8x8 Inc (EGHT) 2018 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the 8x8 Second Quarter fiscal 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Joan Citelli, Director of Investor Relations.

Thank you, operator, 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 8x8's second quarter fiscal 2018 financial results for the period ended September 30, 2017. The earnings press release, which was issued today after market close, conference call script and accompanying slide presentation are available on the Investor section 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 using the terminology may, will, believe, expect, plans, anticipates, predict, forecast and expressions which reflect something other than historical fact are intended to identify forward-looking statements.

These forward-looking statements involve a number of risks and uncertainties, including factors discussed in the Risk Factors sections of our annual report on Form 10-K, in our quarterly reports on Form 10-Q and in our other SEC filings and company releases. Our actual results may differ materially from any forward-looking statements due to such risks and uncertainties. The company undertakes no obligation to revise or update any forward-looking statements in order to reflect events or circumstances that may arise after this conference call, except as required by law.

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 principles in addition to our GAAP results. Management uses these non-GAAP financial measures internally to analyze our financial results and believes they are useful to investors as a supplement to GAAP measures in evaluating the company's ongoing operational performance. Please refer to today's press release for a reconciliation of GAAP to non-GAAP financial performance and additional disclosures regarding these measures.

I'd now like to turn the call over to Vik Verma, Chief Executive Officer of 8x8.

Thank you, Joan, and thank you all for joining us on our Second Quarter Fiscal 2018 Earnings Conference Call.

This has been a very busy and productive quarter for 8x8. I'm pleased to report that we have made significant progress implementing the strategic initiatives we laid out last quarter. I'll review this progress shortly, but let me first begin with a high-level summary of our financial performance during the quarter.

8x8 posted solid top and bottom line results for our second fiscal quarter with an 18% increase in service revenue to $68.1 million and a 15% increase in overall revenue to $72.5 million. Service revenue from mid-market and enterprise customers, those billing greater than $1,000 in monthly recurring revenue, increased 28% and now represent 58% of total service revenue. Our non-GAAP pretax net income was $4.2 million, or 6% of revenue, and service margins remained strong at 83%.

The market continues to inflect, and we see tremendous opportunities for accelerated growth across the core customer segments we serve, from small business to mid-market and enterprise. Our goal is to drive revenue growth across our entire business with a continued focus on mid-market and enterprise customers along with new initiatives to accelerate revenue growth from small-business customers.

In order to position ourselves most effectively for our next phase of growth, we have identified and have begun to execute on several strategic initiatives. First, we are aligning global business units around our core market segment to optimize for growth. At the beginning of October, we segmented our internal sales operations into 2 separate business units: Small Business & eCommerce, aimed at businesses with 1 to 99 employees, and Mid-market and Enterprise aimed at businesses with 100-plus employees. We determined that establishing 2 separate business units will enable us to unlock the growth potential of each unit and allow us to optimize our sales and marketing strategies around the specific needs of each customer segment. These business units will align sales and delivery and be tightly coupled with demand generation, service and support to drive segment revenue growth and profitability globally.

Small Business & eCommerce will focus on our high-volume transactional business with an aim to accelerate growth and productivity through e-commerce and self-service. Mid-market and Enterprise will focus on both creating and leveraging channel relationship and building a direct sales force to drive a consultative approach to our land-and-expand strategy for larger accounts in the U.S., EMEA and APAC.

Second, we've appointed top industry talent to newly created executive leadership position in our marketing and sales organization to align with our new business unit and accelerate adoption of our solutions across all market segments. With these changes, we're aggressively gearing up to accelerate growth.

Third, we've expanded our global field sales organization with both mid-market and enterprise sales executive and channel development managers. Our field sales executives work directly with customers prospects to understand and customize the optimal solution for their business, while channel development managers are responsible for recruiting and enabling partners in their respective territory, evangelizing the 8x8 brand and growing the sales pipeline with partners.

In Q2, we had 21 new partners participating in our Channel Enablement Program with 6 of them already bringing us deals in the August and September time frame. 5 of our top 10 deals in the September quarter were brought in by our channel partners. Our unique differentiation in the market, driven by internally owned voice, collaboration, contact center and analytic technologies makes us a highly desired vendor partner to Master Agents and VARs that are rapidly evolving their business models to accommodate the transition from legacy to cloud communications that is occurring today.

Fourth, we laid the groundwork for some new marketing, branding and lead-generation initiatives designed to highlight the true value of our solutions over those of both legacy vendors and cloud competitors. 8x8 has the most comprehensive set of cloud communications, contact center and analytic capabilities in the industry.

Over the past several years, we have created, assembled and expanded the building blocks to reinvent the business communications market. We have transformed our core Virtual Office communications platform into an open platform with APIs, Script8, extensive integration and the leading global voice quality in the industry. In parallel, we've added a full spectrum of Contact Center and customer engagement capabilities with the acquisitions of Contactual, which brought us high-end contact center capabilities; and DXI with their innovative easy-to-use Contact Center functionality for business teams.

With the acquisition of Quality Software in Sameroom and their leading-edge technologies, we're ready to further leapfrog the industry with speech analytics for everybody and next-generation collaboration capabilities.

This has enabled us to further disrupt the market with a new suite of products that unifies cloud communications, collaboration, online meeting and contact center solutions with an end-to-end data analytics platform. Representing a combination of technologies from years of continuous innovation from 8x8, this launch signifies a new age of truly unified cloud communications.

In early October, we launched our new Virtual Office Editions product suite, including our groundbreaking 8x8 Virtual Office X8 Edition. Designed for easy consumption by small and midsize businesses from a pricing and packaging standpoint, VO Editions also includes 3 enterprise class business communication options, provides customers with the flexibility and mix-and-match pricing models that's best suited for their needs.

Our new 8x8 Virtual Office X8 Edition offers a unique and powerful business communication and collaboration solution allowing employees to interact anytime from anywhere and includes easy-to-use contact center capabilities, such as inbound call handling, outbound campaign dialing and rich reporting and analytics for new-business insights. This new offering enables companies to connect everyone throughout the organization, including both contact center agents and employees with a single unified solution.

8x8 continued to execute in the market with many sizeable customer wins during the quarter, including 13 large enterprise deals. 61% of the new monthly recurring revenue booked in Q2 came from mid-market and enterprise customers. One of our largest enterprise deals, carrying a total contract value of approximately $7 million, came from our U.K. team, which continues to enjoy excellent traction in the market, specifically in the public sector with local and central government opportunities. This latest government contract with Lewishan/Brent Council calls for an initial deployment of 10,000 Virtual Office seats and 600 Virtual Contact Center seats and potentially provides an opportunity to deploy our services to 30 additional London boroughs.

We continue to win sizeable mid-market and enterprise customers with our integrated Virtual Office/Virtual Contact Center solution, which was present in 8 of our top 10 deals in the September quarter. A new marquee customer win in the U.S. is Lenox Corporation, a market leader in quality tabletop giftware and collectables. For Lenox, we will be replacing a legacy on-premise system with approximately 600 Virtual Office seats and 70 Virtual Contact Center seats. 8x8 won this deal following a competitive RFP process that involves several of the UCaaS and CCaaS providers.

Another combination win was Standard Motor Products, a leading independent manufacturer, distributor and marketer of replacement parts for motor vehicles, calling for a deployment of over 2,200 Virtual Office seats and 1,000 Virtual Contact Center seats. 8x8 was selected because of our integrated platform, our global reach and our superior voice quality.

Collette Travel Services, a global travel agency, also selected 8x8 for a combined deployment of 530 Virtual Office seats and 140 Virtual Contact Center seats. Collette was upgrading to the cloud from an antiquated legacy system they had been using for 17 years and wanted to upgrade to the cloud. Our Contact Center solution was the driving factor for this global customer win.

Finally, 8x8 garnered recognition as an industry leader for the sixth consecutive year in Gartner's 2017 Magic Quadrant for UC-as-a-Service, an important validation of our continued investments to drive innovation in the cloud communication space and an acknowledgment of the great strides we have made in delivering measurable benefits for mid-market and enterprise companies. We were also named a challenger for the second year in the Gartner Magic Quadrant for Contact-Center-as-a-Service. And in a recent report published by Synergy Research Group, 8x8 was named the worldwide leader in both revenue and subscriber seats in the mid-market and enterprise segments of the UCaaS market.

In summary, our second fiscal quarter has been one of significant changes, which I believe, over time, will materially alter our growth rate trajectory. We brought some amazing new talent on board, rolled out our next-generation platform, launched a highly differentiated UCaaS offering and realigned our business by creating 2 distinct go-to-market vehicles that will materially improve our efficiency and win rate, all within the last 90 days.

However, we anticipate that the sheer volume of these changes will take 1 or 2 quarters to bear fruit. As such, we feel it is prudent at this time to reset the bar on our revenue expectations for fiscal 2018, but I feel confident that the investments we have made keep us on track for achieving 25% service revenue growth exiting fiscal 2019.

With that, I'll turn the call over to Mary Ellen for a more detailed discussion of our financial results and revised guidance.

Thank you, Vik. And thank you all for joining us on the call today. My commentary will cover financial highlights along with key operating metrics from the quarter. These measures will be based on non-GAAP results, unless otherwise noted. And I remind you to please refer to the tables in today's earnings press release for a reconciliation of GAAP to non-GAAP results.

Foreign exchange rate fluctuations did not have a significant impact on our comparative results this quarter as the British pound remained flat versus prior year. So none of the financial information we are presenting has been adjusted for constant currency.

Total revenue in the second quarter of fiscal 2018 grew 15% year-over-year or 5% sequentially to a record $72.5 million. Adjusting for the discontinuation of the noncore voice-message broadcasting segment of our DXI operations, total revenue grew 16% from the year-ago period.

Turning to specific revenue, line-item contributions. Service revenue increased 18% year-over-year or 5% sequentially to $68.1 million. On an adjusted basis, service revenue increased 19% from the year-ago period. Product revenue, which constituted approximately 6% of total revenue in the quarter, declined 20% from the year-ago period.

Service revenue from mid-market and enterprise customers grew 28% year-over-year and 6% sequentially. 58% of our service revenue is from our mid-market and enterprise customers compared with 53% in the prior year period and 1 percentage point improvement sequentially.

Gross margin for the quarter was 77%, almost a 2 percentage point improvement year-over-year and flat sequentially. Service margin was 83%, flat over the year-ago period and sequentially down 1 percentage point to the increase in -- due to the increase in third-party networking service costs, which are attributed to higher usage. Product margin was negative 17% compared with negative 6% last year.

Moving to operating expenses. Sales and marketing expenses in the quarter, which includes customer service, product management and deployment costs, were $38 million or 52% of revenue. This is up 2 percentage points versus the same year-ago period as we continue to execute on our strategic initiatives around channel deployment and demand generation.

R&D expenses were $7 million or 10% of revenue. This is up 1 percentage point from a year ago as we continue to invest and execute on our commitment to develop truly unified best-in-class communications solutions for our customers.

G&A expenses were $7.1 million or 10% of revenue. Quarterly net income before taxes was $4.2 million or $0.04 per share and 6% of revenue compared with $5.4 million or $0.06 per share and 9% of revenue in the same year-ago quarter.

We saw solid improvements in key operating metrics for the quarter. The average revenue per mid-market and enterprise customer grew to $4,697 compared with $4,351 in the same year-ago period. Average revenue per business customer was $442 compared with $409 in the same period a year ago.

Gross monthly service revenue churn on an organic basis, excluding DXI, was 0.4% compared with 0.6% in the same period last year. Please note that the third fiscal quarter revenue churn may be higher than second quarter results due to the upcoming holiday season.

New monthly recurring revenue, or MRR bookings, from mid-market and enterprise customers and by channel sales teams comprised 61% of the new monthly recurring revenue booked in the quarter on an adjusted basis. New MRR was essentially flat on an adjusted basis compared to prior year. Sequentially, we saw positive momentum across the mid-market and enterprise channel and small-business segments.

Cash, cash equivalents and investments were $167 million at September 30, 2017, compared with $170 million 1 year ago. Cash flow from operating activities was $5 million in the second fiscal quarter compared with $6.9 million the same period last year. Capital expenditures, including capitalized software, were $4.8 million in the quarter or 7% of revenue and increased 9% sequentially.

During the quarter, we repurchased approximately 1.1 million shares at a price of $13.23 for a total of $14.1 million. We currently have about $11 million available for share repurchase under our current program, which goes through May of 2018. 8x8 has a clear capital allocation strategy of investing cash to grow our business organically through acquisitions and strategic partnerships and returning cash to shareholders through share buybacks. This approach is a strategy we have been and remain committed to.

Looking ahead to the second half of the fiscal year, we continue to recruit world-class talent primarily in sales, marketing, and our research and development teams while enabling our channel programs to enhance demand generation and support our global brand.

To better model third and fourth fiscal quarters, operating expense growth is expected to be in the low to mid-double-digit range versus the first half of the year. Q4 is expected to be sequentially higher than Q3 and the highest quarter of spend for the full year.

Specifically, sales and marketing expenses will increase from added headcount, channel enablement execution, commissions, and advertising spend to support the brand and go-to-market strategic initiatives on the mid-market and enterprise. As a percentage of total revenue, we expect sales and marketing to be in the range of 55% to 56% during the second half of this fiscal year with Q4 being the highest sales and marketing expense quarter. As a reminder, product management, customer support and deployment services is included in our sales and marketing expenses and represents approximately 14% of revenue.

R&D will increase modestly in absolute dollars to support the development of unified solutions and our cross-platform real time analytics but will remain stable as a percentage of revenue from previous quarter. As a percentage of total revenue, we expect G&A expenses to be approximately 11% during the second half of the year.

We also anticipate our quarterly service margin to decline slightly from the second quarter level in the second half of the year due to additional expenses related to the amortization of previously capitalized software. In addition, we will continue to invest and deploy our capital to execute on our strategic business initiatives while taking a very disciplined approach to share repurchases.

Having said all this, we are modifying our revenue outlook for the full year due to 3 primary factors. The first factor is attributable to our U.K. Easy Contact Now product. During the first half of the year, service revenue from the product was largely in line with our expectations. However, due to our strategic decision to integrate the core technology into our recent Virtual Office X8 product launch, we're now deemphasizing selling the stand-alone product. The underlying technology is strong and has tremendous value to the business as part of an integrated platform. The second factor is related to a large enterprise client that has revised its time line for a major rollout of services due to constraints on their end.

Lastly, we have recently realigned our global sales and marketing leadership teams and operating structure to support our strategic initiatives to generate revenue growth and support sales execution. We have streamlined these 2 important corporate business units to generate demand, accelerate bookings growth and respond more quickly to customer needs. We will also continue to build out global functions to strengthen our leadership position in the unified communication space. Although we have made good progress to-date in our strategic initiatives, we may need another quarter or 2 to see improved bookings.

Taking all these factors into account, we have revised our outlook for the fiscal full year. Total revenue in the $262 million to $294 million range, representing approximately 15% to 16% year-over-year increase. Service revenue in the $275 million to $277 million range, representing approximately 17% year-over-year increase, adjusting for the discontinued revenue from the noncore voice message broadcasting segment of our DXI operations, service revenue growth in the range of 17% to 18% and total revenue growth in the range of 16% to 17%.

We continue to expect fiscal 2018 outlook of non-GAAP pretax income to be approximately $9 million or 3% of revenue. Our estimated non-GAAP effective tax rate is expected to be approximately 36%. Cash taxes are expected to be less than $1 million.

Lastly, taking into account -- lastly, taking into consideration our increased investment in the business, our market-leading position and the market opportunity, we continue to expect that service revenue growth will begin to accelerate in fiscal 2019 with an exit growth rate of approximately 25% in the fourth quarter of fiscal 2019.

To clarify, total revenue -- for guidance, total revenue is expected to be between $292 million and $294 million.

The series of strategic investments and initiatives mentioned earlier are all contemplated in our financial outlook. We believe this is the right time and prudent use of our capital to increase future growth for fiscal 2019 and beyond.

We are on the right path and taking action for the long-term success of our company. We are investing in our brand, employees, product innovation, demand generation and channel to enable our global clients to grow their business and reduce their costs. We made good progress on this front with many of our partners, and this is a longstanding commitment on our part.

Before we begin our questions-and-answer session, I have one more topic. During the summer, Joan informed me of her decision to retire at the end of this month. On behalf of 8x8's management team, I would like to thank Joan for her 13 years of contributions to the company. Joan built the Investor Relations department and established and nurtured relationships with all of you over the years. We wish Joan all the best in her future endeavors.

I'd also like to introduce Victoria Hyde-Dunn. She joined 8x8 four weeks ago from Visa and will be your Investor Relations contact going forward.

With that, operator, we are ready for questions.

(Operator Instructions) Your first question comes from Meta Marshall with Morgan Stanley.

I was wondering if you could just kind of talk about how you decided kind of like now is the time for the reorganization because it seems as if, a couple of quarters ago, you identified that you needed to increase branding efforts, and then 1 quarter or 2 after that, you decided you wanted to kind of increase sales and marketing and then you're making more changes. And So I just wonder like how you decided on kind of timing and the rollout of some of these changes and, particularly, with there being kind of other disruptions in this space as far as M&A or bankruptcies? And just kind of like, why not make all the changes at once or kind of what led to the time line of the changes that have been made?

Okay, those are very good questions, Meta. So let me kind of clarify that one. So I think we talked about it last quarter, where I think that was the comment, which is why did we decide to materially increase our investment. We got the sense that the market was inflecting. We wanted to get the right people in place in marketing before we needed to go out and really emphasize that we're willing to go out and kind of really ramp up our marketing expenses. And as part of that, as we talked about it, we telegraphed to you that, essentially, our business is 2 parts. We have our small business, which has been growing -- essentially is a drag on our business, particularly our micro business, and then a mid-market enterprise that is growing pretty healthily. And as I went through and really did a detailed review, it became increasingly obvious to me that what we had done is we made a nice foundation of sales, but what we needed to do was essentially get specialists, the person who's very good at growing a very fast pace essentially self-service, low-end business is very different than the person that builds a large enterprise mid-market business. We felt bifurcating the business was critical. And the other part that became more and more obvious to us is we have a unique asset, which we have essentially paid for in blood, which is we have all core technologies that constitute voice, video, text, contact center, essentially on one roof, which then become obvious to us as we were kind of using our new management team as coming in and looking at it with fresh eyes as to why do we have to live with other people's definition of what constitutes Contact Center and what constitutes Virtual Office. We have the ability to mix and match. So as we've kind of combined all of these things together, we made 3 very clear decisions. One is, let's take our Contact Now product, which is essentially a very easy-to-use Contact Center, and why don't we integrate that essentially as part of our Virtual Office solution to now, in essence, as built into your core PBX for essentially the same price. You have the core simplified functionality of Contact Center. So people who didn't even know they were contact centers as part of their phone system can get that. We think that gives us nontrivial differentiation, and we think that gives us a very significant opportunity to -- almost create a category for people who are literally saying, hey, I bought a phone system and my phone system comes with the ability to prioritize who I should answer, to keep records of everybody who called, to route calls where I can get other people involved to address a particular problem and have a complete record of all of those things that contact centers consider part and parcel, we're now going to bundle into a [wheel], which we think gives us something pure -- significantly disruptive. And then, we're starting to see our enterprise market take off. But the thing that is fascinating about our enterprise market is they're looking more and more at APIs. They're also -- where, for example, with one particular customer, we're starting to do everything from 2-factor authentication to literally creating workflow rules, leveraging our API solutions. So with all of those things, we figured this was a perfect time -- we brought the head of essentially engineering in place who comes from an analytics background, so you have the ability to do cross-platform analytics. We brought on board a marketing person who also comes from an analytics background and has in her background spent a lot of time creating new categories. And then in essence, we bifurcated sales into somebody who comes from a pure e-commerce background, so the idea to do a whole series of self-services. And then we brought on board somebody who's the former CRO for NewVoiceMedia, but prior to that, the head of worldwide analytic sales for IBM and ran as many as 4,000 people. And so with all of those things, we've, if I might say so, we managed to do all of this in 90 days. We think the market's inflecting. We think there is an opportunity, and there's a lot of talent available. Just in the last 90 days, we've been able to add about 40-odd people to our sales and marketing group. And as I said, from that perspective, we felt this gives these folks a clean slate, killed some of -- or deemphasized some of our stand-alone orphan products, more and more integrate towards a series of 3 or 4 very differentiated products and go for it.

Got it. And if I could just ask one follow-up question. I mean, the decision to kind of segment by enterprise and small business versus -- or I guess, I'm just trying to get a sense like is there somebody dedicated to channel versus direct? Are those kind of similar alignments just given the channel development, who's kind of running that at this point?

Exactly. So we see enterprise and mid-market, particularly mid-market channel is a huge part of it. And so if you look at a lot of our hires, and I'm sure all of you follow my various LinkedIn accounts and posts, I'm noticing more and more of the top-tier channel assets, channel managers, BDMs, some of the very best and brightest who are joining because the idea is our problem has always been we've had the best technology. We've just not had enough feet on the street. So channel is now part and parcel of our mid-market and enterprise business unit where, in essence, channel is just a lead source. We make no distinction between having a direct sales force that sells just by itself or channel sales force that sells through the channel. We have one common sales force and channel just becomes a lead source. That eliminates friction. It makes it very clear that we're a very channel-friendly organization, and we view that as an opportunity to really go out and do hypergrowth. And again, channel is inflecting as you can probably guess, and the ability to get one vendor where they can get everything. And then as I indicated, the ability for us to mix and match portions of our product because, since we own every element of our technology, I can carve out portions of my contact center and make it part of our VO, and that gives something disruptive. I can take portions of my APIs and give people the ability to create professional services organizations so that you can provide value-added services. That's why we've kind of bifurcated the company like this. Increasingly, you're going to see more and more on our mid-market and enterprise, particularly enterprise, a focus on analytics. And increasingly on our small business, you're going to see the ability to go in where we will have a Virtual Office offering, but it'll have built-in contact center type functionality so that "it won't just be a replacement PBX or a cheap phone in the cloud. It will have the ability to have a built-in contact center because, essentially, that's now going to get integrated as part of that solution."

Your next question comes from George Sutton with Craig-Hallum.

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Vik, I wanted to make sure I fully appreciated the new suite of products. And can you give us any kind of key competitive differentiators that are going to come from this new suite?

Yes. So as you know one of the things we've done with our VO Edition. So we've had, as you do with a company which has acquired as many technologies and assets we have had and that has been in business as long as we have, you end up with a whole series of different products. And what I started to do or did is bundle them into what I call editions. VO Editions, which is essentially Virtual Office Editions, means you bundle in 3 broad categories, and it required a reengineering of our product literally from the back office. So we have to completely -- go away from the good, old people [SaaS] CRM as we always had, all the way up to creating a new [quoting] cash engine to a new billing engine and then, as I said, creating a self-service portal and fundamentally changing the user interface. And we're now starting to roll this out both for one of our very large strategic customers that is going to use this so that every one of their customers can just do self-service, and we're also rolling this out more and more towards our small business. If you think about it, we have had our legacy small business that has been a drag on our business, but now the ability to have a product like Editions, where literally, it's A, B, or C. You can have these 3 options. If you want Contact Center built in, X8. if you want just the basic telephony, X1 or X2. We're basically making it so that it literally becomes something where people can add to it, self-revision. They can modify, so less and less support cost, less and less sales cost. This was one of the key reasons why we wanted to do this because it allows us to continue to not have to increase our investment in our small business but accelerate our growth rate. Then you also have a common platform that now starts all across, and then particularly now that we add our VCC Editions, you have cross-platform analytics that nobody else can provide. We have a new product coming out called [Falron.] You can probably guess my engineers named it. But [Falron] will basically give you analytics, which will encompass voice, video, text interactions all the way to your contact center interaction in one common dashboard company-wide. So that is what we mean by truly unified communication. It's been about 18 months of work, and I've got to highlight it that it required me having to completely rejigger our back-office system. It required us to completely rejigger our provisioning system. It required us to completely change our configuration manager. And as I said, we now started to roll all of these things out. And we think, as I said, by unifying all of this, it decreases my support cost, it increases the velocity with which I can sell and allows me to bundle stuff together where I can create disruption in the market.

Got you. Great. And one other question on the ongoing Avaya gifts that you're getting. Where are we in that migration from your perspective? And then can you just discuss some of the other M&A activity that's occurred over the quarter, the ShoreTel, MYtel and the Broadsoft-Cisco in terms of what you think that means for you?

Whatever M&A gods that are out there, I am on bended knees and thanking him for it. Again, it's very easy to see. You guys do a phenomenal job of channel checks as well as figuring out -- we have been the beneficiary of some incredible talent from all of the people that are kind of now going through all of this stuff. We're also seeing a lot of channel partners now migrate to us. The fact that the weakness and the strength of 8x8 has been we are the techie geek company with the greatest technology, but then everybody said from a branding and a selling perspective, we were not world class. I brought in world-class talent on that and, particularly in channel, you're starting to see channel gravitate to us because, in essence, they view us, a, as a one-stop shop. They are now seeing the same people they have dealt with before here. And they're seeing our commitment to massive investment in this space and that we will do whatever it takes to own this space. I think from that perspective, we think we're going to be a significant beneficiary of all that is going on. So there's a few other people that you can recommend get bought, as some of the rumors are out there. I hope all those rumors end up being true because we love it.

Your next question comes from Jonathan Kees with Summit Redstone.

I just wanted to, I guess, dig a little bit deeper in terms of the reasons for the revision. There was first the product in U.K. that was no longer going to be sold separately, but it's now going to be integrated, the Easy Contact. I would think if it's going to be integrated, then the ARPU would go up to kind of offset the stand-alone sales you would get normally. And then second, you had mentioned about the large-enterprise customer. They pushed out your service revenues. I guess, is that implying that it's going to be pushed out to the second half -- fiscal second half? Or is that still a big question mark? And then there's (inaudible) you kind of talk about in terms of the sales.

Okay. Yes, fair enough. That's a very valid question. Let me take that on, because ultimately, I made this call. Three things. One, we continue to sell our U.K. ECN product. It's just something we have deemphasized. By that, I mean, we're syphoning off all the resources from selling that product more and more. The existing customers will continue to support, but we're syphoning off -- so you're starting to see a very significant drop in the product, because as we takeaway resources from adding features and/or support and our sales from that product and move it more towards X-8, which is still early days and hasn't kicked in, you're starting to see that the new sales in that product is coming in well below plan and it's something I'm not trying to reverse because, in the end, it's coming out faster than I would have liked, but it's not one that is worth reversing. So that's step one. Step 2, this customer that I talked about, their plans actually have expanded, and one of the key elements -- they've been a great driver in creating the self-service element of the product, and they had put together a very detailed schedule and rollout plan, and they have started against that rollout plan, just the ramp has been a little bit slower than anticipated because of resource constraints on their end. But we anticipate over the next 2, 3 months the ramp will pick up. But as you can tell with service revenue, if the ramp starts out slower, you kind of are not able to recognize the service revenue. And then the third, just the sheer volume of changes I've instituted. I believe it's the right thing to do and, obviously, that was why I telegraphed that I was going to change -- or not telegraph. I told you guys I was going to change my investment profile, and I was going to significantly increase my investment in sales and marketing. So as you think about it, 2 SVPs, 1 to head up sales and 1 to head up -- 1 to head up, I'm sorry, Mid-market and Enterprise, 1 to head up eCommerce and Small Business, all brought on board in the last 90 days plus another 40-or-so sales and marketing people, including probably 4 marketing VPs and I can't remember, 3 or 4 marketing, sorry, sales VPs globally. All of that's happening -- part of what I want to do is take a little bit of the pressure off these guys. In other words, come on board, give them a couple of quarters to get there feet wet. I'm doing massive amounts of change, creation all of these business units. So I wanted to kind of provide the air cover to say, guys, there is going to be. I don't think there's going to be major disruption, but there's going to be something. And so with these 3 things, I felt the right thing to do was take this guidance down and just go for it. It doesn't fundamentally affect our views on the growth rate. As a matter of fact, we feel that our growth rate accelerates, but I just don't want to give short-term pressure on people that I just brought on board.

No, that certainly makes sense, and that's very reasonable. If I can sneak in one last question and on a more promising note here. I just wanted to see if you could talk about your partnership with HipChat. Is that -- how was that going to move the needle? I'm thinking that's going to be -- not exclusive because you're also partnered with their product, the service desk, but you're also partnered with the Zendesk service desk. So I'm thinking this is not exclusive, but it will still contribute towards revenue growth.

Stay tuned. As I told you, we have some awesome technology, and I have spent 18 to 24 months just kind of building all of this stuff up. You're going to start to see, this is where editions, this is where essentially the ability to have a LeChat, which is our next generation of collaboration engine, which basically allows you to integrate with everything from Slack to HipChat to whatever. We have got some seriously cool stuff, and now we also have just brought on board a VP of strategic alliances who came from IBM, and she's got a stellar background. You're going to start seeing some more and more fascinating stuff. We have been a technology company, and I know that has been the rap on us, but there's a reason why we've been a technology company. Build really cool stuff, then bring on board the people with all the relevant backgrounds, put some gas in the engine for executive management to provide enough air cover so that they're not being forced to do stupid things in the short term, and they have the ability to make stuff happen and then go kick a**. That's what I think we've done.

Your next question comes from Mike Latimore with Northland Capital.

Just to get to the longer-term growth goal here. What kind of growth do you need to see out of the small-business segment. You talk a little bit more about, I think, improving the growth on the small-business segment, but does that need to be 10%, 15%. What kind of growth do you need to see there to kind of get your longer-term targets?

I think -- I mean, we don't need a lot because we think we can grow the enterprise and mid-market significantly. But as I said, it is always good to see our small business, which as you know, I ring-fenced and didn't do much around it, was literally, we kind of put them in a room. We fed them pizza under the door and just said give us more. We're now bringing on board some seriously cool talent that's looking at every element of our process, and they're highlighting so many inefficiencies that it's almost pathetic, right. And so, I don't need more than 10-ish percent growth. I think I can get to 15-ish percent growth. But again, as I said, to a large degree, small business was this $150 million, $140 million business that has been this massive drag on our company because as we were moving more and more mid-market and enterprise, which I think we have done well, but all of the changes we made to the product, including this edition, which to a large degree creates the self-service capability and the self-provisioning capability, applies just as easily to small business, and then now we're bringing in people who have 21st Century expertise on how to build high-velocity small businesses and also up-level existing customer base, which is pretty darn incredible. And so I said from that perspective, we think we can see significantly greater than projections growth on small business. Long term, I don't anticipate it's going to be a drag on our business. I think it won't grow anywhere close to how our mid-market and enterprise is going to be, but I think it's not going to be a drag on our business at all.

Got it. And you talked -- you've talk about hiring a lot of salespeople and business development people. Do you have a rough sense of like what percent growth you'll see in those types of employees this year -- this fiscal year?

Some of it, I mean -- Mary Ellen?

Yes -- no, that's one of the critical things that we're hiring for is for the channel, channel enablement, business development managers. We want folks that can help us bring in the best of the best channel partners, enable those channel partners and get more feet on the street so that we can accelerate our growth. Like Vik said earlier, the mid-market is almost all from the channel, and it's a great resource for us, and we have the right people out in the field to help them close the deals. So we would expect it will continue. As we said, there were 40 sales and marketing new employees this quarter, including a couple SVPs. We would expect that continue that, that rate of hiring will continue in Q3 and Q4.

I'll just give you color, and I apologize because I know I'm lowering guidance, but at the same time, I do -- I am a little bit of a proud papa. Just -- we do an onboarding process out here. We make it pretty comprehensive. We do between 3 to 5 days where every employee in the company, whether it's the receptionist all the way up to an SVP goes through an onboarding exercise where they have to learn every element of our product as well as they go through and spend time with every one of my direct reports. It culminates with a dinner in my house where they have to make a presentation in 4-person teams of something new that they can introduce to the company or something that they think they can do to improve the company. This most recent dinner was October, middle -- late October. There were 53 people that showed up plus another 15-or-so of their managers. Let's just say if this keeps going, I'm going to need a bigger house. But just the caliber of people we're getting is just awesome, I mean, some amazing people are joining us.

And just last question, on this deal where you -- it sounded like it was a 1,000-seat contact center deal plus the 2,200 Virtual Office. Can you just talk a little bit about the competitive landscape there. Was your main competition on-premise guys? Or were they a mixture of cloud, PBX and separately cloud contact center? What was like the competitive dynamic on that deal?

Right. Those were on-premise guys. But I will tell you -- and again, it has taken a lot of effort and a lot of pain. But our Contact Center stand-alone is now competitive, right. I don't know -- we all look at Gartner. But even there, we're not quite in the leaders quadrant on Contact Center, but we definitely moved up and to the right. And we're getting to the point that, with our Contact Center, I think we're starting very close and maybe we're 1 year or 2 away, but we'll be in the leaders quadrant but it's stand-alone. It's seriously cool and can stand on its own. Couple that with our VO, you've got a Virtual Office and a Virtual Contact Center that wins out these very large deals. And now, for the mid-market, which is traditionally the one that, if you remember, I told you, they tend not to buy a lot of contact center seats. I've now introduced an integrated contact center as part of our Virtual Office offering. I can kill that category, right. So in particularly mid-market, literally, you buy a Virtual Office, and I have a low-end contact center built in as part of my X8. Game on. That's, as I said, I think at the high end I can start to win with my VO VCC because I've got 2 best-of-breed products. I'm not yet best-of-breed in contact center but getting there. And then I'm integrated our Virtual Office by adding all of these features. So from my perspective, our problem (inaudible) feet on the street, our problem has always been coverage. Our problem has always been brand. Just hired the President of Grey North America -- sorry, Grey San Francisco as our VP of Brand. He comes in. Same thing. You're starting to now see people from across some very interesting segments are coming in here because they see an opportunity with our core technology to kill a category. And I have, as I said, we've got a lot of dry powder. I don't need to do major acquisitions because, to a large degree, we made all of these very unique tuck-in acquisitions, wherein combine them all together. I have a guy who's basically built really big engineering organizations, and now I have a guy in mid-market who's built very big sales organizations. Now we just have to give them time to, as I said, make stuff happen.

Your next question comes from with Dmitry Netis with William Blair.

Certainly appreciate the guide and how you kind of lowered the -- gave yourself some headroom here to execute. I think it's the right move. Also, I just wanted to confirm couple of things. The new (inaudible) MRR was flat, you said, just to confirm that. And also the service revenue exiting fourth quarter of 2019 will grow at 25% versus the prior kind of full year of 2019 growing at 25%. Is that, those are the...

That's correct (inaudible). And Dmitry, that's the same as what we had said last quarter as well that we expect that our fourth fiscal quarter will grow at approximately 25% year-over-year in fiscal 2019.

Okay. All right, good. And then a couple of also quick ones here. On the channel side, how did that segment grow? You had, I think you said 15 -- of 5 of top 10 deals with channel and then you said you had 13 enterprise deals and maybe how many of those 13 came through channel and how fast did the channel grow?

Yes. So I don't have the exact number because as you know now channel is integrated with My Direct. So all sales are essentially being funneled. More and more of my core deals are coming from the channel. Channel is the most interesting and fastest-growing segment, as I indicated to you before. But what we're finding is particularly now that we've removed friction from the system, which is a nontrivial reorg that we did last quarter where we eliminated essentially a team that sold direct and a team that sold through channel and combined them into one common team and channel is basically a source to a skill-based sales team. But more and more, you'll see a bigger emphasis on channel, and we view that as our fastest-growing segment, which is where, as you can see, we have almost doubled and tripled the number of BDMs that we brought onboard that can go out and really service the channel.

Okay, thanks, Vik. And then the -- it sounds like the inflection in sales force productivity, you expect a couple of quarters here, 1 to 2. But let's assume it's the March quarter when you'll be firing, let's say, on all cylinders [here], and the productivity will be kind of top shelf where...

You got it. And that was the thing. I mean, to some extent, as I said, part of executive leadership is to do the right thing for the team you bring on place. And I want to give these guys a chance. I mean, these really are killers, and you can see their resumes. It's -- and you can see how much in demand some of these guys were. I want to give them the air cover to really go in and kick a**. And so I think it'll take them 1 to 2 quarters to come up to speed. They're a pretty aggressive group. So I'm actually quite excited. But I think FY '19 Q1, I'll start to feel very good about where we are, and I think, Q4 of FY '19, my job is to kind of put my feet up on my desk and kind of just watch them roll in.

Maybe last question, guys, and this was asked before, but I just want to kind of (inaudible) from the date on this (inaudible) the big large enterprise customer. And I'm going to connect the dots here, tell me if I'm wrong. But you did expect the inflection (inaudible), which you signed and you had a press release out there for them to start deploying in the second half of this year. So I think October 1 was kind of the license-to-sell date. Did that shift now? What is the new date on that deployment? And maybe double-click a little bit to tell us exactly what happened with that contract. Why did it slip? And maybe even if you could, what's the capacity per quarter number of seats that you could deploy with that customer? Is there a number there? Or is that sort of incident?

Yes, so couple of things. I won't comment on a specific customer because -- I just won't comment on specific customer. But let's just say customers like this, it literally is they needed to get a bunch of infrastructure in place. They've already started the process of deploying. And now, as I indicated, they initially had 14, 15 countries. They are now talking about expanding the scope even much beyond that. They're also now expanding the scope where they want to start selling, which is where the self-service part comes in, reselling it beyond just deployments to their customers. They want to basically create an offering where anybody that uses their facilities can also buy all of the stuff. So the scope keeps expanding. They're an amazing customer. Again, I won't comment on a particular customer, but I would urge you to go -- there was a very interesting talk that was given by the CIO of this particular customer where he laid out all of his vision and his plan that he and the CE have come up with, and I think you will find that fascinating.

When will it deploy, Vik,...?

It's started. It's already started. The ramp is slower.

The deployment is started. The ramp is just a little slower.

Next question comes from Charlie Erlikh with R.W. Baird.

Just wondering if you've seen any meaningful competitive changes this quarter. Are you seeing anything different from Microsoft or Google? Almost seems like Microsoft's kind of stepping off the gas pedal, so to speak. Any comments there would be helpful.

No, I think actually I'm seeing the competitive landscape. That's part of why I'm really turning on the gas. I'm seeing the market play out essentially as anticipated. As you know, Cisco was hot and heavy on Spark. It's unclear exactly how all of this is going to play out, but Broadsoft is an interesting acquisition for them and probably a very good one. Microsoft and the integration of Teams and Skype is going to be interesting. I view this as more and more, I think -- you think about it, all the major contact center players have been taken out. We're the only one that has our own contact center. We have our own essentially collaboration engine. We have own chat engine. And we have our own voice and telephony. And we've started to do as these aggressive investments because of by building these platforms, we have the ability to mix and match. So where we have been probably a little timid, is probably one word, is over the last year, 1.5 years, I probably could have started my investment cycle a little bit earlier, but I wanted to have the right people in place. But you can see, just in the last 90 days how much we've amped up in some of these hirings as well as some of our developments and making some of these tough decisions about deemphasizing orphan products and going after some of our core products. We think that positions us very well for this market, and I do think the market's inflecting, and I don't think any of the big boys are going to be there for a while.

Your next question comes from Catharine Trebnick with Dougherty.

I just have a housekeeping question. You had said you added 20 new partners this quarter. Is that just domestic? Or does that include international?

No, we actually said that we enabled 21 new channel partners this quarter. So we enabled them. They went through all of -- we have brand-new training for our channel partners, where the SEs and the sales representatives come to 8x8 and they learn all about our products, and we teach them everything they need to know to sell. So that's enabling our channel partners, which we think is a very -- that's another big part of this investment program that we have put in place to enable our channel partners to win more and more deals on behalf of 8x8.

Catharine, to build on that, we primarily, primarily U.S., but we are seeing amazing, amazing growth in U.K. as well as now Western Europe as well. That again, I think the fact that we own every element of our technology and the fact that it -- probably from a security, compliance, et cetera, we're top of the world and that our entire core engineering team is essentially employees. I think it's something that channel partners like because it gives them a level of comfort that we'll be around. And so we're seeing very, very strong growth, particularly in the U.K. public sector as well, including some huge wins, including Ministry of Justice and others. So the more you win, the more channel partners are coming to us, and my job is to make sure I enable channel partners so they can make a lot of money. And the more money they make, the happier I am.

All right. And then 6 of these enabled partners started delivering revenue this quarter, correct? I heard that right?

Yes, actually, that's exactly right. So some of these new partners that we've been able to recruit since the beginning of our fiscal year are now bringing us deals, and we're closing those deals with those partners. So it's been very, very good.

Now one of the things I get confused on with this huge investment that you're going forward to get back to the 25% year-over-year growth in services, when a -- and we could take this off-line, too. When someone brings a deal in from your new business development person, does the channel and the business development individual or the channel partner that you assigned both get compensated?

It's a single-compensation model. So the business development managers have a different responsibility. Their responsibility is to recruit the new partners, enable the new partners and to help them develop their pipeline. The actual leads that come from these channel partners go to either our enterprise team in the field or a mid-market team in the field depending on what size deal it is. It goes to the best person in that territory to close the deal. So it's the account executive who actually gets compensated for that. The BDMs have a different structure.

No, I was wondering if the channel also got compensated.

Absolutely, the channel's going to definitely get compensated. Anything -- any channel partner that brings us a deal that we close will be compensated, absolutely.

Your next question comes from Nikolay Beliov with Bank of America.

I'm trying to reconcile the continuing strength in Mid-market and Enterprise deal wins, stable churn. And when I look at new Mid-market/Enterprise channel the last 4 quarters, it's been flattish. And you guys facing much of your comps in the second half of the year. And I know that [thoughts] based on your expectations in the past that as we get closer to anniversary-ing of implementation time lines and whatnot, we would [start] acceleration in new [work.] Can you please update us on the puts and takes folks [getting] under the cover here?

No, I think you've got it. What's happening under the covers is, a company goes through a process. We did a good job laying out the overall foundation vis-a-vis our sales. But we had essentially a sales team that basically service and sales leadership that serviced everybody from 1 line all the way to 10,000, 20,000, 30,000 lines. Did a nice job of laying the foundation. It became increasingly clear that we needed to go build on that foundation and bring onboard specialist. And the bookings have been flattish. It's not necessarily a perfect proxy as I'd indicated because larger enterprise customer -- just to give you a perspective, this quarter, 3 very large enterprise customers closed 1.5 weeks after the quarter ended. It is what it is. I mean, enterprise customers tend to close in their time frame, so be it. But the idea was the reason I'm making all of these changes in the sales team to basically upgrade the talent in terms of specialists is for a reason. And the reason is market is growing fast. My bookings aren't growing the way they should. Ultimately, you have to do whatever is necessary. I'm upgrading marketing, and now, as I said, I'm really ramping up sales, and I'm trying to make sure we have enough feet on the street, so we have enough opportunities. So those are the changes. That's the puts and takes.

Okay. And when we think about fiscal year in '19, we appreciate the guidance on subscription revenue growth rate. How should we think at least qualitatively about a pretax margin for fiscal year '19.

Good question, Nikolay. We do not expect to show leverage next fiscal year. We still believe that we'll be investing in the business. It's a very large market as you know. It's underpenetrated, and we have some -- as Vik had explained earlier, we had some very new, interesting disruptive products that are coming to market. So we will be investing next year. We want to be profitable from a full-year perspective on a non-GAAP basis because we believe that, that shows good disciplined management, but it's not -- we're not going to increase over the 3% that we have this year, at least at this point. We haven't finalized our numbers, but at this point, we don't expect to show leverage for fiscal '19. But growth, that's where we're...

Yes, it's all about growth. I mean, we have managed the company balance between growth and profitability. The market inflected, bringing in everything necessary to really upgrade the company from one end to the other to manage in a hyper-growth environment. I feel like I did the right thing. Silicon Valley companies always do stuff backwards. First, they hire sales marketing and then they try and build the product. We built the product. We then integrated the product. And now what we're doing is we're bringing in that next layer of sales, marketing, branding feet on the street. And we're going to invest in it. I mean, the bias for me right now is growth.

And my last question is around -- you spoken about U.S. and U.K. sales in go-to-market. And how are you addressing with these new sales and management changes in addition to rest of the world outside of the U.S. and the U.K.?

Tightly integrated. I mean, I believe in global team. So there's a global Small Business and eCommerce team, and a global Mid-market and Enterprise team. And again, as I said, look at the people and their backgrounds. Scott Sampson that comes on board as the head of Mid-market and Enterprise globally, was the former Head or CRO for NewVoiceMedia, which is a U.K.-headquartered company. Prior to that, he was worldwide analytics for IBM with about, I think, 4,000-or-so people reporting into him. We have also brought on board the Head of Interactive Intelligence, APAC. He's on board. We have then promoted a person to run all of EMEA. The idea is to build a completely integrated organization, common set of products and then we're going through all this local language, capability, and this is where some of our amazing customers have been the front end, going out, and they've been the ones kind of adopting our products in multiple countries, and that has been a great bit of -- get that product everywhere.

Your last question comes from Mike Crawford with B. Riley.

With the channel, are you seeing a handful of the same channel partners being the top channel partners that are bringing you deals quarter in and quarter out? And ancillary to that is, are you exclusive with any of those?

No. So it's actually a trend. That's a great question, Mike. So initially -- and telco is like this. And we're trying to get people's mindset to change that this is not telco it's SaaS. The original set of channel partners tend to be, okay, we'll introduce you, and we'll introduce a couple of our competitors, and so you need to make sure you have face time with them. We're now starting to increasingly see VARs. That is why we're investing in them in terms of enablement and other things, that are starting to be semi-exclusive. In other words, they'll lead with us, and if they fail with us, then they have the right to go with somebody else or something like that. And eventually, as I said, we may end up getting more and more exclusive. But I'm willing to invest in channel partners, but I'm not just willing to invest in channel partners which are just going to be bringing multiple people. I will do whatever is necessary to earn their business. But you're going to see an inordinate amount of my energy, effort, dollars, time of and just pre-information about product going more and more to those loyal channel partners because I'm trying to create that as a category. And ShoreTel and Avaya had done that very well, which is why those companies survived through some very tough times. And I think we have the opportunity to do that.

Okay, thank you. And then last question is, as you are more and more a one-stop shop for unified communications needs, are you still not seeing anyone that's asking you about network as well?

No. Network, we don't get asked because that's the one thing that is interesting. More and more people are liking this over-the-top stuff and -- because I've got so much analytics. We're a pure software player, right. You do your network. Our stuff is an app that rides on top of your network. So we have not seen that. That tends to be something that really low-end customers ask for. The customers we're dealing with more and more are, I got my own network infrastructure, you're just the over-the-top provider. But the fact that you have analytics that allows me to get cross-network information, so it's not just in-network information about the health of my network, that's a huge differentiator. And then, as I indicated, because of the way we've architected our solution, because of our engineering team and the way they are compensated and the fact the majority are employees, security compliance is something that we are world class at.

I'm showing no further questions at this time. I like to turn the call back over to Vik -- Vikram, your CEO.

Sorry, Vik Verma, by the way. Just -- so closing remarks for me is very simple. We are going to be -- me in particular, we're going to be very active on conferences and nondeal roadshows and will be telling you about some of our new products, some of our new activities. I think there's a lot of exciting stuff going on. So I think expect to see several of you and, I think, Joan will be leaving us, but Victoria has now got me signed up for a lot of various conferences. So I'm sure I'll be seeing a lot of you over the next few weeks. So with that, thank you very much.

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