8x8, Inc. (EGHT) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the 8x8 Inc. Q3 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Joan Citelli, Director of Investor Relations. Please go ahead.

Thank you, Charlotte, and welcome everyone to our call. Today, I am joined by 8x8's Chief Executive Officer, Vik Verma; and our Chief Financial Officer, Mary Ellen Genovese, to discuss 8x8's third fiscal quarter of 2017 financial results for the period ended December 31, 2016. The earnings press release which was issued today after market close is available on the Investor section of 8x8's website at www.8x8.com. Following our comments, there will be an opportunity for questions. Before I turn the call over to Vik, 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. Expressions of future goals including financial guidance and similar expressions using the terminology; may, will, believe, expect, plans, anticipates, predicts, forecasts, and expressions which reflect something other than historical fact are intended to identify forward-looking statements. These forward-looking statements involve a number of risks and uncertainties including factors discussed in the Risk Factors sections of our annual report on Form 10-K and our quarterly reports on Form 10-Q and in our other SEC filings and Company releases. Our actual results may differ materially from any forward-looking statements due to such risks and uncertainties. The Company undertakes no obligation to revise or update any forward-looking statements in order to reflect events or circumstances that may arise after this conference call, except as required by law. I would also like to note that during this call, we will provide financial information that has not been prepared in accordance with Generally Accepted Accounting Principles, in addition to our GAAP results. Management uses these non-GAAP financial measures internally in analyzing our financial results and believes they are useful to investors as a supplement to GAAP measures in evaluating the company's ongoing operational performance. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures. This reconciliation has been provided on the financial statement tables included in our earnings press release. And with that, I'll turn the call over to Vik Verma, Chief Executive Officer of 8x8.

Thank you, Joan, and thank you everyone for joining us today. Our financial results for the third quarter of fiscal 2017 were strong with a 23% increase in service revenue to $60.1 million and a 20% increase in total revenue to $63.7 million. Adjusting for constant currency and the previously reported discontinued segment of our U.K. operations, service revenue grew 28% and total revenue grew 24%. Non-GAAP net income was $5.8 million or 9% of revenue. This is the 27th consecutive quarter that 8x8 has been profitable on a non-GAAP net income basis. Along with this solid top and bottom-line results, we made very good progress during the quarter executing on the strategic initiatives we've outlined for continued growth. These include, one, increasing adoption by midmarket and enterprise customers. Two, building an effective worldwide channel organization, three, enriching our product portfolio with new features and services, and four, enhancing our global systems to support our multinational customers and partners. First, looking at our progress moving up market, I'm pleased to report that during the third quarter of fiscal 2017 service revenue from midmarket and enterprise customers grew 36% year-over-year and now represent 55% of total service revenue. We're now seeing a steady flow of midmarket customers adopting cloud communications solutions similar to what we saw in the SMB segment a few years ago, and enterprises are steadily beginning to come on board. 60% of the new monthly recurring revenue booked during this quarter came from midmarket and enterprise customers and our channel sales team. Our differentiated suite of integrated unified communication context center and analytic services combined with our superior deployment capabilities and reliable high-quality global network are the reasons cited most often by larger customers who choose 8x8 over competitive vendors. Of our top 20 customers, 15 subscribe to both our unified communications and contact center solutions and 19 utilize our analytics capabilities to improve productivity and gain insight from the day-to-day communications activity. Also we're now seeing the enterprise market moving beyond early adopters to more mainstream customers. These customers tend to use the same traditional procurement method that drive other corporate buying decisions and are increasingly employing a land and expand deployment strategy initially committing to a subset of their organization and subsequently adding new locations and users. For example, this quarter we added to our enterprise customer list a division of a large well-known Fortune 50 company that is a good illustration of this land and expand strategy. Brought in by our direct sales team, this high profile healthcare company selected 8x8 as its vendor to transition over 400 offices of the various client medical practices it manages onto a single cloud-based communications system. Our selection followed an extensive 12 month RFP process involving more than a dozen vendors and a rigid proof-of-concept testing culminating in a master service agreement with this customer. Under the agreement 8x8 will provide Virtual Office and Virtual Contact Center services to an initial set of designated locations and we anticipate that the remaining locations will follow. 8x8 successfully went live at the first set of medical practices earlier this month and we're currently finalizing plans to deploy a large practice with 12 locations consisting of 750 Virtual Office extensions and 60 Virtual Contact Center seats in the coming month. By becoming the chosen cloud vendor for this division, we were granted access to a captive market of over 400 medical practices and approximately 10,000 users. In addition, the division with which we contracted is one of many divisions that make autonomous buying decisions but who tend to give way to the buying decisions and previous vetting of vendors by other peer divisions. We now have a proverbial foot in the door of what is essentially a new channel with a partner whom we expect to be a zealous advocate within the larger organization provided we execute to our abilities. The time and resources we invested to become the chosen vendor of one division was substantial and the initial commitment was low but the opportunity is large up to 9 million in contract value for this division alone. By comparison many of our previous early adopter enterprise customers placed an initial order for most or all of their locations resulting in large initial bookings but with gradual deployments generating revenue recognition over subsequent quarters. Although these recent enterprise customers have represented comparatively smaller initial bookings and numeric in this section effective was essentially flat this quarter, we expect them to deploy additional locations at a rate similar to other enterprise customers and do not anticipate an adverse long-term revenue impact. We also continue to add sizable midmarket accounts during the quarter including a leading manufacturer of turnkey sorting and packing solutions for the fresh produced industry with approximately 500 Virtual Office and Virtual Office analytic seats and a provider of products serving the food service and food packaging industry with nearly 600 Virtual Office seats across 12 locations. In addition to new logos being added by our sales team, we are seeing consistently strong expansion revenue each quarter with over 50% of new monthly recurring revenue coming from existing customers in the form of additional seats and services. Some examples of these expansion deals from the third quarter of fiscal 2017 include Regus with an additional 850 Virtual Office and Virtual Contact Center seats, NetSuite with over 500 Virtual Office seats, True Blue with over 400 new seats, Social Finance and Patterson Medical Products each with over 300 Virtual Office and Virtual Contact Center seats and a leading media company based in Los Angeles with over 1100 additional Virtual Office seats. Second, our channel continues to grow and perform well bringing us five of our top 10 deals in the third fiscal quarter. One of those deals is a rapidly growing enterprise retail customer that when fully deployed will encompass over 10,000 Virtual Office extension in 3500 locations across 49 United States. This customer selected 8x8 because of our excellent reputation in the retail space, experienced deploying large customers in an efficient and timely manner, deep analytics capability and ability to provide service internationally as they expand outside of the United States. The channel also brought us a combined Virtual Office and Virtual Contact Center customer, a cemetery and mortuary business with 700 plus seat deployment. This customer chose 8x8 following a successful proof-of-concept trial deployment that demonstrated how 8x8's integrated offering would streamline communications and customer engagements across all of their locations. Another combined Virtual Office and Virtual Contact Center customer that came through the channel is a leading manufacturer and e-commerce retailer of point-of-sale displays. Our single unified communications and contact center platform along with the customers need to be up and running with all users in less than 45 days with two of the reasons they selected 8x8 for this 200 seat deployment. This customer is using mobile and soft phone only demonstrating the growing trend we're seeing away from physical desk phones. We announced several new channel partners during the quarter along with our new PartnerConnect Global portal enhance sales and technical training and expanded channel enablement offerings including marketing and demand generation support. 8x8's Global Channel team has doubled over the past year with employees now in North America, Europe and Australia. Third, on the product innovation front, our recent investments in the contact center capabilities of our platform including global tenants, analytics and quality management are beginning to show good results. Revenue from Virtual Contact Center grew 32% in the third quarter of fiscal 2017 compared with 16% growth in the same period last year. A Q3 deployment of our Virtual Contact Center solution for the International Red Cross by our U.K. office is a good example of how customers are able to easily deploy and utilize our powerful customer engagement solution. Completed in less than one week, this 70 seat deployment supported the Red Cross as serious request family of annual multi-day multimedia fundraising events which recently focus on raising awareness of pneumonia due in part to the swift trouble free implementation of our solution and accompanying reliability that campaign successfully raised nearly €9 million for these costs. Our patent portfolio continues to grow with our recent notification up three new patents for total of 120 awarded patents to date. In addition, we're continuing to expand our resources in Romania to supplement our existing R&D and engineering operations with DevOps, Knock and customer support professionals. We now have nearly 100 full-time employees working out of our Romania office and over 1,000 employees worldwide. With the expanded capacity we have a rich pipeline of new products and enhancements that we will start launching this coming quarter including open platform capabilities, new mobile and desktop apps and more out-of-the-box integration and real-time analytics. Fourth, we made significant progress during the quarter expanding our global capabilities including ongoing investment in our back office infrastructure. We have completed the transition of our global sales team to a single sales cloud environment and we're in the process of implementing a major refresh of our ERP system to unify financial operations across all of our regions. Additionally, we have completed the second of three phases to rollout service cloud across our global support team to enable seamless 24x7 support capabilities to our midmarket and enterprise customers. With these infrastructure projects, we're rapidly preparing our business for the next stage of global growth. Finally I'm excited to announce the completion of a small technology acquisition earlier this month that will bring us some really innovative collaboration capabilities. We will be providing additional details about this technology and how it fits into our global communications platform and strategy in March, so stay tuned. With that, I'll now turn the call over to our CFO, Mary Ellen Genovese.

Thank you, Vik, and thank you all for joining us today. Let's begin with some highlights from our income statements. Total revenue for the third quarter of fiscal 2017 grew 20% to $63.7 million and service revenue grew 23% to $60.1 million. On a constant currency basis current total revenue increased 22% and service revenue increased 25% year-over-year. Further adjusting for the discontinuation of the non-core voice message broadcasting segment of our DXI operations which we announced last quarter, total revenue increased 24% and service revenue increased 28%. We anticipate the continued deprecation of the British Pound against the U.S. Dollar and with the discontinuation of the non-core segment of our U.K. business to have approximately a 350 basis point impact on our GAAP service revenue in our fourth fiscal quarter. On the product side, revenue declined year-over-year by 16%. As mentioned previously, we're seeing a trend whereby customers are shifting away from desk phones in favor of mobile and soft phone apps. This is good news for us and a trend we hope continues. Given the changes in customer adoption, we also anticipate product revenue in the fourth quarter to be comparable to this quarter. Service revenue from our midmarket and enterprise customers grew 36% year-over-year and it was 45% growth when adjusted for constant currencies and a discontinued segment of our U.K. business. 55% of our total service revenue is now coming from these larger customers compared with 50% in the same period a year ago. My comments going forward will be based on non-GAAP results unless otherwise noted and I remind you to refer to the tables included in today's earnings press release for a GAAP to non-GAAP reconciliation. Gross margin during the third fiscal quarter of 2017 was 78.5% compared with 74.8% in the same period last year. Service margin was 84.3% compared with 83% in the same period last year. The improvement in our margins this quarter is a reflection of several factors including the growth of professional services revenue which is increasingly becoming a standard component of contracts with larger customers. Net income for the third quarter of fiscal 2017 was $5.8 million representing 9% of revenue compared with $4.3 million or 8.1% of revenue in the year ago quarter. On a constant currency basis, net income benefited by approximately 50 basis points or approximately $300,000. As Vik mentioned this is 8x8's 27 consecutive quarter of profitability on a non-GAAP net income basis. Sales and marketing expenses in the quarter were $32.9 million or 52% of revenue compared with $25.3 million or 48% of revenue in the same year ago period. As previously indicated, this is one of the areas we have been increasing our investments to build out our channel presence and capture the growing market demand we are seeing. The increase in sales and marketing expenses during the quarter was primarily due to an increase in salary and channel commissions to support our growth in channel, also continued implementation of our new internal systems supporting our global sales and service organizations, and the build out of our global deployment team. Moving on to some of the key operating metrics for the quarter, average revenue per customer was $414 compared with $369 in the same period a year ago. Average revenue per midmarket and enterprise customer grew to $4,412 compared with $4,017 in the same year ago period. Growth monthly business service revenue churn on an organic basis was 1% compared with 1.2% in the same period last year. While the number has hovered around one half of a percent over the past few quarters, we generally see this tick up a bit in the third fiscal quarter due to a less usage over the holiday season. Bookings during the third fiscal quarter for mid-market and enterprise customers and by our channel sales team comprise 60% of the total new monthly recurring revenue sold. 61% on a constant currency basis compared with 58% in the year ago quarter. Adjusting for constant currencies and the discontinued DXI business segments, bookings from mid-market and enterprise customers and by channel sales teams grew 10% year-over-year. In addition as Vik mentioned, we are seeing some of our large customers use traditional procurement methods whereby they buy in tranches from a pre-negotiated master service agreement. We do not anticipate this buying methodology to have an impact on long-term revenue growth. Expansion revenue from existing customers comprised over 50% of the total new monthly recurring revenue booked during the quarter. This remains strong quarter-after-quarter and as a solid testament of the value our solutions deliver and the flexibility our cloud based technology enables to support customer expansion and growth. Cash, cash equivalents and investments were $173 million at December 31, 2016 compared with $155 million in the same period last year. Cash flow from operating activities was $8.8 million in the third fiscal quarter compared with $8.3 million in the same period last year. Capital expenditures were $2.8 million representing 4% of revenue compared with $1.7 million or 3% of revenue one year ago. We are maintaining our annual guidance for fiscal 2017 of revenue in the range of $251 million to $254 million and raising non-GAAP net income guidance to a range of $18 million to $20 million representing non-GAAP net income as a percent of revenue of 7% to 8% from previously issued non-GAAP net income guidance in the range of $16 million to $20 million. As a reminder, last quarter we increased our fiscal 2017 annual revenue guidance from a range of $249 million to $253 million. Despite headwinds of approximately $4.4 million from the discontinuation of the DXI voice messaging service and the continued decline of the British Pound. That concludes my prepared remarks and I will now turn the call over to Vik.

Thank you, Mary Ellen. There is no question that cloud communications adoption by the mid-market and enterprise market segments is upon us. From food producers to health care corporations to mortuaries and 8x8 is favorably positioned to capture more than our fair share of this emerging demand. What's even more exciting is the strategic value these companies are already placing on their communications as a critical component of business productivity, planning and growth. We have recognized this trend several years ago when we began developing analytics tools for customers from our Big Data environment. Now we are committed to taking this value proposition further through what we would believe will be an unprecedented move forward for the cloud communication industry. Stay tuned for more on this in March at Enterprise Connect. With that, we will be happy to take on any questions you may have for us today. Operator, please open the line for any questions.

[Operator Instructions] Our first question comes from the line of Nandan Amladi from Deutsche Bank. Your line is now open.

Hi, good afternoon. Thanks for taking my question. So Vik, as you expand your sales channels overseas can you highlight some of the similarities and differences on how the channel works here in North America versus in other countries?

Slightly different. The North American channel unit to a large degree is more like a referral network where increasingly what we're seeing with the international channels because they are much more value added resellers. They tend to pick one or two vendors, typically one, and then they build a practice around them. That's actually a much better approach because than you don't mind investing significantly and basically making that channel effective. And that's the decision we intend to make on different locations. I want to make sure I have people there that can enable the channel, provide them the support, help to train them but to a large degree I don't need to have that many employees at different parts of the world because I can leverage the channel because they essentially either exclusively or semi-exclusively selling us. So that's been one of the key areas that we see as an area of growth in a way to get leverage and yet maintain our headcount relatively steady.

And how does that impact your sales and marketing spend on a - per unit basis if I could frame it like that?

So we plan for this. I mean that was always our strategy. Over time I think we're starting to get critical mass on sales and marketing, we will start to see more leverage out of the sales and marketing spend over time. I do want to make sure we increase our brand recognition because I think we've now got the entire and comprehensive product portfolio. I've been somewhat reticent to go out and really do a massive branding campaign or anything else like that. I may start to tweak that up but as a as a percentage of revenue growth I assume the sales and marketing going forward will be consistent with or maybe even slightly lower than revenue growth going forward engineering I'll continue to invest that. From my perspective through a combination of luck and hard work, the team has assembled three very core technologies all under one roof. You got the essentially collaboration site technology, we've got the contact center technology and we've got the whole Virtual Office technology and they are all on a common platform and we’re restarting to expose the APIs to a complete refresh on our UI, make sure we head towards much more for micro services architectures. So I feel like that is a huge strategic weapon and will continue to invest in engineering faster than the rate of revenue but sales and marketing will either stay at the rate of revenue or start to decline in terms of investment as compared to revenue growth.

Thank you.

Thank you. Our next question comes from the line of George Sutton from Craig-Hallum. Your line is now open.

Thank you. Vik I realize now how to make you giggle right, you had mentioned cemeteries and mortuaries…

That was hard to read.

So I wanted to take what you just said relative to getting the critical mass on sales and marketing a little bit further and speak more competitively. You have been trying to build up your direct sales force more recently to try to get after more of the opportunities. Do you feel like you're getting the point we're seeing the vast majority of the opportunities and then once you are seeing those, can you just give us a sense of what you're seeing in a win rate?

No, actually we’re not. So that is one of the areas I think I can't make a comment. We are seeing a reasonable share of opportunities but we are not a household brand. We're fundamentally - I would take our technology and put it up against anybody and I would say we're awesome and the fact that we have it all integrated together makes us truly differentiated. We do need to get better as a company in getting our brand out there. And what's been going on with us is, I think we built up a very strong enterprise sales team and we are seeing - I think as you saw we talked about this whole concept of whales, our goal was to go get a couple of whale then next thing you know, 10, 12 whales all jumped on the boat. So from that perspective we do need a rigor boat make. But we're starting to now put much more of a replicable machine together because we’re starting to feel like we understand which of the larger customers have a much predictable buying pattern and buying behavior and what we’re trying to do is sub-segment that market and then create much more efficient teams. So that’s a work in progress and I think we’ll be putting much more effort into creating the level of replicability because we've had such a vast number of the customers from different parts of the industry that we can start to come up with a sense of which once go through, what type of buying behavior, how do they buy, when did they buy, and which ones are the ones at the right for basically quick wins because they all self reference each other. And so we're going to that next stage of evolution as a company.

So you mentioned household brand name and I guess it depends on the household but Avaya is pretty well-known brand name out there obviously just fell for bankruptcy. I wanted if you could just address any potential opportunities you see for 8x8 through that situation.

If I had a [Cessna] [ph] that I could get, I was going to put a little sign on it that says, 8x8 welcomes any potential Avaya customers and/or channel partners to fly around Avaya headquarters. I see that as a logical evolution, I mean you never wish anybody else but Avaya was traditional enterprise - I mean on premise and cloud is disrupting. I mean to use your phraseology, I was actually also startled by some of the type of customers that you start to see now that are adopting cloud and just the way they adopt cloud. So if you think about it, you got the entire circle of life from food producers to healthcare providers to mortuary services you got them all covered and so they're all starting to move towards cloud and I think that's going to accelerate. And also think about how much flexibility a system like ours gets to large company. If you're adopting an Avaya system, a large on-premise type system for a global enterprise, you have to buy the whole shebang or nothing works. In our case, you could literally start with two, three, four offices, once you negotiate the right service agreement and then keep adding rapidly over time. That flexibility then makes it that much more easy for enterprises to start moving. So, I think that trend is coming. I think we have to evolve towards the fact that we are now starting to see the next wave of enterprise. These are not the techie-gig type companies that really are comfortable with cloud, they view cloud as a business value and a way to move in this direction but they are not necessarily that tech savvy, so you have to build your support and as well as your overall sales team to provide some level of education and then make it almost simple for them to use. And that as I said is the next level of maturation that is happening for us as a company.

Thank you.

Thank you. Our next question comes from the line of Rich Valera from Needham & Company. Your line is now open.

Sorry, thank you. I was on mute. Wanted to just follow up on a question regarding the growth of your mid-market MRR, Mary Ellen. You had mentioned that purchases from a master service agreement had caused that to slow relative to historical rates. I was wondering if you just clarify that and talk about how you see that growth rate trending in the future?

Good question Rich. So this quarter as you know we booked a very, very large deal of Fortune 50 deal that we're really honored, very honored to win. We're up against a number of competitors and it was a one year process with the POC that ends up in a very long negotiated master service agreement. And so as part of that, there were a couple of offices that they book this quarter. If you go back a quarter, you go back to let's say our third fiscal quarter of 2016 or even the fourth fiscal quarter of 2016, we had large whales that booked their entire enterprise, right so they booked their entire enterprise big deals for all game stuff, the 4000 stores within the United States was booked all at once. Movement Mortgage 6,000 employees booked all at once. Auto Europe, they were the first to visit contact center then when they realized that the cloud savings would also help them pay for their Virtual Office, they wanted both at the same time. And so you deploy those over a period of anywhere from - depending on the customer anywhere from six months to 12 months to 18 months. We have a big booking upfront but then you deploy the revenue over six, nine or maybe even as far out as 18 months. But in this particular case its different. You get a small number of dollars booked upfront but then you deploy the same way, right they start to - they've already started to release purchase orders, we've already started to deploy these offices and so it will be the same we think over the six, nine or 12 months or 18 months we will get the same amount of revenue regardless of whether we booked the 100% of it upfront or whether we just get the small piece first and then continue to expand. And it may be too early we have a number of customers that have done this may be its too early to call it trend but I wouldn’t – I think moving forward we’re going to see more and more of our enterprise customers more of these traditional enterprise customers book in that regard.

Got it, but your experience so far makes you think that the cadence of new customer addition under that agreement is likely to be similar to those customers that have historically booked the whole thing upfront?

Yes and I think we're seeing that I mean it is quite interesting because where previously as you indicated the early adopters tend to go out and - a sense stretches out over 18 months. These guys will tend to spend a lot of time doing a proof-of-concept and making you either an exclusive or preferred vendor with a well-defined master service agreement. And then that almost became like a catalog and then they start essentially adding addendum after addendum to the catalog and then they expect the deployment to happen in 30 days or 60 days. Very quick deployment okay here is the contract deploy this office 30 days from now it’s done next versus coming up with a large program plan for deployment over 18 month period.

Got it, that makes sense. And then just following up on the theme of investments and it sound like both R&D and sales are clearly focus this year but when you look at your annual guidance for net income it would appear that the fourth quarter you would be down versus the average for the first three which seems that they’re challenging if they’re assuming the revenue goes up. But I’m wondering if you just put a little color around that sort of what, what are some of the incremental investments in the fourth quarter that gets you that pretty significant bump in OpEx that appears to be baked into your guidance? Thanks

Okay. Well thanks - our fourth fiscal quarter typically is a larger investment quarter from the others for two maintenance factors one is you start the security clock all over again right so all of our employees are paying a higher fringe benefit. Second is that we have a fairly big show and enterprise connect at the end of March which is big show for us just a biggest show of the year and this year we expect to have a major launch of our new products. So those are two key things. But in addition to that we want to also prepare for our fiscal 2018 kickoff in April. So we’re hiring the team that going to be needed and required to meet our numbers for fiscal 2018 we want to them to be up to speed and onboard ramp and we enable to kickoff the New Year in a great way. So - all those investments that we’re kick starting for the New Year.

And as I said what Mary Ellen kind of alluded to, we acquired a company in the collaborative space which we think is really innovative. We've also got a major – we’re using enterprise connect as a way to completely refresh our UI for all of our core products because that was one of the areas we put emphasis on. We’ll be introducing several new products into the U.S. market that we've been getting ready to launch the idea is just kind of. We think we've kind of built that critical mass across the board we kind of gone through a series of learning and we want to use that as an opportunity to really go out and show the breadth of products that we have that are all now going to be integrated together with the next generation of UI. So yes so, if you are at enterprise connect we welcome you do join us. I think you won't be disappointed.

Thank you. Our next question comes from the line Amir Rozwadowski from Barclays. Your line is now open.

Good afternoon this Matt for Amir. Just a quick question on the midmarket and enterprise customers that have obviously that has grown from 40% a few years ago to 55% today. Do you have target mix in mind that you would like to hit over next two to three years?

And the number I am looking for is ultimately our future is enterprise. We still have, we will continue to service our SMB customers. We love that we think we can provide significant value for them and remember we’re cloud vendor so anything we develop for the enterprise customers is basically provided to our SMB customers for that same low price. So from that perspective but over time I’d like to see 70%, 80% of our revenue base coming from midmarket and enterprise because the main thing. And I'm becoming a big fan of this because of the fact that we have such a comprehensive product portfolio, there is an unprecedented opportunity for land and expand. So you - once you go in and you build up credibility with the customer by providing them the core communication platform the ability to add contact center becomes very, very, very significant. And then you can add our virtual meeting product which essentially gives you essentially a WebEx equivalent I mean a much lower end of that, but basically gives you that type of functionality. And so in - and then you can add your quality monitoring which gives you speech analytics as well as the ability to do agent training. It allows us to do some of our sales analytics tool so that midmarket and enterprise customers do that. And that's why you start to see land and expand become a bigger and bigger piece. Second, as I said from a contact center perspective we’re typically going to a customer with our virtual office and then we bring in our virtual contact center, but that’s an area we’ve been putting a major amount of push into and as matter of fact I'm going to keep accelerating the push into our virtual contact center because that's a hidden gem. I think you saw this time where the growth rate for virtual contact center has gone from 16% a year ago to 32% this year. And I think that thing is going to keep moving up and then we've got our product in the U.K. which is a very low end contact center which is intended for nontraditional contact centers which will be introducing into the U.S. market in the March timeframe. So that that whole concept of land and expand is increasingly more important to us and that is tailor-made for midmarket and enterprise customers so long-term couple of years from I love for that mix to be 70-ish percent of midmarket enterprise 20-ish 20%, 30% as SMB customers.

And then - just a quick modeling question I know Mary Ellen you had said that the pound is going to be three you’re expecting a 350 basis points of headwind in 4Q. Can you just help us reconcile how that compares to I believe it was 4.4 million you gave us last quarter for the full-year impact.

Right the 4.4 million was a full-year impact so the 350 basis points was only Q4 right. So if you look for instance as an example if you look at this fiscal quarter Q3 23% was our revenue growth on a GAAP basis. But then when you corrected for constant currencies and you corrected for the discontinuation of that one business segment non-core business segment in the U.K. we’re at 28%. So on apples-to-apples basis we would have had 28% growth right so that’s about 500 basis points. Next quarter we don’t expect it to be as significant it will be approximately 350 basis points difference.

Thank you for taking my questions.

Thank you. Our next question comes from the line of Dmitry Netis from William Blair. Your line is now open.

Thanks guys. So just to kind on that last question you addressed. So 500 basis points this quarter 200 of that was that FX and 300 was discontinued operations is that correct?

No, that’s actually not correct.

Okay. Can you can you tell us exactly how that 500 split this quarter?

I mean let me begin so on a wait a minute hold on. So it was a - I am sorry it was 23% you’re right 23% on a GAAP basis 25% on constant currency basis and a 28%. So that is a 300 basis points difference just on the – just on the discontinued basis and at 200 basis points for the constant currency.

Dmitry was correct.

You were correct sorry.

And then 350 next quarter how much is the FX versus discontinued operations?

That’s good question I didn’t actually do it that way but – you could do the same percentage cut if you will. Yes so.

Okay, all right.

Yes.

That makes sense okay and then the midmarket and service revenue growth of 36, if you just for constant currency and exclude FX what would that number look like I think you might have mentioned it but I might have missed it?

I’m sorry what your question is that, is that for the midmarket revenue growth

Yes, it grows 36 but what would be on a constant currency?

45.

45, last quarter it was 40% is that right?

Last quarter it was 40%.

Okay excellent. And I guess I wanted to also see the, the virtual contact centers spectacular growth it’s almost double from a year ago you grew I think 32% year-over-year. I just want to understand is it as a result of competitive environment easing or maybe additional product capability you added it is all those things. So I'd love to see kind of your thoughts on that growth being sustainable going forward and maybe the line of business product sales force analytics, you can comment how that's doing in the market and whether that is going to add to growth or will retain that sort of run rate on VCC side of things.

Look our contact centers are gold mine. I mean in essence, it's an area that we neglected in the sense that, that had not been the push for the company because we had been getting such great growth from our overall core PBX and over the last couple of years I had come more and more to the conclusion that both Virtual Office and Virtual Contact Center belong together and kind of build on each other. And so over the last year, year and half we start to put some major investments into it, we are going through - we went through a period of this whole concept of a global tenant and follow this on we're doing a complete platform refresh by the way you have not lived until you go through and do a platform refresh and any remaining hair I had fell off but what it allows us to do we are doing this complete platform refresh, changing it, adding key features is more and more this product is starting to become a product that standalone can hold its own, it's not quite there but we are getting very close where what we have is we will end up with best of breed products. I would put our BL products against anybody and I would be very confident in what it is. VCC traditionally has been essentially one bubble of center but over time we have started to now make it much more of a focus and I actually think that that has huge growth and I am going to put more and more emphasis on it because the more I dig into VCC, the more I see huge opportunities for that to be not just a standalone product but an additive product with BL. And then we have a third leg to that which is our easy contact narrow contact now product for U.K. which is essentially a try by and deploy contact center. You literally download - not even download I'm sorry, your web, you log on and you are now starting to use your contact center and you can use it to do outbound dialing, you can do - take inbound calls and it's simple to use and it is completely seamless no training involve, no professional services. So for non-traditional contact center, we think it can be very disruptive. We want to introduce all three of these products together, so I expect contact center both VCC and ECN over time to be a very appreciable growth driver for us and we want to make sure that those get the kind of attention in energy and effort that they deserve because in the past we have underinvested in those.

Thank you. Our next question comes from the line of Will Power from R.W. Baird. Your line is now open.

Hi guys, thanks for taking my question. This is actually [Charlie] [ph] on for Will. I was wondering if you could tell us who specifically did you guys compete against for those two large customer wins this quarter and how competitive is that process and how do you ultimately think they ended up winning the contract. Thanks.

So I don't know specifically and the one was 12 vendors and I know one was a whole bunch of vendors, I'm not sure we can tell you who, by I think we all signed an NDA with the customer on terms of the process. What I can tell you and this tells you what is our strength and what is our weakness. We always get brought into every deal like, I figured that part out, and we've just learned to live with the fact that nobody knows our brand as well as they should and our intent is to start to change that so, every deal we have is completed. More often than not the more complex the deal, global Virtual Office, Virtual Contact Center, so the more complex the deal, more demanding the requirement uptime reliability and stuff like that is very critical. We went - if it is pure cosmetics or it’s a simple application and UI is the key driver that's not necessarily our strength. It will become our strength as I said we’re going through a complete refresh but we believe we can kind of compete on all levels but because I think we capture the high ground which is our ability to compete for very complex deals where reliability, integration and the comprehension on the solution is key, we win on this. Right, now I want to make sure UI is world-class and want to say UI is world class and I you said you'll start to see that on the March timeframe. I think we will be tough to beat but then the other part we got to do is more and more we got to start making our brand known and I think with the wins we have had, with the kind of prominence we have had, with the kind of complete comprehension of the portfolio that we have assembled, and the gaps that we had, that we have subsequently filled collaboration being one of them I think we have an opportunity to really be a one-stop shop and so I think we’ll start to really raise our brand, starting in the March timeframe.

Make sense. Thanks.

Thank you. Our next question comes from the line of Mike Latimore from Northland Capital Markets. Your line is now open.

Hi, great thanks a lot. Just on the ARPU, I think it grew about $5 in the quarter it has been growing $10 or so. I guess any influence from the discontinued ops or generally how do you see ARPU trending overtime here?

If you look at the midmarket ARPU it's trending right in the same direction as it has in the past, I mean it is a little lumpy from a percentage perspective this quarter was 10%, last quarter was 7% the quarter before that was 10% - quarter before that was 7%, right, so within that 7% to 10% marketing to be pretty consistent. On the total ARPU it was little bit lower, it's 12% this time and 14% last quarter, 13% a quarter before that. So I think in the ballpark I would say 12% seems to be the low over the last couple of quarters, so maybe 11% to 13% moving forward.

Okay, great Thanks. And then professional services you mentioned I guess and can you give a general sense of what percent of revenue professional services is today what it was maybe year ago?

Yes, that's something that we started this year actually more actively pursuing especially for a larger accounts, professional services contract to do the appointment. And we don’t really get any push - we get push back of course on the smaller customers, but on the larger customers who are used to paying for the deployment. So this particular quarter was slightly more than 1% of revenue, so it's still small, slightly above 1% of revenue. About a year ago it was maybe a 0.5% of revenue.

Okay, thanks.

Thank you. Our next question comes from the line of Mike Crawford from B. Riley & Company. Your line is now open.

To only hit the high end of your guidance for Q4. Looks like OpEx we need to grow about $4 million to $5 million for the pro forma $43 million in Q3, so would you be able to provide just a little bit more color and how much of that might be from the technology acquisition or how much of that is enterprise connect, and how much of that would carry through into next year? Thank you.

Yes, little bit will be from the technology acquisition not a significant amount. We did hire a very capable team, but I think very much like our Quality Rocket acquisition that we did a little bit more than a year and half ago it's coming out with a team of maybe seven or eight individuals pre-revenue but the core some phenomenal technology that we have been able to bring to market very quickly. So that's a same situation here. In addition, we are ramping up our R&D as Vik had said we were down year-over-year from 10.4% on a non-GAAP basis to 9.5%. We really want to pull that up from a non-GAAP perspective, we won't be able to do it over night of course, but we are building a very solid team in our Romanian operations and we are able to get some of the best university students, as well as some folks who have 10 to 15 years of experience that can lead the agile team to scrum team here. So, we will be making investments and we will be preparing again as I had said, getting ready for our new fiscal year in fiscal 2018. So, we will be hiring additional direct sales people and our enterprise team, as well as our midmarket team. And we'll continue to ramp up on the channel because that's where we are seeing the traction - we’re seeing traction on both sides but we're seeing some very, very nice traction on the channel. So we continue to search for general account managers, so you are going to see increases across the board.

Thanks, Mary Ellen. And then the second question is while we fully expect the midmarket enterprise to continue to comprise a little bit more than half 60% this quarter of new book, you also saw booking substantial amounts in your small office, home office business and where would you say the market is relative to small-office, home-office and where it plays in that market?

I mean it's continuing to grow robustly. We will probably - it's important for us in the sense that to me as long as - it's got a great payback, it continues to grow and we'll continue to do whatever is necessary to make sure we get our fair share. So it's not an area we're going to at all neglect, I like the business and I have integrated team who got fully ramped up reps, I got good leadership there, and we're going to actually bringing in some more help for them. And actually even in that area we're going to simplify. We are heading towards much more package solutions which will basically accelerate velocity, because we're starting to see that people are able to buy without the kind of consultative sales process. So from that perspective I actually think there is nontrivial headroom even in our SMB business. So the intent is I want the SMB business to grow, I just want midmarket and enterprise to grow faster.

Right. And one thing to remember Michael, is we’re not necessarily going after the home office the 1 to 2 line customers, we have very small businesses of less than 10 lines, we're moving that team up as well because they payback for that size, 10 plus lines so they focus on the 10 plus lines up to 100 lines and that's much better than the 1 to 10 line business which for us is a – it's a little payback.

Okay, great. Thank you.

Thank you. Our next question comes from the line of Jonathan Kees from Summit Redstone. Your line is now open.

Great, thanks for taking my questions. I just wanted to ask about the CapEx that picked up for the quarter. You are now just expanding those data centers, I know you guys increased the data centers from 9 to 12 are you expanding on them or that's the reason why CapEx tick-up last year.

No, actually this year is a pretty consistent where we’ve been investing in next-generation capabilities and upgrading our technology in each one of our data centers, as well as now we’re bringing the context center now product that we purchased in the U.K., we're bringing that to the U.S., we're building a new data center with new technology for that product here in the U.S. to support that. We're upgrading our technology for all of our Virtual Contact Centers. So we have the 12 media centers that are up in running and I remember that's not huge investments because in that regard we will rent in racks from like something like a partner like an Equinox. So those are relatively inexpensive to do, we might play another one or two next year but right now it's more or less taking our technology in their contact centers to the next generation.

Okay, thanks for that clarification, that explanation there. My next question is at a higher level. There's been talk in the news in terms of 8x8 being acquired or the Board seeking a strategic alternatives. I guess I want to reconfirm that the Board does not seek strategic alternatives and then two, if you can humorous who could possibly be interested in 8x8. We like the hypothetical just humor us.

Look, here is the thing. I think you've seen our governance score as a company that I don’t remember the exactly the calculated but we are as shareholder friendly company. I have no blocking rights. I have no - nor do I see, we don't have multiple classes of shares, we don't have classification everything is - I think is blue ribbon from a governance perspective as possible. We will do what's right for the shareholders. So from time-to-time people express an interest that's fine. Everybody is entitled to express an interest, we have a view on what this company is worth and our view is that the larger the customer - when we can get our midmarket enterprise base, we’re very significant portion of our revenue, the value of the company because the net present value for midmarket and enterprise customers about 35 to 40 times that of SMB customer, that transition we think is well underway and we have - with all of these enterprise customers we have the land and expand opportunities. So, I think we believe we can get to a certain place on our own so, in order for somebody to make a compelling offer they have to kind of bake in that value for us to be fair to our shareholders but I have a general philosophy if anybody ever comes in and gives us an indication of interest or even kind of makes an overture, I always involve my Board because I believe that is my responsibility, I'm not trying to run this company like a [indiscernible]. So who's interested, you know look all kinds, I mean you can get - there is an alphabet soup of companies that one time or the other either express their interest or circled around adding that to me it really comes down to our - when somebody is willing to pay what I think the company is worth, that’s actually the board's discretion, will do the right thing for our shareholders. Ultimately we serve at a pleasure of shareholders and the goal is to ensure we maximize value for shareholders.

Thank you. Our next question comes from the line of Catharine Trebnick from Dougherty & Company. Your line is now open.

Hi, good afternoon. Thanks for taking my question. This is Jack on the line for Catherine. I just want to briefly hit on the international piece. Can you give us the percentage of news that came internationally and are you seeing any differences in penetration rates or purchasing behaviors international relevance to [meet] [ph] environment for you guys?

So for us their total international revenue is a little bit lower, we've been running about 12%, now it will be around 10% because of a drop in the British Pound but when you actually look at our businesses in the U.K., the solutions business that we have is growing well over 30% year-over-year in their current [indiscernible] your currency. So, we haven't seen any slowdown in the U.K. which is where most of our international revenue is. Certainly as we will continue to expand into Europe and that will be a bigger piece of our revenue come next year but for right now we’re not seeing any slowdown in the U.K. market.

And I guess on the second part of that question, are you seeing any difference in penetration rates or purchasing behaviors in the international market relative to the U.S. market for [indiscernible] just any clarity on that.

No, I think the best way to characterize in U.K., U.K. is about two years behind us in terms of adoption. And then I would say Western Europe is probably two to three years behind, Europe behind U.K. So - and Asia is essentially comparable to Western Europe. The inevitability of cloud is starting to become obvious all over. That's quite fascinating to see because it almost has become, as you said all mainstream businesses are starting to go down that direction. So we see - I think we positioned ourselves in U.K at the right time and I think we’re building a core capability that we got quite few people there, we've got couple of hundred people in the U.K between London and [Elsberry] [ph] and now we have 100 people in Romania. So we are as diversified and we've got few people on Australia and a few people on Canada. So we've diversified to take advantage of the trend but I’m increasingly of the view that even though vendor that can provide a comprehensive one platform type solution with Virtual Office, Virtual Contact Center, Virtual Meeting as well as, all of the collaboration capability, do that on a global basis with global support, global sales, as well as global deployment and do it with the highest uptime and reliability stands to take over Avaya's crown that they are in the process of CD. And I think that could be massive for us and so that's what we’re building the company towards, that's what we’re trying to be.

Got it. Thank you.

Thank you. I'm not showing any further questions at this time. And I would like to turn the call back over to Vik Verma for closing remarks.

Thank you all for listening into our call today. We look forward to meeting with you over the coming weeks and perhaps seeing you at Morgan Stanley Technology Media and Telco Conference in San Francisco and even more importantly at the 2017 Enterprise Connect Conference where we will unveil a broad set of new services and features. Again, thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.