Business context and reporting period
8x8, Inc. develops cloud-based business communications services, including VoIP telephony, video, conferencing and unified communications, and also provides managed hosting and cloud computing. It reported approximately 30,500 business customers at September 30, 2012.
This Form 10-Q covers the quarter and six months ended September 30, 2012, the second quarter and first half of fiscal 2013 (fiscal year ending March 31, 2013). The interim financial statements are unaudited.
Financial performance and position
Amounts below are in millions of dollars except per-share data, percentages and customer metrics.
| Metric | Three months ended September 30, 2012 | Comparable 2011 period | Six months ended September 30, 2012 | Comparable 2011 period |
|---|---|---|---|---|
| Service revenue | $24.177 | $18.013 | $47.349 | $35.034 |
| Product revenue | $2.194 | $1.806 | $4.274 | $3.292 |
| Total revenue | $26.371 | $19.819 | $51.623 | $38.326 |
| Income from operations | $2.764 | $0.865 | $17.154 | $2.471 |
| Net income | $1.741 | $0.832 | $10.358 | $2.779 |
| Diluted earnings per share | $0.02 | $0.01 | $0.14 | $0.04 |
| Cash from operating activities | Not presented for the quarter | Not presented for the quarter | $19.363 | $3.242 |
- Quarterly revenue rose 33.1% year over year; service revenue rose 34.2%. Six-month revenue rose 34.7%.
- Quarterly gross margin was 68% (service margin 76%; product margin negative 22%), versus 66% overall in the year-ago quarter. Product costs exceeded product revenue.
- Quarterly operating margin was approximately 10.5% and net margin approximately 6.6%. Six-month operating income included an $11.965 million gain on patent sale, recorded as a reduction of operating expenses.
- Six-month income tax expense was $6.813 million, versus a $0.299 million tax benefit in the prior-year period. The company attributed the current-period provision principally to income including the patent-sale gain.
- At September 30, cash and cash equivalents were $38.108 million and short-term investments were $2.009 million, totaling approximately $40.1 million. Current assets were $47.050 million and current liabilities $11.911 million. Total liabilities were $13.731 million; the filing does not report material borrowings.
- Six-month investing cash outflow was $4.730 million, principally property and equipment purchases. Financing cash inflow was $1.049 million. Cash increased $15.682 million over the six months.
Material changes versus comparable periods
- Service growth reflected expansion of the business-customer base and the company’s shift in marketing toward business customers; management said this strategy was expected to continue. Product revenue also increased, primarily from greater equipment sales to business customers.
- Operating costs increased alongside growth: quarterly cost of service revenue rose 43.5%, sales and marketing 21.3%, research and development 31.8%, and general and administrative expense 24.2%. Higher network-service costs and payroll were notable contributors.
- The patent sale generated $12.0 million in cash, net of transaction costs producing a reported gain just under $12.0 million. The agreement provides for a possible additional payment of up to $3.0 million depending on the purchaser’s future licensing agreements; 8x8 retained limited rights to use the patents.
- Business customer churn was 2.4% in the quarter versus 2.1% a year earlier. An affiliate cancellation involving 411 customers increased reported churn; excluding it, churn was 1.9%. Average monthly service revenue per business customer rose to $256 from $207.
- Cash from operations increased substantially year over year. Management cited the patent-sale proceeds, a $1.7 million landlord reimbursement for tenant improvements, and higher revenue as contributing factors.
Outlook, risks and contingencies
- Management expected service revenue to remain nearly all service revenue and said business-customer growth trends were expected to continue. The filing provides no revenue, earnings or cash-flow guidance.
- Management estimated a fiscal 2013 annual effective tax rate of approximately 40%, subject to quarterly fluctuations from discrete items.
- Risks identified include customer demand and retention, service reliability, pricing and competition, customer acquisition costs, regulation and compliance, product defects and warranty claims, technology innovation, product supply, working-capital needs, intellectual-property claims, and maintaining Nasdaq listing.
- In the Bear Creek patent litigation, the court denied several defendants’ motions to dismiss; 8x8 answered and asserted counterclaims and defenses. The company said it intended to defend the case vigorously but could not estimate potential liability or expense.
- In the Klausner Technologies litigation, a motion to dismiss and a motion to change venue were pending; the company had not answered the amended complaint and said it could not estimate potential liability or expense.
- Commitments included a remaining $2.2 million obligation under a third-party customer-support contract and $1.186 million of future minimum payments under network-service contracts. The new headquarters lease runs through October 2019 and includes rent escalations; $1.8 million of deferred rent was classified as non-current at quarter-end.
- Management reported disclosure controls were effective as of September 30, 2012, with no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Separate recurring operating performance from the one-time patent-sale gain and assess the related tax impact on six-month earnings and cash flow.
- Track business-customer additions, cancellations and churn, particularly the effect of large-customer or affiliate losses, and verify whether higher average revenue per customer persists.
- Monitor service margins and network costs, along with product economics, since product revenue remained below product cost.
- Review the outcome and potential exposure from the Bear Creek and Klausner matters; the filing gives no clear estimate of potential liability.
- Assess cash generation against headquarters investment, lease and vendor commitments, and verify whether the possible additional patent-sale payment is realized.