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8x8, Inc. (NASDAQ:EGHT)

F2Q 2014 Earnings Conference Call

October 23, 2013 4:30 p.m. ET

Executives

Joan Citelli – Director, Corporate Communications

Vik Verma – 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 Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session with instructions following at that time. (Operator Instructions) As a reminder, this conference is being recorded.

Now, I would turn the conference over to your host, Ms. Joan Citelli, Director of Corporate Communications. Please begin.

Joan Citelli

Thanks, and welcome everyone to our call. Today I am joined by 8x8’s Chief Executive Officer, Vik Verma and 8x8’s Chief Financial Officer, Dan Weirich, to discuss our results for 8x8’s second 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 Vik, I would like to remind all participants that during this conference call any forward-looking statements are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Expressions of future goals, including financial guidance and similar expressions, including without limitation, expressions using the terminology may, will, believe, expect, plans, anticipates, predicts, forecasts, and expressions, which reflect something other than historical 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-Q, and in our other SEC filings and company releases. Our actual results may differ materially from any forward-looking statements due to such risks and uncertainties. The company undertakes no obligation to revise or update any forward-looking statements in order to reflect events or circumstances that may arise after this conference call, except as required by law. Thank you.

And with that, I’ll turn the call over to Vik Verma, Chief Executive Officer of 8x8.

Vik Verma

Thank you, Joan and welcome everyone to 8x8's earning call for second quarter ended September 30, 2013 and my first quarter as Chief Executive Officer. For those of you who are unfamiliar with my background, I was formally President and Chairman of Savvy Technology and President of Strategic Venture Development at Lockheed Martin and have been a member of the 8x8 Board of Directors since January of 2012.

On September 9, 2013, I assumed the role of 8x8 CEO while Bryan Martin, our former CEO, took on new responsibilities as 8x8 Chief Technology Officer. I'd like to review some of our high level financial results and accomplishments for the quarter. Following my remarks, our CFO Dan Weirich will discuss the results and metrics in greater detail. We will then be happy to answer any questions you may have for us today.

The key financial results and customer metrics for the second quarter of fiscal 2014 were strong and, in some cases, record-setting. Total revenue for the second quarter of fiscal 2014 grew 22% year-over-year to a record $30.8 million not including $0.7 million of quarterly revenue attributed to our dedicated server hosting business that was divested at the end of the quarter.

We are particularly pleased that our year-on-year total organic revenue growth exceeded 20% while maintaining industry-leading profitability. The revenue from business customers grew a record 25% year-on-year and represented 98% of total revenue. Non-GAAP net income as a percentage of revenue was equally strong at 13% or $4.1 million compared with $3.7 million in the same period last year.

There are five note-worthy points about this quarter. First, the significant uptick we saw in the number of new services added during the quarter. A year-over-year increase of 22% shows that demand for services remain strong in our core domestic SNB market. Maintaining our leadership position in this market segment remains a high priority.

Second, our continuing focus on mid-market and channels is bearing fruit with 33% of new monthly recurring revenue sold in the quarter coming from this sector. This represents an 80% year-on-year increase. We continued to show an increase in the average number of services to which our new business customers subscribed leading to improvements in our average monthly revenue per customer.

Additionally, we signed on two of our largest customers to-date during this quarter, each with greater than 500 services deploying both Virtual Office Unified Communications and Virtual Contact Center call center services. We are seeing more and more customers of this size, many with multi-national locations looking to outsource multiple communication and collaboration services to a single, reliable cloud-based technology partner.

Third, our focus on upselling our existing customer base with a greater number of services continues to be successful. This quarter, nearly half of our new MRR came from existing customers buying additional services. As you are aware, one of the factors which differentiates us is that we are not only selling hosted telephony services with built-in mobile apps, we are also offering integrated complementary communication and collaboration services such as web conferencing, call recording, Internet fax, video conferencing, and contact center services with more differentiated services to follow.

This comprehensive suite of services combined with a highly scalable service architecture enables our customers to quickly and easily deploy additional 8x8 products and services to distributed locations and remote employees in a seamless fashion. Fourth, we continue to build on our global reach initiative. Cloud-based unified communications and collaboration services are under-penetrated in international markets where telephony costs remain high, and this presents a significant opportunity for 8x8.

The international market for our service is even less penetrated than in the US. Further, many of our existing mid-market customers with global operations are requesting our services for their international locations. We launched our service platform in Europe through a new London datacenter this quarter. We're now in the process of migrating service for US customers with European offices to this facility and remain on track to open our next datacenter in Hong Kong by the end of this calendar year, and in South America in the first quarter of calendar 2014.

Fifth, beyond serving the needs of existing customers through our global reach initiative, it is our intent to penetrate international markets through a variety of additional methods including strategic alliances, partners, and acquisitions. In that vein, we achieved another milestone this quarter with the completion and delivery of our virtual desktop infrastructure service under private label for a Japanese telecom partner, Softbank, which they have now begun offering to their enterprise customers.

We would like to thank Softbank for their close partnership and support over the past nine months, and we're excited to share their vision of ubiquitous service availability in the cloud. Our VDI technology adds a new dimension to our cloud services portfolio, one we believe will address certain needs of our mid-market customers as well. This market is at an early stage, but we're intrigued by the possibilities of this new technology.

Two organizational notes: First, we recently announced the sale of our non-core dedicated server hosting business, a low gross margin segment of our operations with declining revenue for $3 million in cash. This, in turn, has enabled us to sharpen our focus on our cloud-based service offerings and will positively impact revenue growth and gross margins.

Second, as mentioned earlier, Bryan Martin has taken on a new role as CTO and will be directly responsible for leading our research and development efforts. This will be an area of focus for us as we scale and expand our cloud-based service technologies. Additionally, we have decided to eliminate the position of President formerly held by Kim Niederman.

This change has been made to streamline the organization effectively removing a layer of management. We thank Kim for all of his contributions to the company and wish him well in his future endeavours. Before I close my remarks, there are a few thoughts I'd like to leave you with. There are three key elements that have enabled our market success to-date and will be the underlying basis for our continued growth.

First, 8x8 provides a comprehensive suite of unified cloud communication and collaboration applications from phone service to web conferencing to contact center and beyond, all built on an internally-developed cloud-based software platform validated by our 91 issued US patents. Second, 8x8 has a profitable and capital-efficient business model that has been optimized over several years.

8x8's CapEx to revenue is the lowest in the industry at approximately 2% while our profitability is industry-leading. Third, our innovative sales and provisioning model has enabled us to rapidly scale and deploy our solutions to tens of thousands of businesses in a very low touch efficient manner. We will increase our investment in all three areas to extend our lead since they have been and will remain the keys to our success.

With that, 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

Thank you, Vik. We reported a notable increase in revenue growth for the quarter with revenue from business customers increasing 25% compared with the second quarter of fiscal 2013, and total revenue increasing 22% during the same period. Service and gross margins were strong with service margin at 81% and gross margin at 71%. Contribution margin defined as service margin, less billing and customer service expense, improved to a record 65% in the September quarter compared with 62% in the same period last year.

Payback, defined as the number of months of contribution margin to payback the subscriber acquisition cost was 6.6 months. On the contribution margin calculation, this is a fully-loaded number that includes all management expenses including senior executives who run our network and customer support functions. As Vik noted, we continue to deliver profitable growth as non-GAAP net come for the quarter was $4.1 million compared with $3.7 million in the same period a year ago.

Non-GAAP net income per diluted share was $0.05 for the quarter and non-GAAP net income as a percentage of revenue was 13% in the quarter. GAAP net income for the quarter was $2.2 million compared with $1.7 million in the year-ago quarter. This includes a pre-tax gain of approximately $1 million on the sale of our dedicated server hosting business during the quarter.

The selected operating statistics included at the bottom of the press release were prepared as if the sale of the dedicated server hosting business occurred on March 31, 2012. Business subscriber acquisition cost for service was $94 per service compared with $86 in the same period a year ago and down $2 from $96 in the first quarter of fiscal 2014.

Monthly business service revenue churn in the quarter was 1.2% compared with 0.9% in the same period a year ago and flat compared with the first quarter of fiscal 2014. Customer churn was flat compared with the first quarter of fiscal 2014 at 1.5% and significantly down from 2.4% compared with the same period a year ago. Business customer average monthly service revenue per customer was $268, a $21 increase over the same period a year ago.

On the sales front, the number of new services sold was a record at 52,412, a 22% increase compared to the same period last year. The number of new services sold increased by 5,094 sequentially and 9,559 compared to the same period a year ago. The average number of subscribed services per business customer over 8x8's entire customer base grew to 12.2 compared with 10.8 in the same period a year ago.

This trend is occurring due to our focus on moving-up market to serve our larger customers for taking our services outside in the United States to meet their business needs. In the past year, the average number of subscribed services for new business customer increased to 17.7 from 14.7, a 20% year-over-year increase. Revenue from our mid-market customers base, which we defined as more than $1,000 in monthly recurring revenue or approximately 50 users represented approximately 35% of our recurring service revenue in the second quarter.

Capital expenditures were $1,455,000 or 2.4% of revenue for the first six months of the fiscal year 2014. The capital investments in our Global Reach initiatives began in the second quarter and will continue through the remainder of the fiscal year. Our cash, cash equivalent and investments increased by $3.4 million during the September quarter to $61 million.

In addition, we received $3 million from the sale of our dedicated server hosting business on October 1, 2013 which is not recorded in cash and cash equivalent, but instead in other assets on our balance sheet for the September quarter. We are well-capitalized with no debt and are ready for strategic corporate development. Moving forward, given the market opportunity that exists and the success we have had to-date, we have decided to increase our investment in sales, marketing and research and development with the goal of continue to drive strong revenue growth.

We remain committed to profitable growth and anticipate we will maintain non-GAAP net income as a percentage of revenue in the high single digit range. We believe now is the time to continue to drive up market, increase market share and invest in growth to extend our lead in the cloud communications and collaboration industry. That concludes my prepared remarks, and I'll now turn the call back over to Vik.

Vik Verma

Thanks, Dan. To amplify on Dan's point, we are happy about our performance this quarter and are pleased with our progress and positioning. We're excited about the opportunities for growth that lie ahead, both domestically and internationally, and therefore believe this is the right time to ramp up our investment in the business. But we will do so in a disciplined and responsible manner.

As always, we will remain committed profitable growth and maximizing shareholder value. With that, we will be happy to take any questions you may have for us today. Operator, please open the lines for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is Raghavan Sarathy of Dougherty & Company. Your line is open.

Raghavan Sarathy – Dougherty & Company

Good afternoon. Thanks for taking my questions, a couple of questions. Hi, can you hear me?

Vik Verma

Yes, we can hear you.

Raghavan Sarathy – Dougherty & Company

Okay, so two questions. First question is for Dan, how much revenue from Softbank was included in the quarter? And then second question is for Vik. The departure of Kim comes as a little bit of surprise, can you talk about who will be handling the channel mid-market sales with his departure and a little more color around the transition. Thank you.

Dan Weirich

On Softbank, we started recognizing revenue for Softbank on August 1, so we recognized two months of revenue or two-thirds of the quarter in revenue for Softbank, and the total revenue recognized is just under $100,000 a month on a monthly basis for Softbank.

Vil Verma

With regard to Kim, I think I came to the conclusion that the company was a little top heavy for our size, so I wanted to remove a layer of management which allowed me to work a lot more closely with all the various department heads. We have, as you know, very senior sales executives – one who runs mid-market and distributor enterprise; one who runs our channels; and a third one who runs our SMB business. All three of them will report to me.

Raghavan Sarathy – Dougherty & Company

Thank you.

Operator

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

Barry McCarver – Stephens Inc.

Hey, good afternoon, guys, and good quarter.

Dan Weirich

Thank you.

Vik Verma

Thanks, Barry.

Barry McCarver – Stephens Inc.

So, Vik, I guess looking at a lot of questions, a lot of good comments that you've already provided, but looking at the growth in this quarter now that you have the discontinued business out of the numbers, kind of your thoughts again on what's your outlook for growth we should be thinking about going forward. And then secondly on your ramp up of research development and sales and marketing, has that already begun, is some of that in this quarter? How quickly should we expect that? And can you give us a little more color on what to expect from those two income statement items? Thanks.

Vik Verma

Fair enough. I think we hit our record 20% year-over-year revenue growth this quarter. I think consider that a base line and then we'll build on top of that, and the goal is to keep building on top of what we've got from a historical perspective. With regard to investments, this will happen over time. I mean look, my general philosophy is I wanted to open up this ticket, but you open it up in a very disciplined manner.

I think the five noteworthy points I made as part of my prepared remarks, each of them is tied very specifically to a strategic initiative and each is tied very specifically to a proof point that shows that the strategy is taking hold. And so in each, we'll be starting to put more and more investments as well as as I indicated, general investment in engineering. We've got a little bit of it baked into this quarter.

We'll start to see it ramp up over the next couple of quarters or so, but I think you should model this high-single digit as net income going forward.

Barry McCarver – Stephens Inc.

Okay. And you mentioned moving internationally, and both in investments moving into channel partners as well as acquisitions to move internationally. Can you give a little color on what kind of channel opportunities, channel partner opportunities you see in the international markets, and then what you meant by acquisitions and what you might be looking forward?

Vik Verma

So, think of our international strategy in essentially two parts, and again it's part of the last two points I made in those comments, those five main points. We're doing this Global Reach initiative which is basically building infrastructure globally which allows our domestic customer with local offices to start using our services. So, that is one element of it. And the second one is the strategic alliances with large global telcos that can white-label our services and get to larger enterprise customers much bigger than what we could reach as well as us buying companies overseas that have a local presence so we can go after international customers with a local presence, a so-called mini-8x8 strategy.

So, I think I gave you two proof points on the first, the Global Reach one where we opened our London datacenter. Softbank is representative of the type of partners that we are looking at to white-label all of our various services, and we have others in the hopper. And then our intent again is we are continuing to look for the right companies. But again, we want to do this in a very disciplined and thoughtful manner to make sure that we get the right thing. But, more importantly, once you buy it you want to be able to make sure you can integrate it properly.

Barry McCarver – Stephens Inc.

Thank you. That's helpful. Thanks a lot, guys.

Operator

Thank you. Your next question is from Dmitry Netis of William Blair & Company. Your line is open.

Dmitry Netis – William Blair & Company

Hey, guys, nice quarter as well for me. Just a couple of housekeeping items, on the number of channel partners, Dan, I'm not sure if I heard that number. What was the number of channel partners in the quarter?

Dan Weirich

We ended at September with 124 channel partners. That's compared to 116 in the prior quarter.

Dmitry Netis – William Blair & Company

Okay, great, thanks. And then on the ARPU, I believe it was flat quarter-to-quarter. Can you give us some puts and takes why hasn't that grown and what’s the trajectory? In the past, we've been sort of expecting $2 or $3 added to the ARPU quarter-over-quarter. You're coming off of a nice mid-market quarter, your number of features, I think you said half of the new MRR (inaudible) existing customers, half of them are buying additional features from you.

So I'm just trying to get a sense of why ARPU hasn't improved this quarter and whether we should be expecting growth out of the ARPU going forward.

Vik Verma

The second to the last table in our press release is called our selected operating statistics. And so, what we've done here is we have presented this as if the dedicated server hosting business that we diversted on September 30 never occurred inside of the company. So all of these figures here, if you look at this closely, some of the quarter's figures are different than what we presented in the past, and so this removes the dedicated server piece.

Specifically to the ARPU or the Average Revenue Per Business Customer, we reported it today at $268, and in the prior quarter it was $263, so it's up $5 sequentially which is fairly consistent with what we had been reporting in the past. Year-over-year, it was up $21. If we were to include the dedicated server hosting piece in here, the year-over-year improvement in ARPU would have been $17.

So, the vast majority of our revenue, excluded dedicated server hosting, was growing at a faster growth rate. It had much higher gross margins, and the size of the customer was growing at a much more rapid rate than our dedicated server hosting customer base. So, I understand that it's a little bit confusing. But if you look at this table, we presented six quarters of statistics.

This should help you with your model. On October 4, we also put out a press release and filed an 8-K with the historical income statement for the five quarters ended June 30 excluding the dedicated server hosting business.

Dmitry Netis – William Blair & Company

Okay, got it. That's very helpful. So on the apples to apples, you basically grew ARPU $5 quarter to quarter

Vik Verma

Yes.

Dmitry Netis – William Blair & Company

And then going forward, what should the expectations be then? Is that sort of the run rate?

Vik Verma

We see no reason why it should not be growing at $5 or more sequentially. If you look at all of our strategic initiatives and points, it's moving up markets, selling to our more established customers and selling our existing customers more and more services. And so ARPU is kind of where the rubber meets the road on that, of whether we're doing well or not.

Dmitry Netis – William Blair & Company

Okay. And then the last question, is there any traction out of the [Central Host] and Insight partnerships, alliances that you have? Anything sort of material to talk about there?

Vik Verma

Central Host is a customer who was our first customer on our product that Softbank ended up purchasing, and then they expanded it into [DDI]. And Central Host has a website out there and they're doing quite well with their business. Insight is a channel partner. You can think of it as more of co-branding. Our solution to the end-user but everyone knows 8x8 is the underlying provider of it.

And we are starting to see some good momentum from that channel and we've been doing some co-marketing with them across the country.

Dan Weirich

Okay. And I think as you're aware, mid-market and channel represented 33% of new MRR compared to 21% of new MRR year-ago quarter.

Dmitry Netis – William Blair & Company

Actually, I think you started accounting for contact center as part of that 33% number you gave. In the past, I believe contact center was not included. If you were to exclude contact center, I think last quarter it was about 9%. You still grew. Is that the run rate I should be looking at, about 9%, 10%? What is that number for the contact center as part of the new MRR?

Vik Verma

That's a number we just don't disclose. The teams are all merged together and they're selling effectively a unified, a fully integrated suite of services. The 33% that we reported, new monthly recurring revenue in this quarter, compared to 29% in the last two quarters, so the June and the March quarter, 21% in the year-ago period. So it's all like an apple-to-apple comparison of all of these figures.

Dmitry Netis – William Blair & Company

Got it, okay. That's it for me. Keep up the good work, gentlemen.

Vik Verma

Great. Thank you, Dmitry.

Operator

Thank you. Your next question is from Mike Latimore of Northland Capital. Your line is open.

Mike Latimore – Northland Capital

On the channels, are there any specific channels that are doing better, being more productive whether it's maybe a telecom series reseller or on-premise reseller or data providers, any sort of channel partner category that's doing better than others?

Vik Verma

I would just say for example the Insights of the world are channels that we're starting to see some pretty good momentum from. We have a broad collection of channels out of the 124 channel partners and so we disclosed. In the past, it's kind of the classic 80/20 where 20% of the channels are generating 80% of business. And across that selection, it's all of those background for you, Mike. But we're starting to see some momentum in some of them, and they're about all walks of life.

Mike Latimore – Northland Capital

How about on the Insight sales, how many people do you have there now? Where do you think that might be by fiscal year-end?

Vik Verma

On quarter term sales reps across all of our sales group, it's a figure that we're not going to disclose going forward. It's a figure that has grown across the board recently. We have forecasted that we'll continue to grow in the future.

Mike Latimore – Northland Capital

Okay. I don't know if you'll disclose this, but do you have win rate in deals, like what percentage of the time do you win when you're [indiscernible]?

Vik Verma

Once again, it's a figure that we don't disclose because it's kind of all of the board. It just depends on the size of customers. It ranges significantly. It's something that I can tell you that we're very focused on win rates. We're very focused on sales productivity and very seldom measures like that. But it's starting to get lots and lots of names out there in the market that people can invest in and chat about who maybe or maybe not competitive to us. This is information that we just would like to keep to ourselves.

Mike Latimore – Northland Capital

Okay. Last on the R&D investment, is the focus on going to be more on getting some new features out or is it going to be more on the core infrastructure that might help with scalability or ease of use, further upgrading context? What's the R&D priority list plan?

Vik Verma

All of the above.

Mike Latimore – Northland Capital

Okay.

Vik Verma

The thing that makes us unique is we have this comprehensive suite of stuff and we are seeing increasing number of customers wanting this comprehensive suite of stuff. We will add functionality. We will add additional features. We will continue to build scalability in the platform. We will do tighter integration. We will basically provide more mobility, all the standard stuff.

Ours is a dynamic market and the fact that we have a market leadership position doesn't mean we get to sit back. I think this is the time to accelerate and add more and more features. We can put some distance between us and everybody else.

Mike Latimore – Northland Capital

Sure, great. Thanks, guys, nice quarter.

Vik Verma

Thank you.

Operator

Thank you. Your next question is from George Sutton of Craig Hallum. Your line is open.

George Sutton – Craig Hallum

Thank you. The way I look at this is you're selling more services to larger customers, and that's a great trend. I'm wondering how do you view that as potentially accelerating with your global initiative. At what point should we start to see that impact?

Vik Verma

We've got two elements to it as I indicated. We're starting to see several of our mid-market customers in particular tend to have international presence. And so therefore they are pushing us to have capabilities overseas so that local offices can use essentially localized datacenters. So we're seeing quite a big push there from our larger customers. But then once you have that foothold, it is very logical particularly with the high cost of telephony overseas, that you could get a critical mass of capabilities so you can start selling these same local services to international customers.

And I think what makes us unique is our platform is scalable. You saw what we talked to you about vis-à-vis the cost of capital. So the intent is to go find platforms where we can basically migrate our platform, migrate our sales methodology, and migrate our provisioning capabilities but that has a book a business. Use that to continue to accelerate and leverage growth.

That's the two-prong strategy. I think you'll see this over time. I probably would model it in the short term because international businesses are a few years behind the US market. But it's starting to uptick quite rapidly, and so we think there are very good opportunities and we want to be there at the ground floor.

George Sutton – Craig Hallum

Okay. I appreciate that. With respect to your – you had called out to greater than 500 C deals. And I wondered if you could give us a little better sense of what kinds of deals those were and give us a sense of the pipeline for those kinds of opportunities that you're seeing relative to what might have occurred in the past.

Vik Verma

We're starting to see more and more of those. One is a very large retailer, one with multiple offices, one is actually federally-oriented again with global presence. We're seeing more and more of those kind of customers. That's an area of focus because look you don't get to that part of the market. You don't start as a consumer company and one day wake up and say yes, I want to be in these markets.

It sounds great from an aspirational point of view, but it takes a lot of blocking and tackling and a lot of scar tissue and a lot of pain and suffering to be able to service the mid-market customer particularly a global mid-market customer. So we're starting to see a healthier and healthier pipeline, and we're also putting in all the various processes and features and capabilities to service our mid-market customers.

The other part that makes these guys very attractive for us is they typically want the suite of services and they're not looking for point solution because they don't want to get a telephony solution from one and a contact center from the second and a virtual meeting from a third. They like the idea of being able to get one platform and buy a whole series of apps.

So our pipeline in that is getting healthier and healthier, but it's been done with a lot of hard work and pain and learning, stuff on the job. It's not an easy transition to make. And I think the great news is, as you can see with the accelerating growth rate there, that it's a trend that the company is basically leveraging and has actually seemed to be getting over the hump and is continuing to get better at.

George Sutton – Craig Hallum

Lastly for me, relative to the Insight sales effort, Ben had come in and had a number of initiatives to improve the productivity. Can you just give us a sense of what kinds of impacts those might have had thus far?

Vik Verma

We're starting progress, generally too early to tell but the overall things he's putting in place, I like. And I think they will continue to bear fruit for us, but also he's putting a level of replicability because again when you start to scale, you want to be able to bring on people into the right environment, make sure that they're trained appropriately, make sure that everything is done for them in such a way that they can get to be very productive very, very quickly. The processes and just general structure and professionalism that he's adding to that particular environment is excellent.

George Sutton – Craig Hallum

Perfect. Thank you very much for your help.

Operator

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

Mike Crawford – B. Riley & Company

Does the market valuing top line growth more than profitability especially if you look at say RingCentral at 8x revenues and Vocalocity selling for just over a couple of times affect your change in investment strategy?

Vik Verma

Nor really. Look, here's the way I've looked at it. Ultimately, you have to do all the blocking and tackling and do it in such a way that you start to see your strategy bearing fruit. The reason I did that five noteworthy points is somewhat deliberate because I look at – it's very good to have aspirational strategies. That's not what we're about. Our goal is to have something that's executable.

So in each case, I think you can see the proof point of what we are doing. So once you prove it out and when you see the fact that it seems like the market is under-penetrated, that's when you ramp up investment. At least, that's been generally my style, which is I look for the proof point, I look for the second point, and say okay let's turn up the stick and let's open it gradually and let's see if we can start to do that.

So I think it's driven more by that and particularly – from my perspective, I think as long as we continue to execute the business, this is such a wide open business with 10% penetration rate. And I think we have this comprehensive suite of solutions where we could basically provide somebody with all the communication and collaboration needs. And we've already started the trend up mid-market and we probably have a jump on everybody else on that.

So I think this is the time for us to build on each of those strategy proof points and continue to ramp up from there. And hopefully, the market will reward the fact that we are a disruptive technology in a huge, huge market.

Mike Crawford – B. Riley & Company

Okay, thank you. And then the next one is along similar lines but more numbers-oriented. With the slight restatement given it just continued on that nice sale of Central Host, I'm not sure exactly what the trailing non-GAAP net income number is. It would have been $15.7 million I think before the restatement. I don't know if you have that number down?

Dan Weirich

The non-GAAP net income for the six-month period is – it's on the last page of our earnings release, at $8.3 million. And I will pull the two prior quarters that this call was on and answer that in a few minutes. I just don't have it right in front of me at the moment. If you just go sum up, it's in the press release that went out on October 4. But we'll pull it really quick.

Mike Crawford – B. Riley & Company

Okay. You're targeting sub-10% margin for that versus somewhere like 13.5% trailing, that implies some additional $10 million or so of investment in R&D, sales and marketing, what-have-you, next year. I think I'm doing that math. So where would you expect those buckets to be filled?

Dan Weirich

The incremental investment is more like $6 million or so, approximately $5 million to $6 million, so the $10 million is a high figure. The buckets, if you look at the buckets, you can see that we spend a lot of money on sales and marketing. Within our sales and marketing figure is customer service. We spend 7%, 8% or so of our revenue on R&D. And so you'll see R&D start to increase, and sales and marketing to increase at a much lower percentage rate than R&D will be increasing. But roughly the increase is roughly equal between the two.

Mike Crawford – B. Riley & Company

Okay. Thank you very much.

Operator

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

Greg Burns – Sidoti & Company

Good afternoon. I just had a question on the competitive landscape. You've had some competitors posting 30% to 40% top line growth. I was just wondering if you're seeing any promotional activity or pricing activity from the competition out there in the market.

Vik Verma

Yes and no. I like people putting up billboards because they spend the money on the billboards and ultimately people are smart enough to go in and check on everybody else that's in the space. So I'm not a big fan of huge billboards. I think our general view is, and I don't speak specifically about any one competitor, I kind of like the discipline and the DNA that we have, where we are committed to profitable growth.

It's amazing. Once you get used to losing money, it becomes very difficult to make that transition where you will get to making money. And so, as you can see, we see an opportunity where we could invest twice or three times more than what we are contemplating. But we want to stay close to that high single digit of profitability because that serves that fiscal discipline out there.

And I think not all revenues the same. We value revenue from larger customers that basically are buying multiple suite of products that are global as better than maybe just a pure point solution because I think there's a level of stickiness and we have seen the trend where these guys keep buying more and more stuff over time. So I'm generally satisfied with our growth. Again, I'm not chasing anybody else to try and meet some mythical number. I'm comfortable with what we're doing.

Greg Burns – Sidoti & Company

Okay. Thank you.

Operator

Thank you. Your next question is from Raghavan Sarathy of Dougherty & Company. Your line is open.

Raghavan Sarathy – Dougherty & Company

Thanks for taking my follow-ups. Two follow-ups, number one, I notice that [indiscernible] increased for the first time slightly in the last quarter. Some of the things, the profit changes you have made this year, deciding to pay dividends, how should we be thinking about this going forward? And then the second question is, you mentioned that you added two large customers. You said there's a sequential increase in number of usage, you said this is numbers approximately slightly. Can you talk maybe about the mix of customers? Thank you.

Vik Verma

On the first question that you asked, some of the processes and procedures are starting to work quite well. These processes and these procedures are a big group. We target 50 and below so if they do better, it brings down the average number across the board, so the two play very, very well or hand in hand with each other. You may have noticed that we actually had a net increase of 1,300 sequentially which is the first time we've done that in a long, long time or ever.

Raghavan Sarathy – Dougherty & Company

Yes, that's what I was looking at. And so I guess the question is, are these profits that you think of continue to work and so we should except [indiscernible]. And the second part of the question is, if I had the underside of the game, if I looked at the average number of services subscribed by new customers, it was up 0.2% 17.7 from 17.5, I think Vik mentioned that you added two large customers and I --

Dan Weirich

The bulk of our focus is on continuing to execute well in the SNB factor and then continue to execute at very impressive growth rates on the mid-market and distributor enterprise side of the business. The latter part is going to be the driver in the average number of services for new customer. But as we're seeing improvement in our SNB group, it is – if you're selling a lot more like ten-person businesses than you were in a part of the quarter, it's going to drive down the average across the entire base.

Raghavan Sarathy – Dougherty & Company

Okay. Thank you.

Vik Verma

Mike Crawford had a question on the trailing for quarters non-GAAP net income excluding the dedicated server hosting business, and it's $15.5 million. So it's $8.3 million in the six months ended September 30, and $15.5 million in the 12 months ended September 30, 2013.

Operator

Thank you. There are no further questions at this time. I would like to turn the call over to management for any closing remarks.

Vik Verma

Thank you, everybody, for listening to our presentation today. For reference and convenience, we have posted a transcript of our prepared remarks on the events and presentation section of 8x8's investor website at investors.8x8.com. I look forward to meeting all of you over the coming months at upcoming financial conferences and other events. And with that, thank you very much and that concludes our call.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.

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