8x8 - Earnings Call - Q4 2018

Transcript

Speaker 0

Good afternoon. My name is Chantal, and I will be your conference operator today. At this time, I would like to welcome everyone to the 8x8, Inc. Fourth Quarter and Full Year Fiscal twenty eighteen Conference Call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer session. Thank you. Victoria Hyde Dunn, Head of Investor Relations, you may begin your conference.

Speaker 1

Thank you, operator. Good afternoon, and welcome to 8x8's fourth quarter and full year twenty eighteen earnings conference call. With me today are Vic Verma, Chief Executive Officer and Mary Ellen Genovese, Chief Financial Officer. Our format today will include prepared remarks followed by Q and A. The earnings press release, presentation and non GAAP to GAAP reconciliations that accompany this call are available in the Investor Relations section of our website at 8x8.com.

A replay of this call will be posted on our website for thirty days. 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. These statements are not guarantees of future performance and our actual results could materially differ as a result of a variety of factors. Additional information concerning those risk factors is available in our most recent reports on Forms 10 ks and 10 Q, which you can find on the SEC's website and the Investor Relations section of our website. With that, I'd now like to turn the call over to Vic.

Speaker 2

Thank you, Victoria. Good afternoon and welcome everyone to our fourth quarter and full year twenty eighteen earnings conference call. Our fourth quarter revenue results were a strong finish to a great year. Total revenue for the fourth quarter grew 19% to $79,300,000 and for the full year 2018, revenue was $296,500,000 for annual year over year growth of 17%. We grew service revenue in the fourth quarter by 20% to $75,300,000 and 19% year over year for the full year to $280,400,000 Revenue came in higher than we guided to during last quarter's conference call.

Before I provide details on the quarter and our fiscal year, let me comment on how we see the market evolving. IDC estimates that the combined global communications collaboration and contact center as a service market opportunity exceeds $40,000,000,000 And yet we believe the total share of this market that has gone to cloud is less than 10% penetrated. We are also seeing customers increasingly looking for seamlessly integrated solutions that span these different segments. Customers want a single system of engagement from the cloud, what we have described as the third wave of enterprise communications. The end result of this shift is that over the next few years, tens of billions of dollars in global spend are up for grabs.

We believe our strategy of owning the complete suite of technology required to deliver a single system of engagement is unique in our market and we are aggressively investing in the sales capacity, innovation and global reach required to accelerate growth at this critical market inflection point. We believe we are defining an emerging market category in which enterprises of all sizes will look to us for a single system of engagement and intelligence for all forms of communication in the cloud. Let me now proceed by highlighting some of our key accomplishments this past quarter and full year. Over the course of fiscal twenty eighteen, we expanded direct sales capacity and significantly increased the breadth of our channel programs. As one example, our sales teams closed '21 large enterprise deals defined as customers with monthly recurring revenue of $10,000 or greater during the quarter.

For the full year, the mid market and enterprise sales teams closed 66 new large enterprise deals, which represented a 22% increase in the number of new large deals closed year over year. One marquee win is a global education provider with over 1,000,000 students and 60,000 faculty members. This customer is rapidly growing and the lack of data analytics and business intelligence from their on premise provider became a major customer pain point. 8x8 won this deal after a very competitive RFP process that involved multiple cloud and on premise providers. They ultimately chose 8x8 for a superior call quality, global footprint and integrated solution.

While their initial order is for more than 2,500 virtual office and analytics seats and 300 virtual contact center seats, the great thing about this particular customer is that we believe they are only getting started. They have placed two additional orders since our fourth quarter closed and there is lots of room for addition expansion globally. Turning to the channel. In the fourth quarter, three S.

Deals were brought in by our channel partners. Channel bookings grew 28% in the quarter. In August, we launched a new channel enablement program and have enrolled 82 partners to date. A recent win in which a key channel partner played an instrumental role is with a large children's specialty apparel retailer who will move 3,000 seats to 8x8 following a competitive takeaway from an on premise provider. The partner was instrumental in bringing 8x8 to the table, positioning our value proposition in the retail space and ultimately recommending 8x8 to the end customer.

Additionally, 8x8 was recognized with a five star rating in CRN's 2018 Partner Program Guide. Subsequent to the quarter end, we announced the hiring of our new SVP of Channels and Alliances, Bill Corbyn, who will be reporting directly to me. Bill arrives with decades of channel partner experience and has already had a meaningful impact with our referral and reseller communities in the brief period that he has been on board. After sales and channel capacity, our second investment focus was continuing to build the most comprehensive and integrated platform of solutions in the market, leading to the upcoming launch of our X Series solutions. Let me remind you of what X Series is.

It is the seamless integration of our contact center, meeting and video conferencing into a single suite. By combining our own technology into X Series, 8x8 is able to provide three core First, dynamic mix and match communication capability targeted to the individual user in the enterprise. Second, analytics that span all of these forms of communication. And third, a level of customer responsiveness and resolution that is not possible from solutions that depend on third party platforms. The X Series encompassing X1 through X8 isn't just a suite, but is designed to be a single system of engagement for our customers.

This may sound like a subtle distinction, but ownership of our technology enables the critical path forward from a system of engagement to a system of intelligence. Applying analytics and machine learning to data that forms all forms of communication can provide completely new business insights. CIOs recognize the importance of a common platform and it is one of the reasons why we win more than our fair share in head to head competition. CIOs want a seamless experience across phone, contact center, conferencing and collaboration on any device, your mobile phone, laptop, desktop or tablet. We see this impact in the increasing number of deals where customers purchase our integrated communications and contact center solution, which we have referred to as combination deals.

This growing propensity to buy a combined product is why we developed our X Series in the first place. During the fourth quarter, about 100 customer deals were combination deals, including six of our top 10 deals overall. In fact, for the full year, more than 50% of new monthly recurring revenue booked from mid market and enterprise came from customers who purchased combined solutions. Our third investment focus was expanding our global footprint. International markets, defined as markets outside of The U.

S. And Canada, represented 10% of total revenue in 2018. Our 8x8 Solutions business in The U. K. Saw exceptional growth with a 35% year over year increase in fiscal twenty eighteen excluding DXI revenue.

We announced our expansion into France with Itansia in March and we continue to build sales capacity in Australia. We also enhanced our global carrier network and have customers in 157 countries around the world. In summary, fiscal twenty eighteen was a transformational year as we invested in talent, technology and infrastructure. These investments have allowed us to become a leading global provider in the mid market and enterprise market as the transition to cloud accelerates among larger and larger customers. For instance, service revenue from customers billing greater than $10,000 in monthly recurring revenue grew approximately 44% year over year and now represents 28% of our total monthly recurring revenue excluding DXI revenue.

Due to this rapid growth, we made a conscious decision in the fourth quarter to accelerate our business spend and hiring plan. We hired more talent across all levels of our organization in the fourth quarter than at any time in our history. And the quality of the talent that has joined the organization is awesome. This accelerated hiring, together with strategic marketing investments and brand awareness and demand generation, resulted in non GAAP pretax net income that was lower than our guidance. As you know, we manage the business for long term shareholder gain and will make decisions in the short term that we are convinced will achieve that goal in the medium to long term.

Now I would like to share our strategy for fiscal twenty nineteen and beyond. There are three key elements which continue to underpin our strategy. First, as previously mentioned, we believe our overall market is inflecting and adopting cloud at an even more rapid pace than previously expected. Second, we are the only pure cloud provider with our own core technology for phone, contact center, conferencing and collaboration. Third and most critically, our vision of this industry differs from the vision that has been articulated by our peers.

We see the industry ultimately standardizing on one seamless integrated solution, which will provide all cloud communications in and out of a company. This is what we refer to as a system of engagement. The adoption of a unified system of engagement will not only maximize the cost savings and convenience associated with the transition to the cloud, but will also unlock another layer of critical business insights and analytics, what we call the system of intelligence. As I mentioned earlier, this strategy has culminated in our X Series suite of solutions, which we believe will be a game changer for 8x8. Consider how valuable the information that our X Series platform captures can be for an enterprise.

Imagine the impact on time to resolution

Speaker 0

satisfaction if a frontline agent could instantly have all the relevant recent

Speaker 2

Imagine phone calls, emails and support interactions summarized and prioritized based on customer persona. Or think about the efficiency that can be gained by analyzing the communication patterns within a business unit including not just phone calls, but also chat, email and other modes of communication. And team collaboration is also part of this integrated suite. X Series integrates with over 30 team collaboration platforms, including Slack, Cisco Spark and Atlassian Stride. As mentioned earlier, AI and machine learning are foundational elements to our X Series solutions.

Our commitment to this vision has led to several notable recent investments and key hires, including our recently announced acquisition of Mariana IQ. We're excited about leveraging both their technology and their talent to deliver one system of intelligence through our X Series solutions. This vision has also informed our fiscal twenty nineteen plan. While we are proud of what we have accomplished in fiscal twenty eighteen, we have concluded that the market in which we are participating represents a once in a decade business and value creation opportunity. Dollars 40,000,000,000 markets that are 10% penetrated and in which we are uniquely positioned do not come along very often.

In order to fully leverage this market opportunity, we are expanding investments in engineering, marketing, sales, deployment and customer support. We are adopting this strategy in order to deliver the most comprehensive integrated system of engagement and intelligence to the market. We believe strongly that this strategy and the investments we are making will drive long term value creation for our shareholders. While Mary Ellen will provide detailed guidance in her section, let me say that we view service revenue growth as our most important metric and are targeting approximately 25% for exit service revenue growth in the 2019 after adjusting for DXi revenue. Our goal is to drive market adoption of our X Series solution suites in the process reshaping our market category and accelerating long term revenue growth past 25%.

Finally, our employees are our greatest assets. We have over 1,200 employees and expect to increase this headcount by approximately 30% in fiscal twenty nineteen. Our success is predicated on retaining, hiring and leading the talented and passionate employees at 8x8. I am very proud of our dedicated employees around the world and thank them for their success in fiscal twenty eighteen and look forward to an exciting fiscal twenty nineteen and beyond. With that, I'll turn the call over to Mary Ellen.

Speaker 3

Thank you, Vic. I will provide a more detailed review of our fourth quarter and full year 2018 financial performance followed by the impact of ASC six zero six and guidance for fiscal twenty nineteen. Our fourth quarter and fiscal full year 2018 are under the historical six zero five accounting standard. Guidance for fiscal twenty nineteen will be under ASC six zero six. We are adopting six zero six starting 04/01/2018 under the modified retrospective method and have provided a table on the impact from ASC six zero six on our full fiscal year 2019 outlook, which is posted on the Investor Relations website.

In addition, unless otherwise indicated, all measures that follow are non GAAP with year over year comparisons. A reconciliation of GAAP to non GAAP results was provided with our earnings press release. Fourth quarter was another strong quarter for 8x8. Total revenue was $79,300,000 an increase of 19% year over year. Service revenue of $75,300,000 grew 20% year over year.

Adjusted for constant currency, service revenue grew approximately 19%. In the fourth quarter, service revenue from mid market and enterprise customers defined as those billing greater than $1,000 in monthly recurring revenue, grew 29% over the prior year and now represents 60% of our total service revenue compared to 56% in the year ago quarter. Turning to small business, defined as 10 to 99 seats, our growth has accelerated the past two quarters by over 300 basis points and we are now growing in line with the market at 15%. Product revenue was approximately 5% of total revenue in the fourth fiscal quarter. Gross margin for the quarter was 76.7% compared with 79.1% in the same period last year.

Service margin in the fourth fiscal quarter was 83.2% compared with 84.5 in the prior year. As expected, service margin trended down by 130 basis points, primarily due to the increase of amortization of previously capitalized software as we release new products to market. Product margin in the fourth quarter was negative 45% compared with negative 9.2% same period last year, primarily due to a one time successful promotion across our small business customer segment to deplete excess inventory. Quarterly net loss was 2,900,000.0 a loss of $03 per share or negative 3.7% of revenue. Areas of additional investment included the following.

With our new sales and marketing leadership in place and seeing the results of our demand generation activities, we accelerated our planned hiring in both sales and marketing. We also accelerated hiring for our product management and engineering teams to advance the development of new innovative products. In addition, we invested in brand awareness, targeted demand generation campaigns and advertising and trade shows to support the launch of our new X Series solutions. As Vic mentioned, these investments will position us to capture solutions. The increase in market opportunity.

Moving on to operating expenses, sales and marketing expenses, which also include customer service and deployment costs were $49,300,000 or 62% of revenue in the fourth fiscal quarter compared with $34,700,000 or 52% of revenue in the same year ago period. The increase in spend is primarily attributable to accelerated hiring and demand generation activities. In addition, we observed an increase in commissions tied to strong performance from our channel partners. Research and development expenses were $8,000,000 or 10% of revenue and increased 30% year over year. We significantly increased spend to support the development of the upcoming launch of X Series.

Turning to annual results for fiscal twenty eighteen, 8x8 posted posted total revenue of $296,500,000 above our guidance range of $293,000,000 to $294,000,000 This represents an increase of 17% year over year on both an adjusted and an unadjusted basis. Service revenue for fiscal twenty eighteen was $280,000,000 an increase of 19% year over year and 19% on an adjusted basis and also above our guidance range of $278,000,000 to $279,000,000 Service revenue from mid market and enterprise customers represented 58% of total service revenue and grew 29% over the prior year. Gross margin in the full year was 77.6 compared with 77.1% in the same period last year. Service margin in the full year was 83.7% compared with 83.8% in the prior year. Pretax net income for fiscal twenty eighteen was $6,200,000 or 2.1% of revenue and below our guidance of $9,000,000 or 3% of revenue.

Net income was $5,900,000 or $06 per share and 2% of revenue. As we observed market accelerating and customer adoption around our integrated platform, we concluded that we are uniquely positioned to deliver the most comprehensive integrated system of engagement and intelligence in the market. With a strong leadership team in place, we made a strategic decision to invest additional capital to accelerate our revenue growth and take advantage of this large underpenetrated market, which is inflecting. Our non GAAP effective tax rate was approximately 5% reflecting our cash taxes for fiscal twenty eighteen. Cash, cash equivalents and investments were $153,000,000 at March 3138 compared with $175,000,000 at the end of fiscal twenty seventeen.

As part of our new lease for our San Jose headquarters, we now also have restricted cash of approximately $8,000,000 on the balance sheet. During the full year, we repurchased 1,400,000.0 shares of common stock at an average price of $13.14 per share for a total of $17,900,000 under the company's approved share repurchase program. We currently have about $7,000,000 available for share repurchase under the current authorization and we will be opportunistic. Cash flow from operating activities was $2,700,000 in the fourth fiscal quarter and capital expenditures including capitalized software were $6,500,000 in the quarter or 8% of revenue. For the full year, cash flow from operating activities was $22,000,000 compared with $28,500,000 in fiscal twenty seventeen.

Capital expenditures, including capitalized software, $21,700,000 or 7% of revenues in fiscal twenty eighteen compared with $14,400,000 or 6% of revenue for fiscal twenty seventeen. The increase in capital expenditures was due to global expansion and support for new product initiatives including the X Series solutions. Now turning to key operating metrics for the fourth quarter. New monthly recurring revenue booked from mid market and enterprise customers increased over 10% year over year and comprised 60% of total bookings. As mentioned during our third quarter earnings call, our 2016 and 2017 had a number of very large enterprise deals, which have made year over year comparisons more difficult for this quarter.

The average revenue per mid market and enterprise customer grew 9% to $4,899 compared with $4,494 in the same year ago period. Average revenue per business customer was $469 and grew 10% when compared to $426 in the same period a year ago. Gross monthly business service revenue churn on an organic basis excluding DXI was 0.3% compared with 0.7% in the same period last year. Beginning next quarter, we will no longer provide a churn metric. We have low churn rates and believe a more compelling metric to measure our continued success across the business is to discuss retention.

Annual retention rate was over 100% across all segments in the fourth quarter. The combination of strong upsell to existing clients and low churn rates will make a positive contribution to our accelerating growth rates. In fact, we continue to book approximately 50% of our new monthly recurring revenue from existing customers. Looking ahead fiscal twenty nineteen, we will continue to invest to accelerate revenue growth and build a sustainable product advantage with our unified communications, contact center, data analytics, analytics, team collaboration and conference in suite. As Vic mentioned earlier, we believe we have the right set of strategic initiatives in place and a market which is inflected.

While we have always taken a balanced approach to capital deployment, including reinvestment in the business for growth, acquisitions and share repurchases, we continue to believe that we will achieve the highest return for our shareholders by investing to drive revenue growth. Before providing guidance for fiscal twenty nineteen, I would like to cover the impact of ASC six zero six, which applies to us starting 04/01/2018. We have elected to use the modified retrospective approach, which means we will not revise previously reported numbers, but represent fiscal twenty nineteen data under the new rules and supplemental information for comparison. First, we do not expect a material difference to our revenue and year over year growth between ASC six zero six and ASC six zero five. Second, we estimate that our fiscal twenty nineteen non GAAP operating expenses will be between $11,000,000 to $13,000,000 lower under ASC six zero six due to the capitalization of a significant portion of commission expense rather than recording it at the time of sale.

Under ASC six zero six, certain sales commissions will be capitalized and amortized over the expected customer life. The impact of this change will result primarily in a decrease to sales and marketing expenses. Third, we estimate that the adoption will increase retained earnings as of 04/01/2018 between $13,000,000 I'm sorry, $35,000,000 and $40,000,000 due to the capitalization of commissions from prior years. As a reminder, this new standard is an accounting change only and has no impact on our operating or free cash flow. Before I speak to our fiscal twenty nineteen guidance, as a reminder, in early fiscal twenty eighteen, we made the strategic decision to integrate platform and have deemphasized selling the standalone DXi EasyContact Now product.

We expect this product revenue to decline by approximately 50% in fiscal twenty nineteen. Now moving on to our outlook. For the full fiscal year 2019 under ASC six zero six, we expect service revenue in the range of $333,000,000 to $338,000,000 representing approximately 19% to 21% year over year increases. Excluding DXI revenue, service revenue growth in the range of 21% to 22%. Total revenue in the range of $347,000,000 to $352,000,000 representing approximately 17% to 19% year over year increase.

Our non GAAP pre tax loss in the range of $13,000,000 to 17,000,000 In addition to full year guidance, the company introduces new quarterly guidance. For the 2019 under ASC six zero six, we expect service revenue in the range of $77,000,000 to $78,000,000 representing approximately 18% to 20% year over year increase. Excluding DXI revenue, we expect service revenue growth in the range of 20% to 21%. Non GAAP pre tax loss in the range of $4,000,000 to 5,000,000 I'll add some additional color to help with your models for the full fiscal year. We are targeting service revenue growth in 2019 to be approximately 25% after adjusting for DXI revenue.

Excluding the micro business defined as one to nine seats and DXI revenue, our core business service revenue in the fourth quarter is already exceeding 25% year over year growth. We expect our full year non GAAP operating expense growth as a percent of revenue to increase by approximately eight to 10 percentage points. We expect research and development expenses net of software capitalization as a percent of revenue to be approximately 13% to 14%. We expect sales and marketing expenses, which includes customer support and deployment as a percentage of revenue to be approximately 60% to 62%. Lastly, general and administrative expenses as a percentage of revenue to be approximately 11%.

We anticipate moving into our new San Jose office in April 2019. While we work on the build out of our new corporate headquarters, which starts this quarter, we will incur quarterly non cash accounting charges of approximately $1,200,000 We will exclude this from non GAAP income since we are not currently occupying the building. We expect full year capital expenditures to be between $6,000,000 and $7,000,000 excluding tenant improvements associated with our new facility. We expect to capitalize software development between $20,000,000 to $22,000,000 We estimate our tax expense to be approximately $150,000 each quarter. Due to the full valuation allowance against deferred tax assets, our tax expense reflects the current cash taxes in certain United States and foreign jurisdictions.

We expect shares to be approximately $95,000,000 on average for the full year 2019. In closing, it has been a very busy and productive year. To recap, we are clearly seeing a large market opportunity, which is Inflecton. We hired top industry talent. We strengthened our cloud offerings to mid market and enterprise customers, and we expanded our global footprint.

For fiscal twenty nineteen, we have a business plan in place to achieve our full guidance and our target of approximately 25% exit service revenue growth in the fourth quarter excluding DXI. Our demand generation initiatives are bearing fruit with fiscal Q3 and Q4 pipeline cohorts validating our fiscal twenty nineteen demand generation assumptions. We met our fourth quarter pipeline targets and we are currently on track with our first fiscal quarter targets. Our channel initiatives and our sales capacity plan are also meeting our expected targets. With that said, we now believe this is the right time to invest to accelerate our revenue growth.

We believe these investments will position us for sustainable growth beyond fiscal twenty nineteen as we continue to build value for our customers and shareholders. With that, operator, we are ready for questions.

Speaker 0

Your first question comes from Tim Horan with Oppenheimer. Your line is open.

Speaker 4

Thanks guys. What was the real catalyst of what did you see in the market to accelerate spending so much? Maybe you can give a little bit more color on the thinking process throughout the quarter and what really drove you over the edge? Thanks.

Speaker 2

Yes. So I think we have been chatting about this for a while that we feel that the market has been taking up, is why we did the major refresh in bringing really world class talent to kind of go for it. In the past, I see this as a completely unconstrained market opportunity. And the biggest constraint to me is the ability to bring on board top tier talent and then make sure that you've got the capacity and the capability onboarded, etcetera. Particularly now, I'm finding that we can hire pretty much anybody and we're getting the best and the brightest, and we're going to able to hire them in significant numbers.

So for me, that was a key catalyst. Second part of it, which is just as critical, is if you really think about it, here, through a combination of organic development as well as acquisitions over the years, I have essentially the equivalent of two public companies of core technologies that make up two public companies already under one roof. I also now have the management management team has been able to hire best and brightest, particularly in sales, engineering, etcetera. And now we're starting to see large enterprises really inflect. In Q4, as I indicated, you saw a 44% increase in the large deal, which is 10 ks monthly recurring revenue year over year.

It's a $40,000,000,000 market opportunity. They don't come along very often, and we find ourselves uniquely positioned. And I'm now feeling more and more comfortable that this is the time that you really turn on the gas and you go for it. I think X Series for us is going to be a game changer.

Speaker 5

Thank you.

Speaker 0

Your next question comes from Will Power with Baird. Your line is open.

Speaker 6

Great, thanks. I guess a

Speaker 5

couple of questions. Maybe starting on enterprise, I think you indicated that enterprise revenue grew 44% year over year. I wonder if you could just talk about competitively what you're seeing? Have you seen any renewed activity from Avaya coming out of bankruptcy? And then I guess the second part of that is you just brought on a new channel head.

I think channel was just three of the top 10 deals in the quarter. What type of accelerant do you expect, I guess? And what are you doing specifically to kind of ramp that channel piece of enterprise even further?

Speaker 2

Okay. So enterprise, which is deals defined as greater than 10 ks monthly recurring revenue is now 28% of our revenue, and that's growing at that 44% as of Q4. The part that is interesting, Bill has been here about four point five, five weeks. He was the Head of Channel and Alliances for CenturyLink and ran, I think, $3,000,000,000 business there. The great thing is he comes on board, he's done a series of channel checks and the basic takeaway is channel likes us, they like our product, they just haven't seen enough of us, that there's just not that coverage.

And so he believes, and I do too, that there is significant opportunity, untapped potential in channel, which can be huge for us. Second, Rainy and her team, which is the marketing team, you can start to see that demand generation engine is starting to chaga, chaga, chaga, and it's starting to beat plan. So you combine those two things together, what is starting to become more and more interesting for us is untapped market where we're now starting to feel like we will get more and more a seat at the table. And then on top of that, what we are seeing is that a lot of the legacy providers are struggling. You've seen recent acquisitions, people coming out of bankruptcy, people going private, all of this is hugely disruptive.

And so for us, we see the channel as ripe and we've brought in the people that can help leverage that. We see enterprise as ripe and we have brought in the people that can leverage that. And that's not even counting the fact that international is starting to take off. As I said, for me, 40,000,000,000 market opportunities don't come along very often. And larger and larger customers are going cloud first, which is why when you think about it, our biggest constraint has been sales coverage.

I think people would acknowledge our product is solid across the board, most comprehensive in the industry. Our ability to basically hire salespeople, get our word out, that's been the constraint. So we feel this is the perfect time with the team in place where you turn on the gas.

Speaker 7

All right. Great. Thanks. Well, good luck with those investments.

Speaker 3

Thank you.

Speaker 0

Your next question comes from the line of Meta Marshall with Morgan Stanley. Your line is open.

Speaker 8

Great, thanks. I just wanted to kind of get a sense of given how much you are raising OpEx or assumptions, like when you would expect to see the benefit of that? Because if you're not raising kind of fiscal twenty nineteen expectations, is it something where you would expect to see those benefits in twelve months out? Just a sense of timeline of the increased investments. Thank you.

Speaker 3

Absolutely, Anita. As you can probably understand, we're building pipeline today for Q3, Q4 and for fiscal twenty twenty. A lot of these investments are absolutely going to be geared towards 2020 because they'll come on and they'll help us continue to build pipeline into 2020, Q1, Q2. Normally, an enterprise sales cycle could be anywhere from three months up to almost twelve months, right? A mid market pipeline or sales cycle could be anywhere from three months to six months.

So we definitely, believe that this will provide growth for 2020. And as a SaaS company, we're not going to be satisfied with just a 25% revenue growth. We continue to want to improve on that. So stay tuned, but this is all about 2020.

Speaker 8

Great. And then maybe just a follow-up on gross margins. There's just a small tick down in service gross margins this quarter. Is that just normal seasonality or kind of things that you mentioned as clearing out some inventory? Or just how should we think about that?

Speaker 3

Yes. So there were two things. One thing was a onetime issue, which was the excess inventory promo that we did for our small business team and that was very successful, both on a new more generation as well as depleting that excess inventory. So you saw a higher margin subsidy than you had in the past. The other thing is an ongoing, which is on the service margin.

As we had mentioned last quarter, we expect now about 130 basis points increase to our service costs as start to amortize previously capitalized software for engineering, from engineering initiatives as we release these products to market.

Speaker 2

Thank you.

Speaker 0

Your next question comes from the line of Nikolay Beliov with Bank of America. Your line is open.

Speaker 6

Hi, thanks for taking my questions.

Speaker 2

Did I hear correctly, you said you're

Speaker 7

going to be increasing your total company headcount by 30% this fiscal year?

Speaker 3

Yes. Yes.

Speaker 7

Mary Anne, I just wanted to understand one of the metrics you percent growth in monthly recurring revenue for the mid market and the enterprise. And that's off of minus 7% last year. So I'm just trying to understand your comment about large deals as tough comps last year. Mean I the comps don't look tough to me. I'm just trying to understand this metric better.

Speaker 3

Yes. No, I understand how it when you look at it, it doesn't look like 2017 Q4 would have been a difficult comp. But you have to go back to 2016 in the fourth fiscal quarter where we had an outrageously fantastic quarter where we had four very large enterprise whale sorts of deals. So even though our 2017 was also very good, it didn't look very good compared to a phenomenal Q4 of twenty sixteen. So this Q4 was actually good as well and it's up from last quarter, but you're not going to see it in the numbers.

But I think all that is behind us now and you'll start to see real acceleration as we go into fiscal twenty nineteen in our mid market bookings mid market and enterprise bookings.

Speaker 7

And I guess that's why to help us, you gave us this new metric, the 44% growth of the 10,000 plus more customers, correct? That's a brand new metric, right?

Speaker 3

Yes, exactly right. Can

Speaker 7

you comment on the trajectory of that metric throughout the year?

Speaker 3

That's not something that we will actually comment on. But as you know, we have been investing in the mid market and enterprise. And on these large enterprise deals, it can be lumpy from quarter over quarter. And by the way, the other thing with enterprise deals is that in many times, some wanted to deploy it immediately, others wanted to deploy it over some period of time. And that period of time could be nine months or it could be over a year.

So we do expect that we will continue to grow both our mid market and our enterprise business faster than what Gartner says the market is growing And in both cases, we are doing that today. And oh, by the way, the other nice thing is that the small business now, which was growing slower than market is growing in line with market.

Speaker 7

Got it. Thank you.

Speaker 0

Your next question comes from the line of Zach Tercot with Dougherty. Your line is open.

Speaker 9

Hey guys, Zach on for Katherine Trebnick. Just quick one or two on the channel. I believe said you 82 partners enrolled since you expanded the channel program. Just wondering kind of how many of those are having serious contribution or revenue at this point? And also what role the channel partners are playing expansion of global footprint?

Speaker 2

Actually quite critical role, particularly for expansion of global footprint. Revenue from channel and bookings from channel is growing pretty quickly, actually faster than our core. And that's before we had Bill and the rest of the team. So Bill's already brought on board some other key folks that we will be coming online. Channel is huge for us.

And it's quite fascinating to me how we started in the channel relatively late and how quickly is it starting to accelerate. So you will see channel become a bigger and bigger portion of our business, particularly internationally. And as I indicated, channels booking is growing at a very healthy clip, and we expect that to actually accelerate beyond that.

Speaker 9

Great. And then just a quick follow-up. If you can give kind of any color on how you feel about the X Series and selling that through the channel. It could fuel to an advantage that you have a simplified product and that will help drive channel sales even further. I know you said bookings were up 28% in Q4, which is pretty big as well as top 10 deals coming from there.

So you see that continuing?

Speaker 2

Yes. No, so a couple of things. I actually and I think we've talked about it and I think I encourage you to look at also my last earnings call. This has been an evolution. X to me is a game changer because think about what we have just done.

We have smashed together telephony, contact center, conferencing, collaboration into one common product suite from X1 through X8. If you want a simple phone, we can provide it to you through X1. If you want a complete contact center solution with analytics, persona, call recordings, detailed speech analytics, etcetera, you get X8. And oh, by the way, one common data layer for the entire enterprise and a machine learning and AI where you can basically take this data and parse it based on buyer persona, customer persona, create rooms where you can have alerts when a particular customer of a particular type is making an issue. So we think it is fundamental and the simplicity of it, where in essence you don't have to spend time trying to figure out are you a contact center, are you a telephony solution.

The simplicity, I think, is key. And I think we are on track for a launch in the June, July time frame. We'll start a soft launch in June, accelerating over the summer. But again, we this X Series for us has been the culmination of four, five years of work acquiring a couple of contact center companies, acquiring SameRoom for the collaboration engine, acquiring QualityRocket for the speech analytics as well as just overall quality monitoring and analytics, and now most recently, Mariana IQ and check up on them. That's an amazing, amazing capability that we brought all together.

So I really think X simplifies everything. It blurs the line between contact center as well as telephony and video conferencing and it allows you to leverage that data so you create one system of engagement, one system of intelligence. That's what we've been working towards.

Speaker 0

Your next question comes from the line of Dmitry Natus with William Blair. Your line is open. So

Speaker 10

I mean going back to the bookings number, guys. I know you said 10% new MRR booked growth was 10%. That's relative to 40% growth last quarter. So it does seem like the bookings, which is 60% of your total bookings, have decelerated here. So I'm trying to understand exactly, is it people dragging feet in anticipation of the new product launch?

Is there something else going on? Is it just the momentum isn't quite there yet as you kind of target the channel? And also trying to understand the channel commissions channel partner commission statement you mentioned, it seems like there's been some kind of an inflation there in the channel. How are you viewing that as far as sustainability of that? Is it you think will normalize eventually?

Or is it continue to tick up as you try to bring in these partners and try woo them in on your side of the pond, if you will?

Speaker 3

Okay. So let's take the first one. On the we grew 10% on the mid market bookings mid market and enterprise bookings. First of all, I want you to remind everybody that we did mention that in our last earnings call that we did not expect to repeat the same growth rate in our fourth fiscal quarter as we had in our third fiscal quarter. Our third fiscal quarter was very strong, came in ahead of plan, and that's a great thing.

Our Q4 was also this past quarter was also very strong with 21 large enterprise deals over $10,000 in new monthly recurring revenue. It just so happens that our Q4 in the last two quarters have been also very

Speaker 2

good,

Speaker 3

right. I think the 2016 having four super whales impacted the growth rate that you saw in our fourth fiscal quarter of twenty seventeen, which impacted our growth rate here from a year over year comparison perspective. But we're very pleased with what we booked in our fourth fiscal quarter. We've been managing very well to our plan. We have a detailed plan in place from demand generation and pipeline build and we're hitting all of those targets.

And we'll expect now as we move into fiscal twenty nineteen, you're going to start seeing that rate accelerate. So we're very pleased on what we see here. We also have our sales team is ramping. Our sales capacity, we hired more

Speaker 6

than

Speaker 3

we had expected to hire from a sales perspective in our fourth fiscal quarter where you have the channel support and we have a seat at the table now. I mean, is a very, very large market and we expect that we're going to get much more than our fair share.

Speaker 10

And on the channel part commissions?

Speaker 3

And on the second part. So the second part was on the channel commissions that you had asked, absolutely. So you see a growth. The numbers that I had said as far as the increase in sales marketing is a year over year comparison for channel revenue year over year by more than 20%, 28 in the fourth fiscal quarter. We would expect I know what you're saying as far as the inflation, it's a very competitive area.

But with Bill on board, it's very targeted. We have strong commitment from our channel partners. That's the whole idea of this channel enablement program. They have to get skin in the game. They come to 8x8, they learn all about how to sell our products, they learn how to do tech support as well as the implementation.

So they have skin in the game. And so we really do believe that we have a strong channel partner channel partners and we're still on board that will start to accelerate.

Speaker 10

Can I ask one more question on the ASC? Thank you very much for the color on the bookings and the channel. But as far as ASC six zero six, six zero five accounting goes, I think you mentioned there's something on the website. Without us looking at it, would you be able to give us kind of a comparative six zero five number of what that service revenue would have looked like on a fiscal twenty nineteen basis. I think you're calling for twenty percent at the midpoint growth on the ASC six zero six basis.

So just trying to understand what it would be on a six zero five basis. And similarly for the OpEx side of the equation, it does sound like you're getting the benefit there of 11,000,000 to $13,000,000 yet you're investing additional 13,000,000 to $17,000,000 So all in, it sounds like you're investing 24,000,000 to $30,000,000 off in OpEx to drive this accelerated growth. I'm just trying to reconcile that that is the correct math.

Speaker 3

Yes. So on the revenue on a service revenue perspective, we don't believe that there's any change or a very small material change between ASC six zero five and ASC six zero six. We might see a slight improvement on the product margin under ASC six zero six versus ASC six zero six versus ASC six zero five, but no impact on the service revenue. As it relates to the operating expenses, yes, we will in fact have a favorable somewhere between 11,000,000 to $13,000,000 of favorable OpEx that will be capitalized and amortized over the next five years. And yes, we do expect a non GAAP pretax income of 13,000,000 to $17,000,000 So your numbers are correct.

This is the time as we had said, we're really, we really believe that we have a very strong position right now in the marketplace. We believe that the market is inflecting. We believe that with our current products as well as with our X Series products that we're in a strong position to capture a significant portion of this. And $40,000,000,000 markets that are less than 10% penetrated don't come around every day. So it's either accelerate growth now or wait and we're building for the long term.

These investments, as I mentioned before, mostly for growth to continue to accelerate beyond our 25% exit rate and into fiscal twenty twenty at an accelerated rate.

Speaker 10

Understood. Thank you, Mary Ellen, for that candid response.

Speaker 0

You're welcome. Your next question comes from the line of Mike Latimore with Northland Capital. Your line is open.

Speaker 6

Yes, great. Thanks very much. Just wanted to sync up two things you mentioned. I think you mentioned that you're seeing the market at an inflection point, but then you also said, I believe, that you've met your pipeline number for the fourth quarter. So I guess, can you just sort of sync that up?

I would have thought you might have beaten your pipeline number if the market was inflecting one.

Speaker 2

No. So the issue is less around the market. The more is around capacity. So for example, capacity as in people bringing on board. Rainy joined us about a year ago.

She started bringing her demand generation team over the last six months. So they are ahead of plan with and I'm talking about our detailed plan that we put together for FY 2019. Bill has been on board for four point five weeks, and he's starting to kind of stuff's already starting to happen out there. Our issue is not the market. Our issue is the capacity and the people that we've had in here.

And that's part of why I mean you've known us for a long time. We have always run the company in a very prudent, almost a GARP way. We are seeing an opportunity to take this market into a high growth mode and we think we've got the right products that we've built up over the right time. And our constraint in the past was the ability to bring on board all the people that we need and we are finding now people are coming to us, and we're being able to bring them onboard, onboard them, and this is the time.

Speaker 6

Got it. And then I know last quarter, you talked about this March being a sort of tougher bookings comp. Any just general kind of qualitative commentary about the June bookings comp?

Speaker 2

We don't I mean it's looking better and better. So the main point is that was why I want to make sure that what we think is over the long term, you're going to continue to see our bookings continue to accelerate. You'll always see some level of fluctuation because a couple of big deals here, there, everywhere, depending on how they happen, can kind of shift from one quarter to the other. But we predicted exactly what Q4 bookings are going to be and we had kind of telegraphed exactly that in our last earnings call and we came in exactly where we expected.

Speaker 6

Got it. And then just last on the sort of clearing out of old inventory, I you said for the small business market, are you just seeing like a new version of phones come to the market that you want to sell? Is that the main thing? Or could you expand that a little bit more?

Speaker 3

Exactly. No, that's exactly right.

Speaker 2

Exactly. Exactly right. There was a bunch of phones that if we kept them much longer, the next generation would have been out. It was good to get them all out and hallelujah.

Speaker 3

We were able to use them to generate some solid monthly recurring revenue for our small business team. Okay. Thanks.

Speaker 0

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

Speaker 11

Thank you. Vic, my perception of this market is it's much more fragmented and we need to see consolidation. And I would kind of debate the concept of a winner take all mentality. So I'm just kind of curious with that as a backdrop, thoughts relative to the competitive landscape.

Speaker 2

So interesting way of asking it, but let's basically, I have had a consistent vision since I've been here over the last four years, which is in the end, it will become one core communications platform, which is why if you think about it, we bought Sentaxial, we bought DXi, we bought SameRoom, we bought Quality Rocket and now Mariana IQ. So we can create all our core technology under one roof. We think that is critical because then you control your own destiny. Ultimately, this is about that core communication platform that does any form of communication and it's that underlying data because that is hugely valuable. Particularly when you put AIML on top of it, that data, what is the core communication data?

Any form of real time interaction that happens in a company happens on our platform. That's huge. And I've built the technology where it's our platform. It's not somebody else's. I don't have to share stuff.

I don't have to worry about somebody having their own ambitions. We are the masters of our own destiny. So I that's part of why, as I said, what we have essentially, we have the equivalent of the core technology of two public companies all under one roof. Constraint in the past has been having the right amount of people as well as the right caliber of talent at the sales and marketing level. I think I got it now, which is why you turn on the gas.

Speaker 11

Last question for me. Relative to at Enterprise Connect, you were very suggestive opportunity on the data side. In fact, I think at one point saying people may end up characterizing us as a data company. There really wasn't any discussion of that today. I'm wondering if you're making any progress there.

Speaker 2

Well, actually, I mean, start with the most relevant progress I made. I bought Mariana IQ and announced that about a week ago. We've also made very significant hires in AIML, and we are now starting to kind of leverage that, let's start with us, where we have the ability inside the company to create for key customers common rooms where any global interaction we're able to basically look use AIML to basically parse those global interactions on order of priority. This is something coming from a really senior executive from our customer may have gone to a Tier two agent somewhere needs to be responded to instantly. These other ones are more run of the mill.

So that's how having that data combined with AIML is going to be a game changer. But Mariana IQ is a I mean, check up on the company. It's very much, I think, the two best acquisitions I've made are Quality Rocket and SameRoom. And this one, I think, is going to be right up there.

Speaker 7

Got you. Thank you.

Speaker 0

Your next question comes from Jonathan Kees with Summit Insight Group. Your line is open.

Speaker 12

Great. Thanks for taking my questions. I just wanted to, I guess, dig a little deeper and try to tie things together. You talked about 30% more hiring in fiscal year twenty nineteen and you kind of gave the OpEx ranges and also some of that is going to there's some OpEx that's going to be capitalized. So I guess I'm trying to pull all together and try to get a sense of the puts and takes.

And maybe the best thing to do is just step back and ask, where do you see most of the hiring going to be in that 30% in those OpEx areas? And are you still, I'm assuming that you're spending less now on brand awareness, which took a lot of your S and M in the past?

Speaker 3

Okay. So, on the increased headcount that will be across the board, okay? It will be across the board. We do have a fairly significant increase in R and D and there'll be significant heads that we will hire across the board in our U. S.

Operations here in San Jose, in our UK facility as well as in our cruise facility. Second is will be continuous hires in the sales and marketing side. We built out most of our marketing team. There will be a couple more that we'll add. But certainly on the sales side, we'll continue to add capacity again to make sure that we have the right team in place and ramped ready for the acceleration of growth into fiscal twenty twenty.

We will also hire in G and A. We didn't talk about that, but we will also hire in G and A. We're building out our HR team and continuing to build out our legal team as we continue to move up market. It's very necessary to have the right team in place to be able to review and do contracts very, very quickly with these enterprise customers. So it will be across the board also from a deployment perspective with all the new business that we're bringing on board.

Key metric to us is, definitely we said service revenue growth is a key metric to us. Numerous bookings is a key metric to us, but time to revenue is a very important metric to us. So we'll be building out our customer deployment team. Customer service in addition, we'll be looking for ways to continue to adopt our technology, which we have adopted inside our company to continue to bring the best information to our customers. So that will be across the board from a spend and from a hiring perspective.

We still expect absolutely that we will spend in demand gen. But we were looking for now that we've actually gone to market and we have a lot of data on what's working, where are we generating the most leads by what programs, we can now really focus in on and put the turn the dials plus or minus on the ones that are really generating the best pipeline for us. So it's very targeted. We're learning a lot about our markets. We're learning a lot about the customers that we're selling to and we're learning a lot about which campaigns are working and not working and we'll be able to fine tune and continue to target them.

So you will see you won't see big billboards, right? You won't see jingles on your radio stations, but we will invest in ways to generate new leads and continue to build our pipeline.

Speaker 12

Okay, great. And then just as a follow-up, are you still looking to bring on channel partners at same rate or accelerated rate from what you did in fiscal twenty eighteen?

Speaker 2

Significantly accelerated rate. Bill, every time we bring on board very senior executives, again, Bill span of control. Bill was Head of Channels and Alliances for CenturyLink and ran a very big operation. He knows every person in our space, Colt. His view is we are just at the very tip of the channel and that with particularly X and the simplicity of X and the ability to basically provision X and then with the kind of investments we've made in back office infrastructure, in his mind channel is right to pop.

So you'll see I mean if you think about it at a macro level bucket, I'm going to invest a lot in engineering because I think I've got a differentiated product. I own it. And to some extent, I'm going to put a lot of wood behind it so I can make sure it continues to be differentiated. And as a matter of fact, it becomes game changing. Second, we're going to invest a heck of a lot in channel because in essence, we've got now the right people who have done it before who are looking at us telling us the channel can pop and then continue to invest in sales capacity across the board.

So that's the three key core areas of investment. And again, it's because, as I said, a culmination of a lot of years that for us where we feel comfortable in making those kind of investments right now.

Speaker 0

There are no further questions at this time. I will now turn the call back over to the presenters.

Speaker 2

Thank you. In conclusion, we are excited about fiscal twenty nineteen, and we look forward to seeing many of you guys at upcoming investor conferences. Also, on behalf of the Board, executive management team and everyone at 8x8, we would invite you to tune in to June 19, where we will be ringing the opening bell at the New York Stock Exchange. We are honored to have 8x8 employees and clients with us in the New York Stock Exchange to celebrate this important occasion and a milestone in the company's history. Thank you very much.

Speaker 0

This concludes today's conference call. You may now disconnect.