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8x8, Inc. (NASDAQ:EGHT)

F1Q 2014 Earnings Conference Call

July 24, 2013 16:30 ET

Executives

Joan Citelli - Director, Corporate Communications

Bryan Martin - Chairman and Chief Executive Officer

Dan Weirich - Chief Financial Officer

Analysts

George Sutton - Craig Hallum

Barry McCarver - Stephens Inc.

Mike Crawford - B. Riley & Company

Dmitry Netis - William Blair

Raghavan Sarathy - Dougherty & Company

Greg Burns - Sidoti & Company

Mike Latimore - Northland Capital

Operator

Good day, ladies and gentlemen, and welcome to the 8x8 Inc. Q1 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will have a question-and-answer session and instructions will follow at that time. (Operator Instructions) And as a reminder, today’s conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms. Joan Citelli, Director of Corporate Communications. Ma’am, you may begin.

Joan Citelli - Director, Corporate Communications

Thanks, and welcome everyone to our call. Today I am joined by 8x8’s Chief Executive Officer and Chairman of the Board, Bryan Martin and 8x8’s Chief Financial Officer, Dan Weirich, to discuss our results for 8x8’s first fiscal quarter of 2014 ended June 30, 2013. If you have not yet seen today’s financial results, the press release is available on the Investors tab of 8x8’s website at www.8x8.com. Following our comments, there will be an opportunity for questions.

Before I turn the call over to Bryan, I would like to remind all participants that during this conference call any forward-looking statements are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Expressions of future goals, including financial guidance and similar expressions, including without limitation, expressions using the terminology may, will, believe, expect, plans, anticipates, predicts, forecasts, and expressions, which reflect something other than historical facts are intended to identify forward-looking statements. These forward-looking statements involve a number of risks and uncertainties, including factors discussed in the risk factors sections of our Annual Report on Form 10-K, and our Quarterly Reports on Form 10-Quarter, and in our other SEC filings and company releases. Our actual results may differ materially from any forward-looking statements due to such risks and uncertainties. The company undertakes no obligation to revise or update any forward-looking statements in order to reflect events or circumstances that may arise after this conference call, except as required by law. Thank you.

And with that, I’ll turn the call over to Bryan Martin, Chief Executive Officer and Chairman of the Board of 8x8.

Bryan Martin - Chairman and Chief Executive Officer

Thank you, Joan, and welcome everyone to 8x8’s earnings call for our first quarter ended June 30, 2013. I will begin by providing an overview of the quarter, which will be followed by Dan’s discussion of the financials in greater detail. We will then be happy to answer any questions you may have for us today.

8x8 reported a solid start to our 2014 fiscal year with total first quarter revenue exceeding $30 million for the first time. 91% of this revenue was recurring service revenue and 9% was product revenue. Revenue from business customers comprised more than 98% of total revenue. Year-over-year, our quarterly revenue from business customers grew 22%. We added 1,127 net new business customers during the quarter for a total business customer base at June 30 of 33,662 businesses who subscribe to our Cloud services. We also further improved our service margins in the first fiscal quarter with GAAP service margin at a record 81% and overall GAAP gross margin at 71%. Non-GAAP net income as a percentage of revenue increased to 14%.

Total new business services sold during the quarter increased to 47,353 versus 41,146 in the same period last year with the average new business customer purchasing 17.5 lines and services. Over our entire customer base, the average number of subscribed services per customer increased sequentially to 11.8% compared with 11.5% in the March quarter. The average monthly recurring revenue per business customer in the June quarter also increased sequentially by $5 per month to $268 million per month, a 7% increase over the same period last year.

Business service revenue churn during the June quarter was very good at 1.2% and business customer churn was at a record quarterly low of 1.4%. All of the churn reduction initiatives we have put in place have started to produce the results we have been expecting and our customer satisfaction surveys are also reflecting these results. During the quarter, we merged our contact center sales team with our channel and mid-market team as both groups are now effectively cross-selling our entire portfolio of communications services into the mid-market segment. The collective channel and mid-market group generated 29% of our total monthly recurring revenue added during the quarter, compared with 29% last quarter and 17% in the same period a year ago, if these sales team results had been merged and bucketed the same way in the past periods. Channel and mid-market new monthly recurring revenue sold in the quarter increased 73% compared with the same period last year. And we ended the quarter with 116 partners in our channel sales program.

I’d now like to provide an update on our cloud services development project with Softbank. We have completed substantially all deliverables related to our initial development project and are working with Softbank in Japan to integrate these services into their datacenter environments. Yesterday, the Executive Vice President and Chief Operating Officer at Softbank, gave the keynote address at Softbank World entitled “Global Cloud to Accelerate Business” which described the capabilities of this new software cloud technology and referenced 8x8’s virtual desktop interface portal as the way customers will control their Softbank infrastructure services globally.

Softbank also conducted a 40-minute portal workshop to demonstrate these new services on the first and second days of Softbank World in Japan, and exhibited the services at a booth at their event with live demos running on both personal computers and iPads. We expect the production release of these services to occur during the September quarter with monthly recurring billings to Softbank following shortly thereafter. I want to congratulate 8x8 and Softbank’s exceptional development teams for completing this large project on schedule, and we look forward to discussing additional development projects with Softbank.

I also am pleased to report that 8x8’s own Global Reach projects for expansion into both the United Kingdom and Asia-Pacific markets later this year remain on schedule. Earlier this month, we executed the agreements related to our new datacenter development in London, and we expect this facility to be the next Global Reach location to launch in production in the fall. We are very excited to be working with our existing U.S. based mid-market customers to help them grow and expand their operations overseas while expanding our own multinational customer base.

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

Dan Weirich - Chief Financial Officer

Thank you, Bryan. Revenue growth was strong in the quarter with revenue from business customers increasing 22% compared to the first quarter of fiscal 2013. I’d note that last year in the first quarter of fiscal 2013, we benefited from an increase in recurring revenue associated with the migration of a significant amount of the telephony traffic generated by our legacy Contactual customers onto the 8x8 network. These are the same customers we picked up from the acquisition of the software-as-a-service contact center service provider which we closed on September 15, 2011.

Without this revenue benefit, our growth rate of revenue from business customers in the first quarter of fiscal 2014 would have increased compared with the fourth quarter of fiscal 2013. In addition, compared with the same year ago periods, overall revenue growth increased 19% in the first quarter of fiscal 2014, 18% last quarter and 17% in the third quarter of fiscal 2013. So, as you can see, we are experiencing a very steady and robust revenue growth rate. Service and gross margins were again at their highest levels in our company history with service margin at a record 81% and gross margin at more than 70%.

Contribution margin, defined as service revenue less billing and customer service expense, improved to 65% in the June quarter, compared with 64% in the March quarter. Payback, defined as the number of months of contribution margin to payback the subscriber acquisition cost, was 6.6 months.

As Bryan noted, non-GAAP net income for the quarter was $4.3 million, a 27% increase compared with $3.4 million in the same period a year ago. Non-GAAP net income per diluted share was $0.06 for the quarter, compared with $0.05 in the same period of fiscal 2013. Non-GAAP net income as a percentage of revenue was 14% in the quarter, compared with 13% in same period a year ago. Now, the gross margin improvement is beginning to flow through to the bottom line even as we have increased our investment in sales and marketing as a percentage of revenue to 44% from 42% in the same period a year ago.

GAAP net income was down compared with the first quarter of fiscal 2013 due to the sale of a family of patents for $12 million in the year ago quarter. This was recorded in our statement of income as a reduction of expense in the amount of $11,965,000. Due to the one-time nature of transactions such as this, we have deducted the benefit from this transaction from our non-GAAP net income to provide better year-over-year comparison.

Business subscriber acquisition cost per service was $96 per service, compared with $97 in the same period a year ago and up $4 from $92 in the fourth quarter of fiscal 2013. Business service revenue churn in the quarter was very low at 1.2% compared with 2.3% in the same period a year ago. Customer churn was a record low of 1.4% compared with 1.7% in the same period a year ago. 54% of our customer churn cancellations were due to business closure and economic environment reasons. This tells us that our customer onboarding and support projects are continuing to improve the portion of customer churn that is within our control.

On the sales front, gross business customer additions and number of new services sold decreased by 106 customers and 3,375 services sequentially. With the exception of the last year, we have historically seen a decline in sales between our fourth and first fiscal quarters. Capital expenditures were $466,000, or 1.6% of revenue, for the quarter. The capital investments in our Global Reach initiatives are beginning now in the second quarter fiscal 2014. These investments are expected to have an incremental effect on our capital expenditures for the remainder of this fiscal year.

Our cash, cash equivalents and investments increased by $5.5 million during the June quarter to $58 million. We have increased this number by more than $5 million in each of the past three consecutive quarters. We continue to be well capitalized with no debt for strategic corporate development. Finally, we expect to incur cash taxes of approximately $700,000 this fiscal year.

That concludes my prepared remarks and I will now turn the call back over to Bryan.

Bryan Martin - Chairman and Chief Executive Officer

Thank you, Dan. Very good. For our attendees’ reference and convenience, we have posted a transcript of these prepared remarks on the Events & Presentations section of 8x8’s Investor website at investors.8x8.com.

8x8’s Annual Meeting of Shareholders will take place tomorrow July 25 at 10:00AM at the company’s corporate headquarters in San Jose. We will also be presenting at the Pacific Crest Global Technology Leadership Forum in Vail, Colorado on August 11 and at the Oppenheimer 16th Annual Technology, Internet and Communications Conference in Boston on August 14. We look forward to seeing you at one of these events.

With that, we will be happy to take any questions you may have for us today. Mary, go ahead and open the lines for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from George Sutton from Craig Hallum. Your line is open.

George Sutton - Craig Hallum

Thank you. Guys, apologies upfront, I’m going to miss the Annual Meeting.

Bryan Martin

No problem, George.

George Sutton - Craig Hallum

Just like everybody else will, so…

Bryan Martin

We will give your seat to someone else.

George Sutton - Craig Hallum

Relative to the Softbank opportunity, can you just give us a sense of the scale potential for that specific program?

Bryan Martin

Yes, again, as we commented, I think certainly last quarter and probably even the quarter before, we expect even with the minimums in the contract that Softbank will become a kind of top five customer on a monthly recurring revenue basis. Again, the initial contract with them is a 36-month term. We have already gotten requests and are kind of entertaining discussions with them on follow-on projects and expanded features and the sort of change orders you would expect to see in a contract of this size. So, again, we are very excited that we have been able to meet their requested schedule. It was one of the reasons they selected 8x8 both the kind of breadth and depth of our technology, but also our speed of execution, our ability to get them to the goal, which was to launch this service and a suite of capabilities out there at their World Trade Conference, which just occurred earlier this week. So, we are happy to get over that finish line with them and looking forward hopefully to additional opportunity as we move forward.

George Sutton - Craig Hallum

Thank you. Relative to the Global Reach project, you’ve talked about some of the datacenter additions you are making, but nothing on the M&A side and I wondered if you could just update us in terms of what you are seeing from an M&A prospective?

Bryan Martin

Yes, we are still actively looking at potential partnerships discussions are at various stages, maturity. So, I don’t have anything to update you with specifically today, George, other than to reiterate kind of what our strategy as we are going to launch these Global Reach sites regardless of whether we have a partner in the region, because our current customer base is looking to expand their existing service offerings that they use from us to these regions anyway. And if we can supplement that expansion with some strategic M&A that would accelerate our presence in those markets. Then we are certainly eager to do that. If we don’t then, we are still very optimistic that we have a very unique product that truly starts to stretch the Cloud-based capabilities of these services to kind of an international presence whereas historically the company for a large percentage of our customer base is only operated here in North America.

George Sutton - Craig Hallum

Great. And finally for me, you are excited when you brought in Ben on the Inside Sales effort and you’ve expected some improved productivity, can you just update us with some of the changes that have been made there and what the plans are for the inside sales effort specifically?

Bryan Martin

Yes, absolutely. So, Ben started here at April 29. So, he just gave a 90-day update to our Board yesterday. We have been very pleased with the changes he has put in place. Some of the new sales managers and sales agents that he has hired, some of the processes I know that he has put in place have been very well received by the sales team, I would say morale is very high and we are very excited to see what he can do. I have been very impressed at what he has been able to accomplish in a very short period of time. So, Ben, and of course, Kim Niederman do, is one of the best recruiters on the planet in terms of locating these types of individuals. We are very pleased with their progress so far. And hopefully you will see that translate into gross ads that are going up into the right in future periods.

George Sutton - Craig Hallum

Okay, thanks for your help.

Bryan Martin

Thank you, George. We’ll miss you tomorrow.

Operator

Thank you. Our next question comes from Barry McCarver from Stephens Inc. Your line is open.

Barry McCarver - Stephens Inc.

Hi, good afternoon everybody and a great quarter.

Bryan Martin

Hi, Barry, thank you very much.

Barry McCarver - Stephens Inc.

So, I guess a couple of questions. First off, I didn’t quite understand on the Softbank opportunity is that expected to begin generating revenue in the third quarter, is that what you said?

Bryan Martin

It will begin – we expect it will begin generating revenue in the September quarter, which is or the quarter we are in right now are second fiscal quarter.

Barry McCarver - Stephens Inc.

Yes, I am sorry, that’s what I meant, yes, okay.

Bryan Martin

So, we should have a more quantifiable update on that as to confirm that, that actually began billing in our next call.

Barry McCarver - Stephens Inc.

Okay. And then you mentioned in your prepared remarks, the channel partner revenue as a percentage of total revenue, was 29% flat with last quarter. I am wondering could you breakout what was truly mid-market sales from slightly larger customers versus what the channel actually brought in? I am wondering if there is any change and I guess any acceleration in the slightly larger companies started to come in and take your product.

Bryan Martin

Barry, I would answer that. Let me try to answer that at general level and I’ll see if Dan has anything to follow-up on. The general we had a tremendous March quarter with that team just really blowout sales. And I think there was a little bit of overhang going into this quarter just because the pipeline basically gotten emptied at the March quarter. Our March quarter is historically very, very strong. It’s usually our best quarter of the year. I think part of it is it’s our fourth fiscal quarter and so everyone across the company is just focused on turning in the final results for our fiscal year. And then coupled with that, we think the companies we sell to as a calendar year they have gotten clearance for their New Year’s budgets, they are ready to invest for the year. They have got money to spend before it gets kind of cutback later in the year.

And so, that’s kind of a thesis we have as to why those mid-market customers are so prone to buying in that quarter. Sales were basically flat as you said. You have interpreted our remarks correctly, so whether you used the new bucketing that we are going to use from this fiscal quarter forward or you were to re-bucket the quarter we just reported, the way we reported it last quarter, especially that group was flat. I don’t think there is any concern there coming out of it. We look at the top 5, top 10 partners. They are kind of the same names on the list and kind of the same MRR amounts that they sold in the previous quarter. Just maybe slightly smaller deal, so you kind of saw the erosion down to 17.5 new lines and services is primarily being driven by just slightly smaller sales in the mid-market team, but nothing I think that was too surprising in terms of the change there. Do you have anything to add to that, Dan?

Dan Weirich

No, I think you covered it pretty well.

Barry McCarver - Stephens Inc.

Okay. And then just lastly if I may very strong pop in margins, particularly, gross margins in the quarter. Of course a lot of that was expected, but just thinking about how we rollout the rest of the year seasonally, is there upside in the near term to at least the gross margin side if not both here in the near-term?

Bryan Martin

So, on the service margin side, we have tremendous visibility there, and we feel very confident as we stated last quarter that it will be in excess of 80%. We are going to be making some investments on these datacenters outside the United States in the next three quarters, but even with those investments, we are confident that we are going to be above 80%. The product subsidy side or negative product margin has been fairly volatile from a percentage standpoint, from an absolute dollar change. It’s been fairly material. But I would say that collectively with service margins in excess of 80%, it would typically result in overall gross margin in excess of 70%. So, that’s something we are very comfortable with.

Barry McCarver - Stephens Inc.

And you brought up a good point there on the product margins or the negative margins there, you mean, you can kind of see it’s been within the range although it does move around each quarter. Is there anything in those product trends I would suggest that it’s going to exceed the range to the high that it’s been maybe over the last two, three quarters?

Bryan Martin

I don’t think so Barry. I think you are right. We have narrowed the range. We don’t have these like wild swings like we used to, but we’ll still do promotions and things that will drive it one way or the other. And again, I think the general trend, yes, some of our mid-market customers don’t want, they don’t have any budget to pay for the equipment. We work with them on that. Some of them are willing to buy the equipment at near full price and we are happy to take that order. I do think as bigger mix of our new customers is more in the mid-market segment that might help stabilize that further, but right now, I wouldn’t read anything into one way or the other, and it’s going to probably keep bouncing around hopefully within this slightly narrow range than it’s been.

Barry McCarver - Stephens Inc.

Very good. Thanks a lot guys.

Bryan Martin

Alright, thanks Barry.

Operator

Thank you. Our next question comes from Mike Crawford from B. Riley & Company. Your line is open.

Mike Crawford - B. Riley & Company

Thank you. Further regarding the cloud services around what percent of revenue were data services now and where do you think that gets to once Softbank ramps up?

Bryan Martin

We got the question, Mike, we are just Dan is looking through some numbers. For the Softbank side I mean as we said as we’ll be the top 10 customer from any kind of threshold measurement of materiality what we’ve done to-date with the Softbank is well below any materiality level. So, we are talking at well below a 5% revenue customer and so I would think of it is like extremely low one-digit percentage of revenue type level of customer and so that revenue would be kind of categorized into this data cloud type revenue, which is kind of like the non-unified communications revenue that we have today. But let me - the collective like manage hosting and cloud revenue is roughly 4% of total revenue and that compares to roughly about 9% a year ago of total revenue. So, it’s a business that as we mentioned a couple of quarters ago we had diverted kind of some of the marketing resources and kind of transitioned the model into more this licensing type model that we’ve illustrated with CoSentry and the second customer were Softbank.

Dan Weirich

And just to be clear then Mike, the 4% number will have – there isn’t zero Softbank revenue in the June quarter that we just reported today.

Mike Crawford - B. Riley & Company

Right, thank you. And then on the global reach, the datacenter instance investments you will be making, is that something that’s going to be $3 million or $4 million of net investments over the next 6 to 9 months or is it too early to say.

Bryan Martin

No and so we reported capital expenditures as a percentage of revenue of 1.6% this quarter. And I think on a full year basis we’ll probably be closer to 2.5% or so – may be 2.5% or 3%. So, we are looking at may be like approximately like 1.5% of revenue would be invested in this global reach initiative from a CapEx perspective.

Mike Crawford - B. Riley & Company

Probably.

Bryan Martin

A little bit lower.

Mike Crawford - B. Riley & Company

And then it would likely decline a bit the following years.

Bryan Martin

Yeah, this is like a one-time investment, but so it’s sort of – for some of you long timers if you recall we put the – expanded to the East Coast a few years ago, we had a specific one-time investment hence we setup our Virginia datacenter and then CapEx rapidly declined as a percentage of revenue and I think of it the same way.

Mike Crawford - B. Riley & Company

Thanks. And the final question is any changes in any of the competitive dynamics where you are coming in, against host of PBX providers or any other maybe – any other service providers?

Bryan Martin

Well, I think the only change is I think we are winning more deals. If we are in the deal, we’ve got a very good chance of winning it and kind of speaks to the maturity of the sales team that we know what we have to code on a pricing professional services basis to a larger customer to win the deal and so I think our close rate has actually improved versus where we were last year on opportunities we are in. And other than that the competitive landscape has been pretty stable, which is a surprising thing to say after the decade we went through in 2000 with kind of the emergence so these technologies in the early part of that decade and then the effects of the crash on the business climate in the U.S. after 2008. So, hopefully, it’s a little smoother sailing as we continue to scale, Mike.

Mike Crawford - B. Riley & Company

Great, thank you.

Bryan Martin

Thank you.

Operator

Thank you. Our next question comes from Dmitry Netis from William Blair. Your line is open.

Dmitry Netis - William Blair

Hey, guys. Congrats again on a good quarter and pretty good metrics across the board.

Bryan Martin

Hi, Dmitry. Thank you very much.

Dmitry Netis - William Blair

Okay. I have a couple of quick ones here. I guess, the first one I wanted to see on the churn you have been pointing to this economic churn for a number of quarters, it’s sort of been over 50%. Has that improved, I mean, are you seeing macro environment improving and thereby what’s driving your churn to this record low number?

Bryan Martin

Actually, if you look at it from the percentage of total cancellations, it was almost like an all-time high at 54% in this quarter, but if overall the denominator piece of the equation was smaller. So, the absolute number of cancellations due to economic reasons was the smaller number…

Dan Weirich

Slightly smaller.

Bryan Martin

Slightly smaller, yes, we are talking like maybe like 30 customers or something. So, I would not say that it’s an indicator in any respect of like a macro recovery in the economy. Dan and I don’t hold any political office, so we are not going to come to 30 saved businesses.

Dmitry Netis - William Blair

Alright, fair enough. Well, thanks for that. And then the other question I would have is as I look at your subscriber acquisition costs, it’s been sort of on uptrend over the last couple of years. It said about $1,133 this quarter, the June quarter, which is about $153 year-over-year increase in subscriber acquisition cost. So, I just want to not necessarily that there is anything wrong with this, I understand you are selling a lot more services, but give us some puts and takes what goes behind us and why this thing either continues to grow or may stay at the levels it is at right now?

Bryan Martin

Yes, I think the way you are doing the calculation is you are just doing, I believe the calculation would be like the $96.

Dmitry Netis - William Blair

Exactly right, yes, exactly right, yes, the total service, yes.

Bryan Martin

Okay. So, the number of service, I mean, one thing is the number of services that you are multiplying it by is just a bigger number than it was a year ago. And so the way that we tend to look at it is how much is it costing us to acquire the service that’s going to generate recurring revenue costs and so that’s why we have brought it down to kind of the lowest common denominator of other service and year-over-year with in our view being up $4 is like flat for us. And if we go back and look at many, many years of data, the highpoint was roughly 110 plus or minus couple of dollars and the low point was 90 kind of plus or minus a couple of dollars. So, we are in a fairly tight range. And for the last five quarters, we have been kind of just below the average there. And we kind of view the average at $100. And so the reason why larger customers would result in higher acquisition cost is when we have a meaningful percentage of our sales come from our referral program, which is detailed on our website and that has paid a dollar amount for fiscal line that is sold. And so on a 100 line opportunity, they would be paid 100 lines times that referral fee and on a 10 line opportunity they would be paid 10 lines times that same figure. So, that’s one of the big drivers that pushes it up and then the subsidy piece is factored in there as well. So, on larger sales opportunities, the absolute dollar amount of the subsidy is greater.

Dmitry Netis - William Blair

Okay, that’s helpful. And as far as kind of the marketing dollars going into acquiring those bigger customers, that obviously has to grow right going forward. And does that anything – just have to do anything with the competition being maybe fierce in the mid-market versus the SMB, if you can maybe comment there as far as the marketing activity trying to go after the bigger customer?

Bryan Martin

I think there is if you are asking why the bigger line count deals have a higher overall acquisition costs. It’s really just driven more by the sales cycle as longer. And so we invest more resources not necessarily on the lead generation, but more on the – through the selling process a lot of the bigger deals we participate in have written request for proposals that require some of set down write a full.

Vote and grants and kind have how we would install this and kind of get all of that on paper and so just the sales cycle can stretch anywhere from at the low end maybe three to six month timeframe to we have deals that are more than 24 months and are still in process. And these are deals we believe we can close are just very long sales cycle deals. So, that’s kind of more what drives that expense. I don’t think the – as I said in the last – with the last caller I don’t think the competitive landscape is really all that difference than it was other than there is a growing acceptance of these really customers of all sizes not just the larger customers to look at a cloud based offering as a viable alternative or as a means of expansion or upgrading their current solution.

Dmitry Netis - William Blair

And the cost of lead generation has that been pretty consistent?

Dan Weirich

Yeah. It really has surprisingly consistent even going back to when we started in the consumer world. So, it’s never really to get out the routes or the law of nature that preserves a certain dollar amount you have to spend but it’s I haven’t seen any real material changes there.

Dmitry Netis - William Blair

Okay, excellent. Thank you. I would have one question on the federal side given that we’re heading in this fiscal year end on the federal. If you could maybe gives an update there I know you’ve been donning this opportunity down for quite some time. Is there any…

Bryan Martin

Yeah, well. Speaking of sales cycle times we always refer to some of our – I don’t want to say all of us some of them are very quite, but some of our federal customers and opportunities are very special incarnations of a mid market customer and so some of them have extremely slower than normally they may not just do one RFP they may decide to redo the RFP and maybe do it a third time and respond the protest and all sorts of fun things that we get into. Things are still slow there. I have heard other companies blame the sequester I have heard them blame the political deadlock people are scared to spend money in Washington, all sorts of things. I don’t think we are operating at a big enough take rate to really comment on why, but I mean what we observe is the deals are very, very slow. Execution seems to have…

Dmitry Netis - William Blair

We should be expecting – we shouldn’t be expecting anything next quarter basically is what you’re saying right?

Bryan Martin

Exactly I – it is their fiscal year end and they do need to spend some money. There are accounts we have with the federal government where they actually prepay for a full year, but I would – I am not going to stick my neck out and say you’re going see any bump from federal based on what we’re seeing right now in the deal flow there.

Dmitry Netis - William Blair

Okay good and then how many guys have you added – how many what’s the headcount at the end of the year?

Bryan Martin

So.

Dmitry Netis - William Blair

Last housekeeping question here.

Dan Weirich

Our total headcount at the end of the quarter is 414 people.

Dmitry Netis - William Blair

Great, okay. Well, thank you very much.

Bryan Martin

Thank you, Dmitry.

Dmitry Netis - William Blair

Okay. Keep up the good work gentlemen.

Bryan Martin

I appreciate it. Thank you.

Operator

Thank you. Our next question comes from Raghavan Sarathy from Dougherty & Company.

Bryan Martin

Hello.

Operator

Your line is open.

Raghavan Sarathy - Dougherty & Company

Yeah, hello.

Bryan Martin

Hello, we can hear you now. Yes.

Raghavan Sarathy - Dougherty & Company

Hi, good afternoon. First question is on mid-market Bryan you talked about it slightly smaller deals average number of services for the new customer is 17.5, new MRR was flat from fourth quarter. But if you look at the pipeline, if you look at the productivity of the team is the first quarter kind of the low point should we expect the trend to go higher from here?

Bryan Martin

Yes. I mean visibility there in terms of the existing pipeline is solid. There is no issue with the pipeline other than the fact I think that team really cleaned their pipeline in March. And we just had very slow April as a result. As I said we had 116 partners approximately half of those did business in FQ1. We saw the same kind of overall mix that 25% of the partners did the really the bulk of the business. And so, yes, I don’t – like I said, I don’t read anything into that. And we are focused as we talked about, we had our first deal out of Insight on our last quarter’s call and even that team has had some transitions during the quarter, the gentlemen, we worked with there to set that deal up retired and let the company during the quarter. So, we have a new kind of overall VP we are working with. We have been very closely working with that team. I don’t think any of those changes had any disruption to the deal flow there. We have been very successfully onboarding the customers coming from these larger channel partners. And I think that will yield more deal flow as they gain confidence that we can provide a very good alternative to their competitive solutions that they have carried in the past typically on the on-premise side. So, that’s kind of my commentary on it.

Raghavan Sarathy - Dougherty & Company

Okay. And then in terms of sales and marketing expenses, it was running between maybe about $11 million and $11.5 million in the first half of last year that stepped up to $13 million. If I look at the stack, it’s flat year-over-year at $96. So, where are you making those investments? Are they going more towards supporting the larger customer share bringing in and then sort of how should we think about going forward?

Bryan Martin

Sure, yes. So, I mean, the reason that you see the cost of acquisition excludes payroll and related expenses effectively. The increase is related to payroll and expenses. So, sales and marketing as a whole year-over-year was up $1.6 million on payroll and related expenses. And I mean that’s just the bulk of the investment is just us hiring more quarter carrying sales people and go past them.

Raghavan Sarathy - Dougherty & Company

And then in terms of the churn, it was record low and Bryan you talked some of the initiatives paying off, is there a further room for improvement or this is how should we think about this?

Bryan Martin

Yeah, I apologize for laughing. There is always room for further improvement on insurance. So, we are never happy, never satisfied. It’s a very frustrating job for our customer service and onboarding team. So, we are continuing, we have some projects underway, especially on the mid-market side, a lot of the onboarding processes and tools that we utilized and kind of graduated out of developments that were done for the smaller size customers, and they are not always ideal for a mid-market customer or a mid-market customer with multiple locations, and so one of our goals here is to really drive a lot of automation and a lot of really advanced tools into making the onboarding process much easier for these larger customers.

And I think that is where most of the low hanging fruit lies and that’s where we have a lot of development efforts, but having said that, we are actually taking kind of a hard look at how our services are delivered to what we have historically called our micro business is, which are kind of 25 seats or fewer. And I think there is product improvements that can be driven into that segment, that will also yield higher customer satisfaction. I mentioned, customer satisfaction surveys in the prepared remarks, and we are very closely monitoring and measuring and taking a look at what our customers think about how we help them do business. And that’s given us a lot of ideas for improvement. So, even at the low end of the market, I think there is room for improvement, but I think there is lower hanging fruit with the mid-market onboarding process that’s in place currently.

Raghavan Sarathy - Dougherty & Company

Okay. Just one final question, so you talked about bringing onboard the VP of Sales, Inside Sales, and he has put some process in place. So, let me get a better understanding, so when you look at the micro business and potentially in underperformance, where do you see is it more driven, is it because of the top of the final issue or it’s more of a conversion issue or what some of the factors you are looking at?

Bryan Martin

Yes, I think it’s really about scaling that team and enabling us to make that team much larger than it’s ever been. We have added sales people to that team over where we were last year, but we are trying to plan for the future where we could be doubling, quadrupling really if you visit our offices there is a lot or room here to expand productive sales people and we would love to do that. But you can’t grow under certain level or if you are not organizing how the process is in place, so I might go with Dan and I know the entire sales team on the inside sales organization is really to drive this thing to a much larger scale than we have ever operated that before and that’s what a lot of our focus is around.

Raghavan Sarathy - Dougherty & Company

Okay. Thank you

Bryan Martin

Yes, thank you

Operator

Thank you. Our next question comes from Greg Burns from Sidoti & Company. Your line is open.

Greg Burns - Sidoti & Company

Good afternoon.

Bryan Martin

Hi, Greg.

Greg Burns - Sidoti & Company

Hi, recently Mitel announced some partnerships with carriers and I was wondering if that kind of wholesale licensing model is something you might have reconsidered in the future to expand you distribution?

Bryan Martin

Yes, I would say yes selectively. We don’t view it today as our core business outside of maybe the cloud data segment that Dan it’s really become kind of our core distribution model of those technologies. But because we do own the complete end to end platforms that deliver our business communications services, we are certainly in a position to private liable portions or the entire platform and provide a white label kind of OEM service provider channel. And so in past we’ve done that with companies like AT&T Mobile with their Call International product began for the as Dan said all the timers on the call you remember we did a BellSouth private labeled offering before unfortunately just before AT&T bought them in 2005. So, company looks for opportunities like that we currently white label our call centre services for Bell Canada, we have other OEM kind of relationships and discussion both in place and kind of under discussion. And so opportunistically for large brands that are willing to pay very large minimums and make sure so that we are sure they are committed to really launching something in volume we will happily provide our technologies via that sort of channel distribution.

Greg Burns - Sidoti & Company

Okay. With Softbank under your belt, could you just kind of talk about the pipeline that you are seeing for the (Xerago) provisioning products or service and are you seeing more in down calls now that you have kind of that reference customer with Softbank?

Bryan Martin

Yeah, their service really just launched and it was kind of a soft launch in terms of production availability, but it will be production in the next 30 days or so. So, I expect that as people kind of digest what they have been able to do with our technology that will lead to that. We have been – we have in other discussions in the heels of both CoSentry and Softbank with other opportunities to distribute that technology, but again nothing to update you on today.

Greg Burns - Sidoti & Company

Okay and lastly in terms of you just discussed wanting to scale up your inside sales, is that the size of your inside sales force, the bottleneck you feel you are limited in kind of investments you can make that generate leads or I am just trying to understand if that the bottleneck or is it lead generation of what is kind of holding you back?

Bryan Martin

I don’t think our current – our new management team for that organization feels constrained by leads, I think it’s more about again process and having the right organizational structure, some of that being read on the management team that needs to be in place under the head of inside sales and so we have been hiring some very exciting individuals from some very well-known brands in both the cloud and kind of telecom space and they are now on board in this past quarter. They are driving some of those increases in sales and marketing costs that we talked about little earlier on the call, but we fully expect that they are going to the investment in improving that management team will pay dividends that make the whole thing very, very worthwhile.

We kind of have to put infrastructure and the organization and the processes in place for that team to kind of take it to the next level and we are partway through that process. I don’t think we are there we are not declaring victory, but I am very confident that we are making very good headway and improving that overall organization and like I said very positive review of the 90 day progress yesterday.

Greg Burns - Sidoti & Company

Alright, thank you.

Bryan Martin

Alright, thanks.

Operator

Thank you. And our next question comes from Mike Latimore from Northland Capital. Your line is open.

Mike Latimore - Northland Capital

Thank you. Hi guys.

Bryan Martin

Hi, Mike.

Mike Latimore - Northland Capital

Hi, there, very nice quarter.

Bryan Martin

Thank you.

Mike Latimore – Northland Capital

Just back on, I guess on the Inside Sales, how many sales people are in that group at this point?

Dan Weirich

Our Inside Sales group is approximately 50 quota carrying sales people today. And so that would be just defined as all quota carrying people outside of our channel in this marker group.

Mike Latimore - Northland Capital

Okay. And Bryan, did you say that you would like to double that channel or triple is that we said?

Bryan Martin

Absolutely, yes, over the long-term, Mike. I am not going to do it this quarter, but…

Mike Latimore - Northland Capital

I understand you are in the foundation place here.

Bryan Martin

Exactly.

Mike Latimore - Northland Capital

I guess, I’ll say a year from now, what would be as things go well, what would be a good number about a year from now?

Bryan Martin

Double probably.

Mike Latimore - Northland Capital

Alright.

Bryan Martin

But productively double, we are big on as you have seen on the balance sheet kind of making cash around here and free cash flow, and so we are not just doubling, it’s a double, but double it very productively and profitably.

Dan Weirich

Yes, I mean, so, we over the years have aggressively grown the Inside Sales group and then kind of less aggressively grown it and the one thing that we have learned over the years and when I am saying years, I am talking about five, six-year period, and is that if you were to do something to the effect of like doubling the Inside Sales group in a 12-month period that you tend to run into some imbalances that kind of just result in. It’s not as successful as if you would have just grown it more gradually. So, I mean, that’s effectively the plan.

Mike Latimore - Northland Capital

Okay, got it. And then on the channel partners, obviously, there is a few that are doing the most business there, are those still the kind of the telecom resellers or have some data VARs sort of stepped up here?

Bryan Martin

There is a mix of effectively three buckets. So, it is telecom service providers, data VARs, and then the smaller component is IT consultants. And the telecom service providers and the data VARs are the two biggest groups of the three.

Mike Latimore – Northland Capital

Okay.

Bryan Martin

I would say that we mentioned a couple of quarters ago that albeit it was a smaller figure, but I mean, we are starting to see like good trends in recurring a repetitive sales from the data VARs, and they are folks who are kind of fundamentally having to like changed their revenue generation model, because historically they have received large checks upon sale of equipment and/or is this building more of an annuity stream rather than a big lump-sum upfront.

Mike Latimore - Northland Capital

Yes. And you grew ARPU $5 on this quarter, is that still kind of the way to think about the trend there sort of $4 million to $6 million a quarter?

Bryan Martin

Yes.

Mike Latimore - Northland Capital

Okay. And then roughly how many contact center deals that you are doing in a quarter now?

Bryan Martin

Contact center is I mean, we don’t disclose. And frankly we don’t track it so much unlike how many contact center deals we closed in a quarter. And the reason being is that more often than not when we sell a contact center, it is integrated and bundled then with the PBX. So, we have had last couple of quarters get success in selling to small cap public companies who are roughly about by its size plus or minus a little bit, and they have got few 100 employees and they have got 250 people on the PBX and they have 40 on the call center. I mean, that’s kind of like that is the reason we acquired contractual 20 or so months ago. And we are just kind of the indicator there is where is the ARPU trend going, and the reason that it’s moving up into the right is because we are just having continual success on selling a merged hosted in PBX and contact center. And as far as we know, we are the only provider to sell a fully integrated PBX and contact center products on a hosted delivery basis.

Michael Latimore - Northland Capital

Last question just I am sure and I know you guys are executing well, in terms of onboarding and so forth, what about just, I mean is there a way to show kind of as you get as your customer will get bigger the churn is going to come down to, so is that sort of happening?

Bryan Martin

I mean, that is a function of why you are seeing churn coming down, because larger customers and we just kind broadly defined that as customers would spend more than $1,000. We thought this we noted last quarter represent about a third of our total. Recurring revenue at today, they have a lower churn rate. And so if you just look at like the future revenue drive from those customers, it represents greater than 50% of our total revenue that we currently have today.

Michael Latimore - Northland Capital

Yes, okay.

Bryan Martin

Because they are going to be with us for so much longer. And I just have one clarifying point, because might I know that you put it in your section too, earlier Mike Crawford asked a question about the percentage of our revenue from this Cloud data business. And I believe he was asking more total revenue and I incorrectly answered the question on what kind of like the sales component was. So, what I answered was 9% a year ago and 4% in this most recent quarter. And that was what the Cloud data represented of our sales. On a total revenue basis, it was approximately 5% a year ago and 4% in this most recent period that we just announced, and again, none of that had Softbank in either period.

Michael Latimore - Northland Capital

Thanks.

Bryan Martin

Okay. Thanks Mike.

Operator

Thank you. I show no further questions. I would like to turn the conference back to Mr. Bryan Martin for closing remarks.

Bryan Martin - Chairman and Chief Executive Officer

Okay, thanks, Mary, and thank you everybody for listening in on our presentation today. We will conclude today’s call by asking for your support in our social media outreach efforts. Throughout 2013, 8x8 has been driving an active social media campaign and all of our investors, in addition to supporting us in the public markets, can also support us by Liking us on Facebook, and following us on Google+, Twitter, LinkedIn and YouTube. So, please visit 8x8.com/social to connect with us on the channels of your choice. This outreach improves our Internet search results, and enables you to connect with us further on social media for the latest in product news, access to our experts, getting helpful tips from our customers and webinars, and providing us with feedback on how we can make all of our services even better. Thank you for your assistance in these efforts. And with that, we will conclude today’s call. Go ahead, Mary.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect at this time.

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