8X8's CEO Presents at Acquisition of Voicenet Solutions Conference (Transcript)

Dec. 3.13 | About: 8X8 Inc (EGHT)

8X8 Inc (NASDAQ:EGHT)

Acquisition of Voicenet Solutions Conference Call

December 03, 2013 8:30 AM ET

Executives

Joan Citelli – Director-Corporate Communications

Vik Verma – Chief Executive Officer

Dan Weirich – Chief Financial Officer

Analysts

Amir Rozwadowski – Barclays Capital, Inc.

George F. Sutton – Craig-Hallum Capital Group LLC

Kash Gopalan Rangan – Merrill Lynch, Pierce, Fenner & Smith, Inc.

Raghavan Sarathy – Dougherty & Company

Greg J. Burns – Sidoti & Co. LLC

Mike Latimore – Northland Capital Markets

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the 8x8 Conference Call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded.

I would now like to introduce your host for today, Ms. Joan Citelli, 8x8 Director of Corporate Communications. Please go ahead.

Joan Citelli

Thank you, operator, and good morning, everyone. Thank you for joining us, especially given the short notice of today’s call. Today I am joined by 8x8’s Chief Executive Officer, Vik Verma and Chief Financial Officer, Dan Weirich.

This call is being webcast and an audio version of the call will be available on our website for one year. In addition, a telephonic replay of this call will be available until midnight December 9, 2013. The details for accessing the replay are included in the press release we issued yesterday afternoon, which is available on the Investors tab of 8x8’s website at www.8x8.com. We ask that during the question-and-answer session of today’s conference call, questions be limited to those related to today’s announcement and our global reach strategy.

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 similar 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 will turn the call over to Vik Verma, 8x8 Chief Executive Officer.

Vik Verma

Thank you, Joan. Good morning everyone and thank you for joining us. Yesterday we announced the completion of our acquisition of Voicenet Solutions, one of U.K.’s leading providers of cloud business telephony and unified communication services for $18.4 million in cash. This acquisition represents a significant milestone in the execution of our global reach initiative as it provides us with an established, fully operational footprint from which we can broaden our mid-market and distributed enterprise customer base within the U.K. and in Europe. According to a recent Wainhouse Research market forecast, the European UCaaS market is expected to experience a 36% compound annual growth rate over the next five years, reaching 1.5 billion by 2017.

As we have previously stated, expanding our operations and customer base beyond North American boundaries to serve existing and new customers is one of our key strategic corporate initiatives. We have also indicated that we’re committed to profitable growth and anticipate even with acquisitions such as these that we will maintain non-GAAP net income as a percentage of revenue in the high single digit range for the foreseeable future. Longer term we expect Voicenet to deliver results consistent with 8x8’s metrics, but with more of a focus on the Mid-Market segment.

Since its establishment in 2004, Voicenet has done well in the U.K. market with double-digit revenue growth rate and revenues of approximately $4.7 million for the six-month period ended September 30, 2013. Voicenet’s growth in the communications industry was recognized in 2012 by Deloitte, which awarded it a spot on the 2011 Deloitte Fast 500 Technology EMEA list. I’m pleased to announce that Voicenet CEO, Kevin Scott-Cowell, a Conference.com executive with over 25 years experience in this industry will continue to lead the U.K. team of 44 employees as part of the 8x8 organization.

Voicenet Solutions currently serves more than 1,000 business customers with communication services that include hosted VoIP with mobile apps, hosted contact center and service add-on such as call recording. Voicenet customers on average are approximately double the size of 8x8’s average customer and are generating high monthly recurring revenue.

The current Voicenet solution is based on an earlier version of the BroadSoft platform. Starting in early 2014 we will be providing service to new U.K. customers on the 8x8 technology platform, which we recently installed in London as part of our previously stated global reach corporate initiative. Over time we will also migrate Voicenet’s existing business customers over to the 8x8 platform and we look forward to offer these businesses a complete suite of unified communications and collaboration services on the cloud.

In addition to adding new customers and migrating its existing customer base, Voicenet will also become our base of operations for the European region responsible for supporting 8x8’s customers throughout Europe. As we expand beyond the U.K., 8x8 will deploy local dial plan so that our European customers can use the platform with no change in user behavior.

As is the case with our North American service platform, our European platform will utilize 8x8 Geo Routing technology to dynamically route 8x8 services to the 8x8 data center closet the users’ location. We believe this localized support, dial plans, language and time zone assistance will result in greater customer satisfaction and we look forward to leading the way in the European region in much the same way as we have in North America.

With that, I’ll now turn the call over to 8x8 Chief Financial Officer, Dan Weirich.

Dan Weirich

Thank you, Vik. We’re excited to add this new operation to 8x8 business and we will be using our traditional management methodologies to assist them in marketing, sales and financial controls. The key areas of focus will be improvement in gross margin, boosting marketing and generating more granular matrix in line with 8x8’s business practice. We believe we can improve Voicenet’s gross margins, which are currently approximately 40% to margins more consistent with 8x8 by installing 8x8’s platform and eliminating the resale of non-essential services such as broadband connectivity, which earned inherently very low margin and by changing the way the sales process and product offers are conducted.

For example, Voicenet has traditionally used third-party financial organizations to provide lease financing for IT firms and other hardware sold, primarily to optimize cash flow for the Company. We will no longer use the types of financing arrangements going forward and we will fund the sales of products from 8x8’s growing balance sheet.

Voicenet’s lower gross margins will reduce the combined companies gross margin between 200 and 300 basis points beginning in the fourth quarter of fiscal 2014. We expect it will take 18 to 24 months to increase Voicenet’s gross margins to be consistent with 8x8’s gross margin.

On the marketing front, we have already been generating leads in the U.K. market which we are previously unable to address with the local sales presence. These leads and additional lead generation specific to the U.K. and European market will now be funneled directly to Voicenet’s experienced sales team, and we expect U.K. revenue to grow at least at the same rate of growth as 8x8.

We expect these changes to be consistent with 8x8’s normal SG&A percentage ranges. We are also adding additional financial resources at Voicenet in order to bring their systems and procedures in line with those of a U.S. publicly listed company, and we are confident we will quickly make this acquisition a success.

I will provide additional metrics on the financial trends and performance of the combined company on our third quarter conference call in late January. Before we move on to a brief question-and-answer session, let me just mention that during this call we will not be commenting on the current quarter or discussing our financials or forward outlook.

With that we will be happy to take any questions. Operator, please open the lines.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Amir Rozwadowski with Barclays. Your line is open. Amir, your line is open.

Amir Rozwadowski – Barclays Capital, Inc.

Thank you, very much and good morning folks.

Vik Verma

Hi, Amir, how are you?

Amir Rozwadowski – Barclays Capital, Inc.

Well, just wanted to touch based little bit more in terms of the growth prospects that you see for Voicenet. It seems as though, right now, you do have some regeneration and the opportunity set seems to be expecting sort of growth in line with sort of your company or corporate average at the moment. I was just wondering, if you could give us some color as to, is that growth coming from new business in the European markets or you expecting this to help drive incremental business with some of your larger customer base that perhaps has much more of an international presence?

Vik Verma

Actually from both. So I mean, I think Amir, as we’ve talked before our global reach strategy has two parts. One is to put infrastructure all over the world, so in essence we can provide our U.S. based customers that have a global presence, the ability to expand globally leveraging our systems. And then on top of that once you put infrastructure globally, the ability to have a local sales force and a local support team and essentially a local presence allows you to go after local customers and basically provide them the same thing in reverse, if they have offices in Europe, but they also want to do business in North America or Asia, we basically have the ability to provide that for the local sales force.

So it will be a combination of both; the initial global reach infrastructure that we put up in U.K. was driven by the needs of our U.S. customers. What we found very interesting about Voicenet is, we could basically leverage that infrastructure we have put in to service our international of the needs of our U.S. customers internationally to also provide local capability to Voicenet customers and so in essence, you got a fully functioning company, a fully functioning support team, a fully functioning sales force which will basically have the ability to grow the market in the U.K. as well.

Amir Rozwadowski – Barclays Capital, Inc.

That’s very helpful Vik. If I may one follow-up; in thinking about now where your sort of footprints stands on a global basis, are there other areas geographic regions where we should think about potentially you folks adding additional sort of resources in order to continue the strategy for a build-out of global footprint?

Vik Verma

Yes, Amir, I think we have talked about previously, we plan by end of this year to have a datacenter or an infrastructure in Asia and probably in the first quarter of next year, we will have one in Latin America. It’s consistent with what we are trying to do. The business we are in is a global business and I think what makes us different is the fact that we will have a global footprint. And I think as you can see the way we are doing it, it’s very hard to go out and sell globally without having feet on the street that are local. And I think that’s an essence what we are doing with Voicenet will initially put infrastructure in Asia and Latin America and who knows overtime we may look into potentially adding people there as well.

Amir Rozwadowski – Barclays Capital, Inc.

Great, thank you very much for the incremental color.

Vik Verma

Thanks Amir.

Operator

Our next question comes from George Sutton with Craig Hallum. Your line is open.

George F. Sutton – Craig-Hallum Capital Group LLC

Thank you. I just wanted to see if you could give us a sense of how much of the revenues were broadband connectivity and how do you work out of that part of the business, how long does it take you to work out of that part of the business?

Dan Weirich

Hi George, it’s Dan. Broadband represents 10% of the Company’s revenue. It’s something that in our future sales we will not be providing broadband connectivity. We will be looking to partnerships for that.

On the existing customers that we’re providing broadband too will continue to provide that, but just on future sales, it will not occur and overtime as the business grows, that the growth here are quite healthy, so it will become a lower and lower percentage of the legacy Voicenet revenue than it is today.

George F. Sutton – Craig-Hallum Capital Group LLC

Got you. And Vik, you mentioned the Wainhouse 36% compounded growth rate over the next five years, can you just talk about Voicenet relative to that macro expectation?

Vik Verma

Sure. Keep in mind Voicenet is in the U.K. market which is did not really penetrated Europe in any meaningful way, but we expect with our balance sheet behind them that we can do that in a much more substantial way. So they have been growing actually in the teens, but this has been a way under capitalized company actually which is why we’re so pleased to find them. I mean, it’s a strong group individuals that have basically been bootstrapping their operations for a long period of time and despite that there have been able to grow in the low teens and the market you can kind of see both in Europe and in U.K. is starting to pop.

So all of these various researches are forward-looking where they are basically predicting significant increase in the overall market adoption of this technology. My guess is both Europe and U.K. are essentially about three years behind the U.S. market, so basically the same kind of growth that companies of our scale experience over the last three years in the U.S. – I think they are going to see something very comparable to that in U.K. and Europe.

George F. Sutton – Craig-Hallum Capital Group LLC

Perfect, okay. Thanks guys.

Vik Verma

Thanks, George.

Dan Weirich

Thanks, George.

Operator

Our next question comes from [indiscernible] with Merrill Lynch. Your line is open.

Kash Gopalan Rangan – Merrill Lynch, Pierce, Fenner & Smith, Inc.

Hi, that would be Kash Rangan with Merrill Lynch. Thank you very much for taking my questions. For you with respect to accelerating your plans to degenerate growth in Europe, what specifically can you offer as by the way of sending your balance sheet that 8x8 can do to accelerate the Voicenet business in Europe. And on the financials Dan, question for you, when you had guided after your previous quarter results you must have had some knowledge of potential and pending deals. So does your forward-looking guidance or did your forward-looking guidance that point in time already incorporate any potential valuation of this transaction or should we be adjusting our models incrementally based on the transaction announced today. Thank you very much.

Vik Verma

Kash, I think going back these guys are basically I think their marketing budget was £5,000 a year. Their lead generation is pretty much non-existent and as I said, despite that they have been able to grow the company and their team. So infrastructure I mean if you were to look at some of the computers out here they are little on the older side. But again very talented team and you can kind of see from their customer base, they have done a phenomenal job of servicing their customers.

Their customers are satisfied. They have an extreme amount of knowledge and credibility out here and there, in our view one of the very few pure plays in this particular space in the U.K. So we obviously bring a lot of expertise to the table. We also have the ability now that they can move onto our infrastructure that we have already invested in Europe.

And plus, we’ve got some level of expertise both in marketing and selling and processes and customer support and automation of systems et cetera, that they will be able to leverage as we think we will really free them up, to go forward. So that is essentially the genesis behind their strategy.

A little bit more is that they, the Voicenet team has been making money on the hardware and so we are going to put in some of our procedures of their breaking even or losing a little bit of money on the hardware to kind of stimulate customers to move off premise devices onto cloud products. And so that is what our balance sheet enables us to do.

On your guidance question it’s an excellent question, so when we did initiate this guidance in our October call we did know that this transaction was imminent. And so we are expecting that and factors that into the high single digit.

So I received a lot of questions following that guidance. It’s like how do you get to the high single digits because you have been consistently in kind of the low teens percentage. And this is one of the reasons why we are in the kind of high single digit figures. We have been aggressively ramping up our investments into research and development as well as sales and marketing, and specifically in our product groups, which is also bringing our profits down. But in regards to the future models and investment we define high single digits as the percentage of revenue.

It’s between somewhere between 6% to 9% and Voicenet is effectively breakeven. So when you’re layering on in the range of just under $10 million a year of revenue with breakeven, which just naturally bring that percentage down, but actually expectations if any one has those of double digit non-GAAP net income as a percentage of revenue figures, it’s an unrealistic expectation and that we will be reporting for the foreseeable future high single digit non-GAAP net income as a percentage of revenue and you can find it between 6% to 9%.

Kash Gopalan Rangan – Merrill Lynch, Pierce, Fenner & Smith, Inc.

Got it. Thank you very much.

Dan Weirich

Thanks Kash.

Operator

Our next question comes from Raghavan Sarathy with Dougherty & Company. Your line is open.

Raghavan Sarathy – Dougherty & Company

Yes. Hi, good morning. Thanks for taking my questions. First on, I’m trying to get some sense for the revenue mix. I’m wondering if Voicenet is also reselling phones like you do here in the U.S. and if so what is the mix between products and services?

Vik Verma

They have been reselling phones. The representation of the products is between 15% and 17% of revenue. So it’s just under double the percentage of revenue of 8x8. It’s like that for two reasons, one is as I noted on the previous question, Voicenet has been making a profit on the resale of the phones and so it just – they’re charging just a little bit more than 8x8 has historically been charging on phones. And two, the company is much smaller and are much lower level so the new sales represent a much greater percentage across the entire base. And so the split out is roughly 15% to 17% of product sales and the remaining 83% to 85% of service revenue is comprised of effectively 73% to 75% is the hosted voice over IP solution and the remaining 10% is the resale of broadband services.

Raghavan Sarathy – Dougherty & Company

Okay, and then my second question is I think Vik mentioned that the customers base is roughly twice the size of 8x8. Can you talk about the ARPU of Voicenet and also the pricing environment in UK, how does that compare to U.S.?

Dan Weirich

Yes, so in the ARPU side, the average customer is paying approximately $600 a month. If you kind of extract the broadband component out there, you get in the neighborhood of like $540 or so in ARPU which is where we get to the – roughly double the size. From a seat count basis, the seats are roughly two-thirds greater than 8x8. So it implies pricing in the U.K. is little bit higher than the United States. And it’s a market that’s penetrated extremely low levels probably in the 5% or so level, and it’s just kind of at the early stages of growth and adoption.

Raghavan Sarathy – Dougherty & Company

Okay. And then one final question. In terms of, I know you just gave us some guidance around what's your expectation for this year on this acquisition? Is it reasonable to assume some sort of an annualized run rate at least at the baseline for the full year and from a non-GAAP net income perspective, high single-digit or are you going to making some investments in this business, as you look out to the full year?

Dan Weirich

Okay, so the Voicenet business generated $4.7 million in revenue in the six months ended September 30, 2013. It’s very convenient for us as Voicenet fiscal year ended identical day by which is March 31, and of that $4.7 million roughly $200,000 of that is deferred revenue which you do to acquisition accounting will be fair-valued and reduced. So in an absolute worst case, the business is doing $4.5 million in future reportable revenue adds for the six months period. And so it’s been growing as Vik noted, can be in the teens percentage and we expect that over the next year or so to get it up to a minimum 8x8’s growth level. And so I think that should give you an update just kind of on the Voicenet component and the revenue.

On the non-GAAP net income side that is for the company wide figure out of the entire combined companies including Voicenet and 8x8 and that’s what we’ve been guiding to in the high single-digit figures.

For Voicenet itself the business is roughly break-even today and when I say it’s break-even there is like some one’s that the business makes money and some one’s the business does not make money. But for alternative purposes think of its break-even, we will be making in additional investments into the business and there will be points that probably go negative for a period of time but we see a lot of low hanging fruit on improvements and gross margin that is running at significantly lower gross margin than 8x8’s business and it’s putting our platform in place and will not have like third-party licensing fees and things of that sort on a go forward basis that should result in margin expansion which effectively will offset the additional SG&A investment.

Raghavan Sarathy – Dougherty & Company

Okay, great, thank you.

Dan Weirich

Thanks Rag.

Operator

Our next question comes from Greg Burns with Sidoti & Co. Your line is open.

Greg J. Burns – Sidoti & Co. LLC

Good morning, just a question generally about the global reach initiative and I understand you’re defining it, the business as a global business but domestic market is still well under penetrated, still a lot of room for growth domestically. So I’m just wondering how you’re looking at kind of balancing your investments internationally and domestically and whether you have the bandwidth and you will handle that without leaving…

Vik Verma

Yes, no actually, I think as we’ve talked before I think the issue has been that as we go more and more up into the mid-markets and the distributed enterprise, mid-market distributed enterprises are inherently not always but generally global. So they typically have an office in Singapore. They have a call center in Philippines. They may have a manufacturing facility in some place in Asia.

And so what we are finding is those are the guys that are pushing us more and more, because there will come to us and say, hey wait a minute we need their connectivity, four digit connectivity with all our offices, all over the world and what you mean you can provide them for us, and as you know, with our system initially, if you were in the U.K. or in Asia basically the signal has been routed to one of our data centers in the U.S. and then being routed back. And so we were being pushed to go global just by the fact that we are much more going into the mid-market and distributed enterprise and that we view as our sweet spot.

And then once you’re there, once you’re putting infrastructure up globally, it is pretty logical that should go out and then figure out somebody that can get used out of that infrastructure not just using it for the U.S. customers that basically want an international presence, but also for using it for local customers who want either a local or an international presence. And so in an essence that’s how we’ve been going about.

So I think with regard to our U.S. market as well as our international market, I think we are in a phase where we have to walk and choose them at the same time. I don’t think we can just – unless you’re willing to just focus purely on the five line type customers, you can’t stay in the U.S. I think the moment you get to 25, 30, 40, 50 lines, you’re starting to see more and more of a need to go international. And so when you’re going international you’re putting infrastructure up.

It absolutely makes sense to kind of leverage it. But again my general philosophy is, try and find an operating company, which is well run, which is googled, which has good solid genes, expertise et cetera that is then capable of having our platform grafted on to it, so we can get dual use out of our platform and then go from there.

Greg J. Burns – Sidoti & Co. LLC

Thank you.

Operator

Our next question comes from Mike Latimore with Northland Capital. Your line is open.

Mike Latimore – Northland Capital Markets

Great, thanks. Yes. Do you guys have a sense of where Voicenet ranks in the U.K. in terms of size, is it top five or top ten vendor?

Dan Weirich

Hi, Mike, it’s Dan. So if you look at that, the hosted PBX market in the U.K., it’s the top five vendor. The market is very – extremely fragmented and if you look at kind of 8x8 and some folks on the hosted PBX side in the U.S., there is no one that are like, critical sides of any definition in the U.K.

Mike Latimore – Northland Capital Markets

Yes. Do you see the market playing out similar to the U.S. or will there be more a receptivity to the – among the mid-market type of enterprises in the U.K., as the market evolves there?

Dan Weirich

Actually what is interesting is that the receptivity of the mid-market is actually comfortable even though outside the whole VoIP market here, they’re three years or so behind the U.S. The faster adoption seems to be happening by the mid-market out here. I mean I think as you can kind of see from some of the customers we cited, the larger guys going to VoIP faster out here than even what we saw in the U.S., which implied one of the attractions of Voicenet for us because I think in essence we saw them more as a mid-market play because they are capable of doing these large mid-market implementations, and they’ve been able to do it with the existing teams that they have in place.

Mike Latimore – Northland Capital Markets

Great. And just last from a reporting standpoint, are you going to – statement, it’s down a little bit in the next quarter or two or will it be blended in from a metric standpoint like ours certainly?

Dan Weirich

We’re going to blend it in with all of the rest of our business. I mean there are some entity requirements on geographical reporting that we’ll be reporting from a revenue standpoint, but all of our metrics were embargoed in, but we’ll disclose like we did when we part contractual two years and three months ago, their figures kind of for that respective period.

Mike Latimore – Northland Capital Markets

Okay, great. Thanks.

Operator

Our next question is a follow up from Raghavan Sarathy with Dougherty & Company. Your line is open.

Raghavan Sarathy – Dougherty & Company

Yes, thank you. Thanks for taking my call up. Quick question on the product portfolio. Vik, you mentioned they have a hosted VoIP and also they have a contact center and since have the mobility solution. Are there certain modules or products that they offer that you don’t offer and vice versa?

Vik Verma

No. I think we anticipate over time to basically migrate them to one common suite of products, which is all based on our 8x8 platform. So basically everything from VO, VCC, Virtual Meeting, Virtual Room, we will be basically – they will be reselling essentially that or they’ll be basically bundling it and then providing that. They were – their VCC part is essentially a resale of ours. So that’s why we have had some knowledge of this company and we’ve been tracking them for a while. And then their VO solution was on an old box of platform that we’ll be migrating to an 8x8 platform.

Raghavan Sarathy – Dougherty & Company

Okay, great. Thank you.

Operator

And I’m showing no further questions. I will now turn the call back over to Vik Verma for closing remarks.

Vik Verma

Thank you very much folks for attending today’s call. We look forward to updating you on our quarterly earnings call next month. Again, thank you and signing off from U.K.

Operator

Thank you, ladies and gentlemen. That does conclude today’s conference. You may all disconnect and have a wonderful day.

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