead the agile teams, the [scrum] teams there.

We will be making investments. We will be preparing again, as I had said, getting ready for our new fiscal year and FY18, so we will be hiring additional direct salespeople in our enterprise team as well as our midmarket team. And we will continue to ramp up on the channel because that is where seeing the traction. We're seeing traction on both sides, but we're seeing some very nice traction on the channel. So we continue to search for channel account managers. You are going to see increases across the board.

Thanks, Mary Ellen, and then the second question is the -- while we fully expect the midmarket enterprise to continue to comprise a little bit more than half, 60% this quarter of new [mirror] book. You also started booking substantial amounts in your small office, home office business. Where would you say the market is relative to small office, home office and where 8 x 8 plays in that market?

It is continuing to grow robustly. We probably, it is important for us in the sense, that to me, as long as it has a great payback, it continues to grow, and we will continue to do whatever is necessary to make sure that we get our fair share. It is not an area we're going to at all neglect.

I like the business, and I have an integrated team. We have fully ramped up reps and good leadership there. And we are going to actually bring in some more help for them and actually even in that area we are going to simplify.

We are heading towards much more packaged solutions which will basically accelerate velocity because we are starting to see that people are able to buy without the kind of consultative sales process. From that perspective I actually think there is nontrivial headroom even in our SMB business. So the intent is I want the SMB business to grow. I just want midmarket and enterprise to grow faster.

One thing to remember, Michael, is that we are not necessarily going after the home office, the one to two line customers or the very small businesses of less than 10 lines. We are moving that team up as well because the payback for that size 10 plus lines they focus on the 10 plus lines up to 100 lines. And that is much better than the 1 to 10 line business which for us is a low payback.

Okay. Great. Thank you.

Jonathan Kees, Summit Redstone.

Great. Thanks for taking my questions. I want to ask about the CapEx that ticked up for the quarter. Are you now just expanding on the data centers? I know you had an increase of data centers from 9 to 12. Are you expanding on them. Is that the reason why CapEx ticked up from last year?

No. Actually this year is pretty consistent where we have been investing in next-generation capabilities and upgrading our technology in each one of our data centers, as well as now we are bringing the contact center now product that we purchased in the UK, we are bringing that to the US. We are building a new data center with new technology for that product here in the US to support that.

We are upgrading our technology for all of our virtual contact centers. We have the 12 media centers. They are up and running. Remember that is not huge investments because in that regard we are renting racks from a partner like an Equinox. Those are relatively inexpensive to do.

We might deploy another one or two next year. But right now it is more or less taking our technology in their contact centers to the next generation.

Okay. Thanks for the clarification - the explanation there. My next question is at a higher level. There has been talk in the news in terms of 8 x 8 being acquired or the board seeking strategic alternatives. I guess I want to reconfirm that the board is not seeking strategic alternatives, and then two if you can humorous, who could possibly be interested in 8 x 8? (laughter) I realize it's hypothetical. Just humor me.

Here's the thing. I think you've seen our governance score as a company, I don't remember the exact way they calculate it but we are as shareholder friendly a company. I have no blocking rights. I have no, nor do I seek them. We don't have multiple classes of shares. We don't have classification.

Everything is as blue-ribbon from a governance perspective as possible. We will do what is right for the shareholders. From time to time people express an interest. That is fine. Everybody is entitled to express an interest. We have a view on what this Company is worth.

Our view is that the larger the customer -- when we can get our midmarket enterprise base to be a very significant portion of our revenue, the value of the Company because the net present value for mid-market and enterprise customers 35 to 40 times that of an SMB customer that transition we think is well underway.

We have with all of these enterprise customers we have the land and expand opportunity. I think we believe we can get to a certain place on our own. In order for somebody to make a compelling offer they have to kind of bake in that value for us to be fair to our shareholders.

But I have a general philosophy. If anybody ever comes in and gives us an indication of interest or even makes an overture, I always involve my board because I believe that is my responsibility. I'm not trying to run this company like a fiefdom.

Who is interested? All kinds. You can get -- there is an alphabet soup of companies that at one time or the other either expressed an interest or circled around. To me it really comes down to are -- when somebody is willing to pay what I think the company is worth, and that is actually at the boards discretion, we will do the right thing for our shareholders.

Ultimately we serve at the pleasure of shareholders and the goal is to ensure that we maximize value for shareholders.

Catharine Trebnick, Dougherty & Company.

Good afternoon, thank you for taking my question. This is Jack on the line for Catherine. I just want to briefly hit on the international piece. Can you give us a percentage of the news that came internationally and are you seeing any differences in penetration rates, or purchasing behavior with international relative to the domestic environment for UCaaS?

For us our total international revenue is a little bit lower. We have been running about 12%, and it will be around 10% because the drop in the British pound. But when you actually look at our businesses in the UK, the solutions business that we have is growing well over 30% year over year in their current -- (multiple speakers) in their currency.

We have not seen any slowdown in the UK which is where most of our international revenue is. Certainly we will continue to expand into Europe and that will be a bigger piece of our revenue come next year. For right now we are not seeing any slowdown in the UK market.

I guess on the second part of that question are you seeing any difference in penetration rates, or purchasing behaviors in the international market relative to the US market for UCaaS? Any clarity on that.

I think the best way to characterize it is UK is about two to three years behind us in terms of adoption. And then I would say Western Europe is probably two to three years behind the UK. So, and Asia it is essentially comparable to Western Europe.

The inevitability of cloud is starting to become obvious all over. That is quite fascinating to see because it almost has become where as you said all mainstream businesses are starting to go down that direction. We see having positioned ourselves in the UK at the right time, and I think we're building a core capability that we've got quite a few people.

We've got a couple hundred people in the UK between London and Aylesbury, and now we have 100 people in Romania. We are as diversified and have a few people in Australia and a few people in Canada. We are diversified to take advantage of the trend.

I'm increasingly of the view that the vendor that can provide a comprehensive one platform type solution with virtual office, virtual contact center, virtual meeting as well as all of the collaboration capability, do that on a global basis with global support and global sales as well as global deployment and do it with the highest uptime and reliability stands to take over Avaya's crown that they are in the process of ceding.

I think that could be massive for us because that is what we are building the company towards, and that is what we are trying to be.

Got it. Thank you.

Thank you. I'm not showing any further questions at this time, and I would like to turn the call back over to Vik Verma for closing remarks.

Thank you all for listening in to our call today. We look forward to meeting with you over the coming weeks and perhaps seeing you at Morgan Stanley technology media and telco conference in San Francisco and even more importantly at the 2017 Enterprise Connect conference where we will unveil a broad set of new services and features. Again, thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you all disconnect. Everyone have a great day.