8x8 Finds a Path to Profitability in VOIP Land

| About: 8X8 Inc (EGHT)

8x8 Inc. (NASDAQ:EGHT) offers a variety of telecommunications services for IP, telephony and video applications. This includes web based conferencing, unified communications services and thanks to a recent acquisition, managed hosting and cloud based computing.

The company has been shifting to an enterprise focus from a residential one where it has found a more solid growth opportunity. Recently, losses from the residential side have masked the very substantial gains on the business and enterprise side, but the residential revenues have bottomed, and overall growth is starting to become more apparent.

8x8 owns several patents, has original software and generates the majority of their revenue from subscription services, about $16 million last quarter. They also sell IP telephones accounting for a small percentage of their total revenues, $1.3 million last quarter, taking a loss that helps them secure and facilitate their subscriptions.

Since the product and service cannot exist without each other, it's probably a good idea to look at their operating margins as a whole, since some of the service cost of revenue may be hiding in the product cost of revenue. The overall gross margin is 68% with the IP telephones dragging down the service margin by 10%. Overall gross margin has remained at 68% for the last four quarters, up from an average of 65% during the previous four quarters.

Vonage (NYSE:VG), although a much bigger company in the VOIP space, currently has a 65% gross operating margin focusing on residential customers. It seems that the three percent margin improvement from business customers has brought 8x8 into profitability, something that Vonage has yet to achieve.

The company currently gets a little over $200 per business subscriber per month, and it is costing them about $825 to acquire one subscriber. This is a four month payback as opposed to a ten month payback for residential acquisitions over at Vonage. 8X8 has a total of 22,167 business customers, up from 21,362 the previous quarter, and up from 18,199 the previous year.

EGHT bettered VG's churn rate last quarter as well, posting 2.2% compared to 2.7% a year ago, and 3.1 % two years ago. Churn rate is a measure of how many subscribers they lose per month based on the average number of total subscribers during the three month period.

Better margins and a better churn rate have started to bring in earnings over the last year or two. The company earned close to $4 million or $0.06 per shares during the year ending March 31, 2010, and has already earned $0.05 per share during the first two quarters of this fiscal year.

The two analysts covering this company, who were beat by a penny in each of the last two quarters, predict 3 cents this quarter, 4 the next and 17 cents for the fiscal year ending March 31, 2012. A trailing P/E of 29, a forward P/E of 14 and a price to book ratio of 10 do not make this look like the cheapest stock around, but a couple of factors may help its valuation in the near future.

Beating estimates again would help, as well as a share buyback program that has been ongoing for quite a while now. Shares outstanding more than doubled to 61.1 million from 2001 to 2006. Since then, total shares out have only climbed a couple of million to where they are now at 63.2 million. The company has had about $18 million in cash for the last three quarters.

The buyback program was announced in July of 2009, with authorization to repurchase up to $2 million worth of common stock. In July of 2010, they extended the plan, and upped it to three million. As of September 30, 2010, the company had actually repurchased all $3 million that was authorized, and in October, they decided to authorize another $10 million.

Although not a giant force to be reckoned with just yet, 8x8 has found the path to profitability in VOIP that Vonage and others have not.

Disclosure: No positions