8x8, Inc. — Fiscal 2014 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended December 31, 2013; the company’s fiscal year ends March 31. Unaudited results. 8x8 sells cloud-based communications and collaboration services, principally by subscription, and reported approximately 36,800 business customers.
Financial performance
| Metric | Quarter ended Dec. 31, 2013 | Prior-year quarter | Nine months ended Dec. 31, 2013 | Prior-year nine months |
|---|---|---|---|---|
| Revenue | $32.7 million | $26.4 million | $92.8 million | $76.0 million |
| Service revenue | $29.7 million | $24.0 million | $84.1 million | $69.3 million |
| Product revenue | $3.0 million | $2.4 million | $8.7 million | $6.7 million |
| Operating income (loss) | $(1.8) million | $2.5 million | $3.4 million | $19.3 million |
| Net income | $0.1 million | $1.9 million | $4.5 million | $12.3 million |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $11.6 million | $26.0 million |
- Quarterly revenue grew 24% year over year; nine-month revenue grew 22%. Management attributed service growth mainly to customer-base expansion and higher average monthly service revenue per customer.
- Reported overall gross margin was 71% for the quarter, compared with 69% a year earlier. Service margin was 81%; product margin was negative 34%, reflecting product costs exceeding product revenue.
- Quarterly operating expenses rose to $34.5 million from $23.9 million. Higher sales and marketing, research and development, and general and administrative spending outweighed revenue growth.
- Cash, cash equivalents and short-term investments totaled approximately $174.0 million at December 31, 2013. Cash and cash equivalents alone were $172.1 million. Total liabilities were $21.2 million; the balance sheet reports no conventional debt balance.
- For the nine months, investing activities used $18.1 million, including $18.5 million for the Voicenet acquisition, net of acquired cash. Financing activities provided $128.4 million, principally from the November stock offering.
Material changes and notable items
- In November 2013, 8x8 sold 14.375 million common shares, receiving approximately $125.8 million net of issuance costs. This materially increased cash and stockholders’ equity; shares outstanding were 87,874,850 as of January 24, 2014.
- 8x8 acquired UK cloud communications provider Voicenet on November 29 for $19.3 million, including $3.0 million held in escrow. Preliminary purchase accounting included $14.1 million of goodwill and $6.4 million of customer-relationship intangibles. Voicenet contributed approximately $0.8 million revenue and a $0.2 million net loss after acquisition through December 31.
- The dedicated server hosting business was sold on September 30 for $3.0 million cash and reported as discontinued operations. The nine-month results include $0.3 million income from discontinued operations and a $0.6 million after-tax disposal gain.
- Nine-month 2012 operating results included a $12.0 million patent-sale gain; there was no comparable gain in 2013. This is a major factor in the year-over-year decline in operating income and net income. Nine-month 2013 other income also included a $0.6 million Contactual escrow settlement gain.
- Quarterly general and administrative expense included approximately $1.1 million of stock-based compensation associated with the president’s October 2013 resignation. Total stock-based compensation was $5.2 million for the nine months, versus $1.8 million a year earlier.
Outlook, risks and contingencies
- No numeric revenue, earnings, or margin guidance is provided. Management said it planned to invest in research and development and sales and marketing at rates comparable to the third quarter for the foreseeable future.
- Management cited momentum in new services sold, mid-market and channel activity, sales of additional services to existing customers, and international expansion. New services sold increased 38% year over year in the quarter; customer average monthly service revenue was $274, versus $252 a year earlier.
- Expansion plans included migrating non-U.S. customers to overseas infrastructure, following the January 2014 installation of a Hong Kong data center, and planning a South America data center in fiscal 2015. The company also identified strategic alliances, partners and acquisitions as potential routes to international growth.
- Key stated risks include customer demand, retention and acquisition costs; service quality and competition; integration and realization of acquisition benefits; regulatory and tax matters; product and warranty issues; and dependence on Internet and broadband access. A January 2014 appeals-court ruling struck down key FCC network-neutrality restrictions; the company said it could not predict the outcome or business impact.
- Legal matters include Bear Creek patent litigation, which was stayed pending patent reexamination, and Klausner patent litigation. The company said it could not estimate potential liability in either matter. It also disclosed indemnification arrangements whose maximum exposure may not be contractually limited, and $2.2 million remaining under a third-party customer-support commitment.
- Management stated that available funds were sufficient for current and anticipated liquidity needs, while noting possible future capital needs and financing risk. The filing also cites currency exposure without hedging, though most sales and contract-manufacturer arrangements are in U.S. dollars. Disclosure controls were deemed effective at December 31, 2013.
Important facts for investors to verify
- Whether customer and service growth can translate into operating profitability as sales and marketing, R&D, and G&A spending rises.
- The sustainability of service margins and the economics of product sales, which remained loss-making on a gross-margin basis.
- Voicenet’s integration, performance, purchase accounting, and the eventual release of its $3.0 million escrow.
- The degree to which year-over-year earnings comparisons are affected by the prior-year patent gain and current-period tax and settlement items.
- Potential dilution from the public offering and equity compensation, plus the status and exposure of disclosed litigation and contractual commitments.