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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 voice
over Internet protocol, or VoIP, telephony products and services, the
reliability of our services, the prices for our services, customer renewal
rates, customer acquisition costs, actions by our competitors, including price
reductions for their telephone services, potential federal and state regulatory
actions, compliance costs, potential warranty claims and product defects, our
needs for and the availability of adequate working capital, our ability to
innovate technologically, the timely supply of products by our contract
manufacturers, potential future intellectual property infringement claims that
could adversely affect our business and operating results, and our ability to
retain our listing on the NASDAQ Capital Market. 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 those factors discussed elsewhere in this Form 10-Q,
see the Risk Factors discussion in Item 1A of our 2012 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 cloud-based business communications services encompassing
internally developed Voice over Internet Protocol ("VoIP") technologies. These
services enable telephony and video applications as well as web-based
conferencing and unified communications capabilities. We also provide managed
hosting and cloud-based computing services. As of December 31, 2012, we had
approximately 31,500 business customers. Since fiscal 2004, substantially all of
our revenue has been generated from the sale, license and provision of VoIP
products, services and technology. Prior to fiscal 2003, our focus was on our
VoIP 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 2013 refers to the fiscal year
ending March 31, 2013).
No customer represented greater than 10% of our total revenue for the three and
nine months ended December 31, 2012 and 2011. Revenue from customers outside the
United States was not material for the three and nine months ended December 31,
2012 or 2011.
CRITICAL ACCOUNTING POLICIES & ESTIMATES
The discussion and analysis of our financial condition and results of operations
are based upon our 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. Our
critical accounting policies and estimates are discussed in our Annual Report on
Form 10-K for the fiscal year ended March 31, 2012. As of December 31, 2012,
there had been no material changes to our critical accounting policies and
estimates.
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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:
Three Months Ended
Dec 31, Sept. 30, June 30, March 31, Dec 31,
2012 2012 2012 2012 2011
Gross business customer additions
(1) 2,617 2,915 2,943 2,892 2,836
Gross business customer
cancellations (less
cancellations
within 30 days of sign-up) 1,504 2,149 1,458 1,697 1,642
Business customer churn (less cancellations within 30 days
of sign-up) (2) 1.6% 2.4% 1.7% 2.0% 2.0%
Business service revenue churn 2.6% 1.0% 2.3% 1.6% 1.9%
Total business customers (3) 31,473 30,498 29,913 28,671 27,677
Business customer average monthly
service revenue per customer
(4) $ 260 $ 256 $ 250 $ 244 $ 239
Overall service margin 78% 76% 75% 76% 77%
Overall product margin -34% -22% -30% -15% -24%
Overall gross margin 68% 68% 67% 68% 68%
Business subscriber acquisition
cost
per service (5) $ 98 $ 89 $ 97 $ 99 $ 92
Average number of subscribed
services
per business customer 11.2 10.6 10.1 9.8 9.4
Average number of subscribed
services per new business customer (6) 17.0 14.7 14.0 13.6 14.1
(1) Does not include customers of Virtual Office Solo or Zerigo, Inc. ("Zerigo").
(2) Business customer churn is calculated by dividing the number of business
customers that terminated (after the expiration of the 30-day trial) during
that period by the simple average number of business customers during the
period and dividing the result by the number of months in the period. The
simple average number of business customers during the period is the number
of business customers on the first day of the period plus the number of
business customers on the last day of the period divided by two. In the
second quarter of fiscal 2013, an affiliate with 411 business customers
representing approximately $9,000 of monthly service revenue cancelled
service. Excluding these 411 cancellations, business customer churn (less cancellations within 30 days of sign-up) was 1.9%.
(3) 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 or
Zerigo services are not included as business customers.
(4) 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.
(5) Business subscriber acquisition cost per service is defined as the combined
costs of advertising, marketing, promotions, sales commissions and equipment
subsidies for business services sold during the period divided by the number
of gross business services added during the period.
(6) Total new services sold in the period divided by gross business customer
additions.
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RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our condensed
consolidated financial statements and the notes thereto.
December 31, Dollar Percent
Service revenue 2012 2011 Change Change
(dollar amounts in thousands)
Three months ended $ 24,958 $ 21,200 $ 3,758 17.7%
Percentage of total revenue 91.3% 91.1%
Nine months ended $ 72,307 $ 56,234 $ 16,073 28.6%
Percentage of total revenue 91.6% 91.3%
Service revenue consists primarily of revenue attributable to the provision of
our 8x8 VoIP services and royalties earned under our VoIP technology licenses.
We expect that 8x8 service revenues will continue to comprise nearly all of our
service revenues for the foreseeable future. 8x8 service revenue increased in
the third quarter of fiscal 2013 primarily due to the increase in our business
customer subscriber base. Our business subscriber base grew from 27,677 business
customers on December 31, 2011, to 31,473 on December 31, 2012. The increase for
the first nine months of fiscal 2013 also was primarily attributable to the
increase in our business customer base from approximately 24,000 businesses on
April 1, 2011 to 31,473 on December 31, 2012. The increase was partially offset
by a decrease in customers of our residential services. These changes were
consistent with the redirection of our marketing efforts toward our business
customer service. We expect the trends to continue in future periods.
December 31, Dollar Percent
Product revenue 2012 2011 Change Change
(dollar amounts in thousands)
Three months ended $ 2,382 $ 2,078 $ 304 14.6%
Percentage of total revenue 8.7% 8.9%
Nine months ended $ 6,656 $ 5,370 $ 1,286 23.9%
Percentage of total revenue 8.4% 8.7%
Product revenue consists primarily of revenue from sales of IP telephones
attributable to our 8x8 service. Product revenue increased for the three and
nine months ended December 31, 2012 primarily due to an increase in equipment
sales to business customers.
December 31, Dollar Percent
Cost of service revenue 2012 2011 Change Change
(dollar amounts in thousands)
Three months ended $ 5,473 $ 4,890 $ 583 11.9%
Percentage of service revenue 21.9% 23.1%
Nine months ended $ 16,984 $ 12,764 $ 4,220 33.1%
Percentage of service revenue 23.5% 22.7%
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 December 31, 2012 increased
over the comparable period in the prior fiscal year primarily due to a $0.5
million increase in third party network service expenses as a result of the
increase in our business subscriber base, a $0.2 million increase in
depreciation expense, and a $0.1 million increase in payroll and related costs.
The increase in expense was partially offset by a $0.1 million reduction in
expensed license and fees and a $0.1 million reduction in temporary personnel,
consulting and outside service expenses.
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Cost of service revenue for the nine months ended December 31, 2012 increased
from the comparable period in the prior fiscal year primarily due to a $2.7
million increase in third party network service fees as a result of the increase
in our business subscriber base, a $0.8 million increase in payroll and related
costs, a $0.5 million increase in depreciation expense, a $0.4 million increase
in amortization expense due to intangibles acquired in acquisition of
businesses, and a $0.1 million increase in consulting and outside service
expenses. The increase in expense was partially offset by a $0.3 million
reduction in expensed license and fees.
December 31, Dollar Percent
Cost of product revenue 2012 2011 Change Change
(dollar amounts in thousands)
Three months ended $ 3,203 $ 2,584 $ 619 24.0%
Percentage of product revenue 134.5% 124.4%
Nine months ended
$ 8,585 $ 7,467 $ 1,118 15.0%
Percentage of product revenue 129.0% 139.1%
The cost of product revenue consists of costs associated with systems,
components, system manufacturing, assembly and testing performed by third-party
vendors, estimated warranty obligations and direct and indirect costs associated
with product purchasing, scheduling, quality assurance, 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 December 31, 2012 increased over the
comparable period in the prior fiscal year primarily due to a $0.5 million
increase in the shipment of equipment to customers and a $0.1 million increase
in warranty expense.
The cost of product revenue for the nine months ended December 31, 2012
increased over the comparable period in the prior fiscal year due to a $0.9
million increase in the shipment of equipment to customers, a $0.1 million
increase in warranty expense and a $0.1 million increase in freight expenses.
December 31, Dollar Percent
Research and development 2012 2011 Change Change
(dollar amounts in thousands)
Three months ended $ 2,117 $ 1,955 $ 162 8.3%
Percentage of total revenue 7.7% 8.4%
Nine months ended $ 5,973 $ 4,902 $ 1,071 21.8%
Percentage of total revenue 7.6% 8.0%
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. We expense research and
development costs as they are incurred. The research and development expenses
for the three months ended December 31, 2012 increased over the comparable
period in the prior fiscal year primarily due to a $0.1 million increase in
payroll and related costs and a $0.1 million increase in other research and
development expenses.
The research and development expenses for the nine months ended December 31,
2012 increased over the comparable period in the prior fiscal year due to a $0.8
million increase in payroll and related costs, a $0.1 million increase in
recruiting expenses and a $0.2 million increase in other research and
development expenses.
December 31, Dollar Percent
Sales and marketing 2012 2011 Change Change
(dollar amounts in thousands)
Three months ended $ 11,651 $ 9,816 $ 1,835 18.7%
Percentage of total revenue 42.6% 42.2%
Nine months ended $ 33,202 $ 27,076 $ 6,126 22.6%
Percentage of total revenue 42.0% 44.0%
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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 December 31, 2012 increased
over the same quarter in the prior fiscal year primarily because of a $1.4
million increase in payroll and related costs, a $0.1 million increase in third
party sales commissions, a $0.1 million increase in bad debt expenses, a $0.1
million increase in credit card processing fees, and a $0.3 million increase in
other miscellaneous sales and marketing expenses. The increase in expense was
partially offset by a $0.2 million reduction in temporary personnel, consulting
and outside service expenses.
Sales and marketing expenses for the first nine months of fiscal 2013 increased
over the same period in the prior fiscal year primarily because of a $4.7
million increase in payroll and related costs, a $0.3 million increase in third
party sales commissions, a $0.2 million increase in amortization of customer
relationship intangibles, a $0.2 million increase in bad debt expense, a $0.1
million increase in credit card processing fees, and a $1.1 million increase in
other sales and marketing expenses. The increase in expenses was partially
offset by a $0.5 million reduction in temporary personnel, consulting and
outside service expenses.
December 31, Dollar Percent
General and administrative 2012 2011 Change Change
(dollar amounts in thousands)
Three months ended $ 2,136 $ 1,481 $ 655 44.2%
Percentage of total revenue 7.8% 6.4%
Nine months ended $ 6,270 $ 4,372 $ 1,898 43.4%
Percentage of total revenue 7.9% 7.1%
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 December 31, 2012 increased
over the same quarter in the prior fiscal year primarily because of a $0.2
million increase in payroll and related costs, a $0.2 million increase in
facility rent and maintenance expenses, a $0.1 million increase in temporary
personnel, consulting and outside service expenses, a $0.1 million increase in
depreciation expense, and a $0.1 million increase in recruiting expenses.
General and administrative expenses for the first nine months of fiscal 2013
increased over the same period in the prior fiscal year primarily because of a
$0.8 million increase in temporary personnel, consulting and outside service
expenses, a $0.6 million increase in payroll and related costs, a $0.5 million
increase in facility rent and maintenance expenses, a $0.2 million increase in
depreciation expense, and a $0.1 million increase in recruiting expenses. The
increase in expense was partially offset by a $0.2 million reduction in legal
expenses and a $0.1 million reduction in other general and administrative
expenses.
December 31, Dollar Percent
Gain on patent sale 2012 2011 Change Change
(dollar amounts in thousands)
Three months ended $ - $ - $ - 0.0%
Percentage of total revenue 0.0% 0.0%
Nine months ended $ (11,965) $ - $ (11,965) 100.0%
Percentage of total revenue -15.2% 0.0%
In June 2012, we entered into a patent purchase agreement for the sale of a
family of United States patents for $12.0 million in cash. We recognized a gain
of slightly less than $12.0 million, net of transaction costs, which has been
recorded as a reduction of operating expenses in the consolidated statements of
operations.
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December 31, Dollar Percent
Other income, net 2012 2011 Change Change
(dollar amounts in thousands)
Three months ended $ 73 $ 49 $ 24 49.0%
Percentage of total revenue 0.3% 0.2%
Nine months ended $ 90 $ 58 $ 32 55.2%
Percentage of total revenue 0.1% 0.1%
In the nine months ended December 31, 2012, other income, net consisted of
interest expense, distribution of capital gains on investments and interest
income earned on our cash, cash equivalents and investments.
December 31, Dollar Percent
Provision (benefit) for income tax 2012 2011 Change Change
(dollar amounts in thousands)
Three months ended $ 913 $ 15 $ 898 5986.7%
Percentage of income
before provision for income taxes 32.2% 0.6%
Nine months ended $ 7,726 $ (284) $ 8,010 -2820.4%
Percentage of income before
provision (benefit) for income taxes 38.6% -5.6%
For the three and nine months ended December 31, 2012, we recorded a provision
for income taxes of $0.9 million and $7.7 million, respectively, which was
primarily attributable to net income from operations, including the gain on
patent sale. For the three and nine months ended December 31, 2011, we released
a portion of our valuation allowance against the deferred tax asset as we deemed
it was more likely than not it would be used to offset the $0.3 million deferred
tax liability recorded in connection with the acquisition of Zerigo.
The increase in income tax expense for the three months ended December 31, 2012
was primarily attributable to net income from operations.
The increase in income tax expense for the nine months ended December 31, 2012
compared with the same period in the prior fiscal year was due to the provision
for income tax of $7.7 million which was primarily attributable to net income
from operations, including the gain on patent sale.
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. The fiscal 2013 estimated annual effective tax rate is
expected to be approximately 40%, but may fluctuate each quarter due to the
timing of other discrete period transactions. 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, changes to tax rates,
state apportionment, and the application and interpretations of existing tax
laws.
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Liquidity and Capital Resources
As of December 31, 2012, we had approximately $46.5 million in cash, cash
equivalents and short-term investments.
Net cash provided by operating activities for the nine months ended December 31,
2012 was approximately $26.0 million, compared with $6.4 million for the nine
months ended December 31, 2011. The increase in cash flow resulted primarily
from a $12.0 million gain on the sale of a patent family in June 2012, a $1.7
million reimbursement from landlord for tenant improvements, and an increase in
service and product revenue in the first nine months of fiscal 2012. 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 $5.2 million during the nine months
ended December 31, 2012, compared with $2.5 million used in investing activities
for the nine months ended December 31, 2011. The increase in cash used in
investing activities during the nine months ended December 31, 2012 is primarily
related to an increase in the purchase of additional equipment, furniture and
fixtures and leasehold improvements ($5.2 million). The increase in cash used
for the purchase of furniture and fixtures and leasehold improvements is
primarily due to the Company's move to its new headquarters facility in San
Jose, California.
Our financing activities for the nine months ended December 31, 2012 consisted
primarily of cash from the issuance of shares due to exercise of employee stock
options ($1.7 million) offset by cash used to repurchase shares of our common
stock ($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.
We entered into a series of noncancelable capital lease agreements for office
equipment bearing interest at various rates. Assets under capital lease at
December 31, 2012 totaled $110,000 with accumulated amortization of $64,000.
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 $430,000. The agreement requires a 150-day notice to terminate. At
December 31, 2012, 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 December 31, 2012, future minimum annual payments under these third
party network service contracts were $629,000 in 2013, $2,155,000 in 2014,
$1,579,000 in 2015 and $52,000 in 2016.
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