TMCnet News
8X8 INC /DE/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) FORWARD-LOOKING STATEMENTS This Management Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, words such as "may," "will," "should," "estimates," "predicts," "potential," "continue," "strategy," "believes," "anticipates," "plans," "expects," "intends," and similar expressions are intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Actual results and trends may differ materially from historical results or those projected in any such forward-looking statements depending on a variety of factors. These factors include, but are not limited to, customer acceptance and demand for our cloud communications and collaboration services, the quality and reliability of our services, the prices for our services, customer renewal rates, customer acquisition costs, our ability to compete effectively in the hosted telecommunications and cloud-based computing services business, actions by our competitors, including price reductions for their competitive services, our ability to provide cost-effective and timely service and support to larger distributed enterprises, potential federal and state regulatory actions, compliance costs, potential warranty claims and product defects, our need for and the availability of adequate working capital, our ability to innovate technologically, the timely supply of products by our contract manufacturers, our management's ability to execute its plans, strategies and objectives for future operations, including the execution of integration plans, and to realize the expected benefits of our acquisitions, and potential future intellectual property infringement claims and other litigation that could adversely affect our business and operating results. All forward-looking statements included in this report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. In addition to the factors discussed elsewhere in this Form 10-Q, see the Risk Factors discussion in Item 1A of our 2013 Form 10-K. The forward-looking statements included in this Form 10-Q are made only as of the date of this report, and we undertake no obligation to update the forward-looking statements to reflect subsequent events or circumstances. BUSINESS OVERVIEW We develop and market a comprehensive portfolio of cloud-based communication and collaboration solutions that include hosted cloud telephony, unified communications, contact center, video conferencing and virtual desktop software and services. These communication and collaboration services are offered from the Internet cloud via a software-as-a-service subscription. We also provide cloud-based computing services. As of September 30, 2014, we had approximately 40,400 business customers. Since fiscal 2004, substantially all of our revenue has been generated from the sale, license and provision of these cloud products, services and technology. Prior to fiscal 2003, our focus was on our Voice over Internet Protocol semiconductor business. Our fiscal year ends on March 31 of each calendar year. Each reference to a fiscal year in this report refers to the fiscal year ending March 31 of the calendar year indicated (for example, fiscal 2015 refers to the fiscal year ending March 31, 2015). SUMMARY AND OUTLOOK In the second quarter of fiscal 2015, we experienced continued momentum with revenue increasing 29% year over year to a record $39.6 million; service revenue increasing 30% year over year; average monthly service revenue per business customer of $299, up 12% compared with $268 in the same period last year; and revenue churn of 0.9%, the second consecutive quarter below 1%. In addition, revenue from our mid-market customers represented 41% of our service revenue in fiscal 2015 compared to 35% for fiscal 2014. We will continue invest in research and development, customer support and sales and marketing to enhance our service offering to target the mid-market and distributed enterprises. 22 -------------------------------------------------------------------------------- CRITICAL ACCOUNTING POLICIES & ESTIMATES The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. RECENT ACCOUNTING PRONOUNCEMENTS See Item 1 of Part I, "Financial Statements - Note 2 - Basis of Presentation - Recent Accounting Pronouncements." SELECTED OPERATING STATISTICS We periodically review certain key business metrics, within the context of our articulated performance goals, in order to evaluate the effectiveness of our operational strategies, allocate resources and maximize the financial performance of our business. The selected operating statistics include the following: Selected Operating Statistics (1) Sept. 30, June 30, March 31, Dec 31, Sept. 30, 2014 2014 2014 2013 2013 Total business customers (2) 40,434 39,340 37,933 36,753 34,674 Business customers average monthly service revenue per customer (3) $ 299 $ 293 $ 287 $ 274 $ 268 Monthly business service revenue churn 0.9% 0.4% 1.2% 1.5% 1.2% Overall service margin 79% 80% 79% 81% 81% Overall product margin -8% -9% -23% -34% -27% Overall gross margin 72% 71% 70% 71% 71% (1) Selected operating statistics table include continuing operations and excludes dedicated server hosting business sold September 30, 2013. (2) Business customers are defined as customers paying for service. Customers that are currently in the 30- day trial period are considered to be customers that are paying for service. Customers subscribing to Virtual Office Solo, DNS or Cloud VPS services are not included as business customers. (3) Business customer average monthly service revenue per customer is service revenue from business customers in the period divided by the number of months in the period divided by the simple average number of business customers during the period. 23-------------------------------------------------------------------------------- RESULTS OF OPERATIONS The following discussion should be read in conjunction with our condensed consolidated financial statements and the notes thereto. September 30, Dollar Percent Service revenue 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ 36,121 $ 27,826 $ 8,295 29.8% Percentage of total revenue 91.2% 90.3% Six months ended $ 70,397 $ 54,325 $ 16,072 29.6% Percentage of total revenue 90.8% 90.4% Service revenue consists primarily of revenue attributable to the provision of our 8x8 cloud communication and collaboration services, and royalties earned from cloud technology licenses. We expect that cloud communication and collaboration service revenues will continue to comprise nearly all of our service revenues for the foreseeable future. Cloud and collaboration service revenues increased in the second quarter of fiscal 2015 primarily due to the increase in our business customer subscriber base (net of customer churn). Our business subscriber base grew from approximately 34,700 business customers on September 30, 2013, to approximately 40,400 on September 30, 2014, and average monthly service revenue per customer increased from $268 at September 30, 2013 to $299 at September 30, 2014. Cloud communication and collaboration service revenues increased in the six months of fiscal 2015 also primarily due to the increases in our business customer subscriber base (net of customer churn) and average monthly service revenue per customer. Our business service subscriber base increased approximately from 37,900 business customers on April 1, 2014, to approximately 40,400 on September 30, 2014, and average monthly service revenue per customer increased from $287 at April 1, 2014 to $299 at September 30, 2014. The increase in business customers included approximately 1,000 customers obtained through our acquisition of Voicenet Ltd, on November 29, 2013. September 30, Dollar Percent Product revenue 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ 3,477 $ 2,989 $ 488 16.3% Percentage of total revenue 8.8% 9.7% Six months ended $ 7,114 $ 5,741 $ 1,373 23.9% Percentage of total revenue 9.2% 9.6% Product revenue consists primarily of revenue from sales of IP telephones in conjunction with our 8x8 cloud telephony service. Product revenue increased for the three and six months ended September 30, 2014 primarily due to an increase in equipment sales to business customers. No customer represented greater than 10% of our total revenues for the three months ended September 30, 2014 or 2013. September 30, Dollar Percent Cost of service revenue 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ 7,505 $ 5,209 $ 2,296 44.1% Percentage of service revenue 20.8% 18.7% Six months ended $ 14,502 $ 9,995 $ 4,507 45.1% Percentage of service revenue 20.6% 18.4% 24-------------------------------------------------------------------------------- The cost of service revenue primarily consists of costs associated with network operations and related personnel, telephony origination and termination services provided by third party carriers and technology license and royalty expenses. Cost of service revenue for the three months ended September 30, 2014 increased over the comparable period in the prior fiscal year primarily due to a $1.3 million increase in third-party network service expenses, a $0.5 million increase in payroll and related expenses, a $0.3 million increase in depreciation, and a $0.1 million increase in stock-based compensation expenses. Cost of service revenue for the six months ended September 30, 2014 increased over the comparable period in the prior fiscal year primarily due to a $2.4 million increase in third party network services expenses, a $0.9 million increase in payroll and related expenses, a $0.4 million increase in depreciation expense, and a $0.1 million increase in stock-based compensation expenses. September 30, Dollar Percent Cost of product revenue 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ 3,762 $ 3,783 $ (21) -0.6% Percentage of product revenue 108.2% 126.6% Six months ended $ 7,731 $ 7,130 $ 601 8.4% Percentage of product revenue 108.7% 124.2% The cost of product revenue consists primarily of IP Telephones, estimated warranty obligations and direct and indirect costs associated with product purchasing, scheduling, shipping and handling. The amount of revenue allocated to product revenue based on the relative selling price is less than the cost of the IP phone equipment. The cost of product revenue for the three months ended September 30, 2014 was consistent with the comparable period. The cost of product revenue for the six months ended September 30, 2014 increased over the comparable period in the prior fiscal year primarily due to an increase in equipment shipped to customers. The decrease in negative margin is due to less discounting of equipment in the current period. September 30, Dollar Percent Research and development 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ 3,496 $ 2,640 $ 856 32.4% Percentage of total revenue 8.8% 8.6% Six months ended $ 6,902 $ 4,976 $ 1,926 38.7% Percentage of total revenue 8.9% 8.3% Historically, our research and development expenses have consisted primarily of personnel, system prototype design, and equipment costs necessary for us to conduct our development and engineering efforts. During the three and six months ended September 30, 2014, we expensed all research and development costs as they were incurred in accordance with ASC 985-20. The research and development expenses for the three months ended September 30, 2014 increased over the comparable period in the prior fiscal year primarily due to a $0.4 million increase in consulting, temporary personnel, and outside service expenses, a $0.4 million increase in payroll and related costs, and a $0.2 million increase in stock-based compensation expenses. The research and development expenses for the six months ended September 30, 2014 increased over the comparable period in the prior fiscal year primarily due to a $0.8 million increase in consulting, temporary personnel, and outside service expenses, a $0.7 million increase in payroll and related costs, and a $0.4 million increase in stock-based compensation expenses. 25 -------------------------------------------------------------------------------- September 30, Dollar Percent Sales and marketing 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ 19,440 $ 13,745 $ 5,695 41.4% Percentage of total revenue 49.1% 44.6% Six months ended $ 38,600 $ 26,817 $ 11,783 43.9% Percentage of total revenue 49.8% 44.6% Sales and marketing expenses consist primarily of personnel and related overhead costs for sales, marketing, and customer service. Such costs also include outsourced customer service call center operations, sales commissions, as well as trade show, advertising and other marketing and promotional expenses. Sales and marketing expenses for the three months ended September 30, 2014 increased over the same quarter in the prior fiscal year primarily because of a $2.9 million increase in payroll and related costs, a $0.5 million increase in stock-based compensation expenses, a $0.4 million increase in indirect channel commission expenses, a $0.3 million increase in temporary personnel, consulting and outside service expenses, a $0.2 million increase in travel expenses, a $0.2 million increase in amortization expense, offset by a $0.1 million decrease in bad debt expenses. Sales and marketing expenses for the six months ended September 30, 2014 increased over the same period in the prior fiscal year primarily because of a $7.0 million increase in payroll and related costs, $0.9 million increase in stock-based compensation expenses, a $0.9 million increase in indirect channel commissions, a $0.7 million increase in temporary personnel, consulting and outside service expenses, a $0.5 million increase in amortization expense, a $0.4 million increase in travel expenses, a $0.2 million increase in sales promotions, and a $0.1 million increase in advertising expenses. September 30, Dollar Percent General and administrative 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ 3,893 $ 3,125 $ 768 24.6% Percentage of total revenue 9.8% 10.1% Six months ended $ 7,771 $ 5,897 $ 1,874 31.8% Percentage of total revenue 10.0% 9.8% General and administrative expenses consist primarily of personnel and related overhead costs for finance, human resources and general management. General and administrative expenses for the three months ended September 30, 2014 increased over the same quarter in the prior fiscal year primarily because of a $0.5 million increase in payroll and related costs, a $0.2 million increase in recruiting expenses, a $0.1 million increase in stock-based compensation expenses, a $0.1 million increase in rent expense, offset by a $0.2 million decrease in legal fees. General and administrative expenses for the six months ended September 30, 2014 increased over the same period in the prior fiscal year primarily because of a $0.8 million increase in payroll and related expenses, a $0.4 million increase in stock-based compensation expenses, a $0.3 million increase in recruiting expenses, and a $0.1 million increase in rent expense. September 30, Dollar Percent Gain on patent sale 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ (1,000) $ - $ (1,000) -100.0% Percentage of total revenue -2.5% 0.0% Six months ended $ (1,000) $ - $ (1,000) -100.0% Percentage of total revenue -1.3% 0.0% 26 -------------------------------------------------------------------------------- In June 2012, we entered into a patent purchase agreement for the sale of a family of United States patents. We recognized a gain of $1.0 million for the three months ended September 30, 2014 due to the third party purchaser entering into a license agreement with its customer. The gain on patent sale has been recorded as a reduction of operating expenses in the consolidated statements of income. September 30, Dollar Percent Other income, net 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ 200 $ 1 $ 199 19900.0% Percentage of total revenue 0.5% 0.0% Six months ended $ 377 $ 16 $ 361 2256.3% Percentage of total revenue 0.5% 0.0% In the three and six months ended September 30, 2014, other income, net primarily consisted of interest income earned on our cash, cash equivalents and investments. September 30, Dollar Percent Provision for income tax 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ 1,411 $ 826 $ 585 70.8%Percentage of income before provision for income taxes 52.2% 35.7% Six months ended $ 2,083 $ 1,787 $ 296 16.6% Percentage of income before provision for income taxes 61.6% 33.9% For the three months ended September 30, 2014, we recorded a provision for income taxes of $1.4 million which was primarily attributable to income from continuing operations, which included a one-time $1.0 million benefit related to the patent license sale. For the three months ended September 30, 2013, we recorded a provision for income taxes of $0.8 million which was primarily attributable to income from continuing operations. For the six months ended September 30, 2014, we recorded a provision for income taxes of $2.1 million which was primarily attributable to income from continuing operations. For the six months ended September 30, 2013, we recorded a provision for income taxes of $1.8 million which was primarily attributable to income from continuing operations, reduced by $0.2 million as an adjustment for prior period city income tax returns that were treated as discrete items for fiscal 2014. The effective tax rate is calculated by dividing the income tax provision by net income before income tax expense. We estimate our annual effective tax rate at the end of each quarter. In estimating the annual effective tax rate, we, in consultation with our tax advisors, consider, among other things, annual pre-tax income, permanent tax differences, the geographic mix of pre-tax income and the application and interpretations of existing tax laws. Operating losses in non-US tax jurisdictions cannot presently be used to offset profits and therefore increases our effective tax rate. 27 -------------------------------------------------------------------------------- Income from discontinued operations, September 30, Dollar Percent net of income tax provision 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ - $ 154 $ (154) -100.0% Percentage of total revenue 0.0% 0.5% Six months ended $ - $ 301 $ (301) -100.0% Percentage of total revenue 0.0% 0.5% On September 30, 2013, we sold our dedicated server hosting business. The current historical results of our dedicated server hosting business have been reclassified to income from discontinued operations, net of income tax provision. Gain on disposal of discontinued September 30, Dollar Percent operations, net of income tax provision 2014 2013 Change Change (dollar amounts in thousands) Three months ended $ - $ 589 $ (589) -100.0% Percentage of total revenue 0.0% 1.9% Six months ended $ - $ 589 $ (589) -100.0% Percentage of total revenue 0.0% 1.0% For the three and six months ended September 30, 2013, we recorded a gain on disposal of our dedicated server hosting business of $1.1 million, net of a tax provision of $0.5 million. Liquidity and Capital Resources As of September 30, 2014, we had approximately $185.6 million in cash, cash equivalents and short-term investments. Net cash provided by operating activities for the six months ended September 30, 2014 was approximately $8.6 million, compared with $9.0 million for the six months ended September 30, 2013. Cash provided by operating activities has historically been affected by the amount of net income, sales of subscriptions, changes in working capital accounts particularly in deferred revenue due to timing of annual plan renewals, add-backs of non-cash expense items such as the use of deferred tax assets, depreciation and amortization and the expense associated with stock-based awards. Net cash used in investing activities was approximately $13.5 million during the six months ended September 30, 2014. We spent approximately $2.6 million on the purchase of property and equipment, and we purchased $10.7 million of short term investments, net of sales, proceeds and maturities of short-term investments. The net cash used in investing activities for the six months ended September 30, 2013 was $1.9 million during which period we spent approximately $1.4 million on the purchase of additional furniture and fixtures and leasehold and capitalized $0.5 million of software costs. Our financing activities for the six months ended September 30, 2014 consisted primarily of cash from the issuance of shares due to exercise of employee stock options and the purchase of shares under the employee stock purchase plan of $1.7 million offset by cash used to repurchase shares of our common stock of $0.1 million and payments under capital leases of $0.1 million. Our financing activities for the six months ended September 30, 2013 consisted primarily of cash from the issuance of shares due to exercise of employee stock options and the purchase of shares under the employee stock purchase plan of $2.2 million offset by cash used to repurchase shares of our common stock of $0.3 million. Contractual Obligations We lease our headquarters facility in San Jose, California under an operating lease agreement that expires in October 2019. The lease is an industrial net lease with monthly base rent of $130,821 for the first 15 months with a 3% increase each year thereafter, and requires us to pay property taxes, utilities and normal maintenance costs. 28 -------------------------------------------------------------------------------- We lease our UK headquarters in Aylesbury UK under an operating lease agreement that expires in March 2017, with a break clause in March 2015 exercisable with six months' notice. The lease has a base monthly rent of $10,087 until March 2015, rising to $13,285 thereafter, and requires us to pay property taxes, service charges, utilities and normal maintenance costs. The lease was amended in September 2014 for additional space. We entered into a series of noncancelable capital lease agreements for office equipment bearing interest at various rates. Assets under capital lease at September 30, 2014 totaled $0.5 million with accumulated amortization of $0.3 million. In the third quarter of 2010, we amended the contract with one of our third party customer support vendors containing a minimum monthly commitment of approximately $0.4 million. The agreement requires a 150-day notice to terminate. At September 30, 2014, the total remaining obligation under the contract was $2.2 million. We have entered into contracts with multiple vendors for third party network services. At September 30, 2014, future minimum annual payments under these third party network service contracts were $1.2 million in fiscal 2015, $1.7 million for fiscal 2016, $1.5 million for fiscal 2017, and $1.0 million for fiscal 2018. |