8x8, Inc. (EGHT) Q4 2018 Earnings Report, Transcript and Summary

Good afternoon. My name is Chantal, and I will be your conference operator today. At this time, I would like to welcome everyone to the 8x8, Inc. Fourth Quarter and Full Year Fiscal 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Victoria Hyde-Dunn, Head of Investor Relations. Ma’am, begin your conference.

Thank you, operator. Good afternoon and welcome to 8x8’s fourth quarter and fiscal full-year 2018 earnings conference call. With me today are Vik Verma, Chief Executive Officer; and Mary Ellen Genovese, Chief Financial Officer. Our format today will include prepared remarks followed by Q&A. The earnings press release, presentation, and non-GAAP to GAAP reconciliations that accompany this call are available in the Investor Relations section of our website at 8x8.com. A replay of this call will be posted on our website for 30 days. 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. These statements are not guarantees of future performance, and our actual results could materially differ as a result of a variety of factors. Additional information concerning those risk factors is available in our most recent reports on Forms 10-K and 10-Q, which you can find on the SEC's website and the Investor Relations section of our website. With that, I’d now like to turn the call over to Vik.

Thank you, Victoria. Good afternoon and welcome everyone to our fourth quarter and full-year 2018 earnings conference call. Our fourth quarter revenue results were a strong finish to a great year. Total revenue for the fourth quarter grew 19% to $79.3 million and for the full-year 2018 revenue was $296.5 million for annual year-over-year growth of 17%. We grew service revenue in the fourth quarter by 20% to $75.3 million and 19% year-over-year for the full-year to $280.4 million. Revenue came in higher than we guided to during last quarter’s conference call. Before I provide details on the quarter and our fiscal year, let me comment on how we see the market evolving. IDC estimates that the combined global communications, collaboration, and contact center as a service market opportunity exceeds $40 billion, and yet we believe the total share of this market that has gone to cloud is less than 10% penetrated. We are also seeing customers increasingly looking for seamlessly integrated solutions that span these different segments. Customers want a single system of engagement from the cloud, what we have described as the third wave of enterprise communications. The end result of this shift is that over the next few years, tens of billions of dollars in global spend are up for grabs. We believe our strategy of owning the complete suite of technology required to deliver a single system of engagement is unique in our market, and we are aggressively investing in the sales capacity, innovation, and global reach required to accelerate growth at this critical market inflection point. We believe we are defining an emerging market category in which enterprises of all sizes will look to us for a single system of engagement and intelligence for all forms of communications in the cloud. Let me now proceed by highlighting some of our key accomplishments this past quarter and full year. Over the course of fiscal 2018 we expanded direct sales capacity and significantly increased the breadth of our channel programs. As one example, our sales teams closed 21 large enterprise deals defined as customers with monthly recurring revenue of $10,000 or greater during the quarter. For the full-year, the mid-market and enterprise sales teams closed 66 new large enterprise deals which represented a 22% increase in the number of new large deals closed year-over-year. One marquee win is a global education provider with over 1 million students and 60,000 faculty members. This customer is rapidly growing and the lack of data analytics and business intelligence from their on-premise provider became a major customer pain point. 8x8 won this deal after a very competitive RFP process that involved multiple cloud and on-premise providers. They ultimately choose 8x8 for our superior call quality, global footprint, and integrated solution. While their initial order is for more than 2,500 Virtual Office and analytics seats and 300 Virtual Contact Center seats, the great thing about this particular customer is that we believe we are only getting started. They have placed two additional orders since our fourth quarter closed and there is lots of room for additional expansion globally. Turning to the channel, in the fourth quarter, three of our top 10 U.S. deals were brought in by our channel partners. Channel bookings grew 28% in the quarter. In August, we launched a new Channel Enablement Program and have enrolled 82 partners to date. A recent win in which a key channel partner played an instrumental role is with a large children’s specialty apparel retailer who will move 3,000 seats to 8x8 following a competitive takeaway from an on-premise provider. The partner was instrumental in bringing 8x8 to the table, positioning our value proposition in the retail space, and ultimately recommending 8x8 to the end customer. Additionally, 8x8 was recognized with a five-star rating in CRN’s 2018 Partner Program Guide. Subsequent to the quarter end, we announced the hiring of our new SVP of Channels and Alliances, Bill Corbin who will be reporting directly to me. Bill arrives with decades of channel partner experience and has already had a meaningful impact with our referral and reseller communities in the brief period he has been onboard. After sales and channel capacity, our second investment focus was continuing to build the most comprehensive and integrated platform of solutions in the market, leading to the upcoming launch of our X Series solutions. Let me remind you of what X Series is. It is the seamless integration of our contact center, meeting, and video conferencing into a single suite. By combining our own technology into X Series, 8x8 is able to provide three core capabilities. First, dynamic mix and match communication capability targeted to the individual user in the enterprise; second, analytics that span all of these forms of communications; and third, a level of customer responsiveness and resolution that is not possible from solutions that depend on third-party platforms. The X Series, encompassing X1 through X8, isn’t just a suite, but is designed to be a single system of engagement for our customers. This may sound like a subtle distinction but ownership of our technology enables the critical path forward from a system of engagement to a system of intelligence. Applying analytics and machine learning to data that spans all forms of communication can provide completely new business insights. CIOs recognize the importance of a common platform and it is one of the reasons why we win more than our fair share in head to head competition. CIOs want a seamless experience across phone, contact center, conferencing, and collaboration on any device, your mobile phone, laptop, desktop, or tablet. We see this impact in the increasing number of deals where customers purchase our integrated communications and contact center solution, which we have referred to as combination deals. This growing propensity to buy our combined product is why we developed our X Series in the first place. During the fourth quarter, about 100 customer deals were combination deals, including 6 of our top 10 deals overall. In fact, for the full-year, more than 50% of new monthly recurring revenue booked from mid-market and enterprise came from customers who purchased combined solutions. Our third investment focus was expanding our global footprint. International markets, defined as markets outside of the US and Canada, represented 10% of total revenue in 2018. Our 8x8 solutions business in the UK saw exceptional growth, with a 35% year-over-year increase in fiscal 2018, excluding DXI revenue. We announced our expansion into France with Itancia in March, and we continued to build sales capacity in Australia. We also enhanced our global carrier network and have customers in 157 countries around the world. In summary, fiscal 2018 was a transformational year, as we invested in talent, technology, and infrastructure. These investments have allowed us to become a leading global provider in the mid-market and enterprise market as the transition to cloud accelerates among larger and larger customers. For instance, service revenue from customers billing greater than $10,000 in monthly recurring revenue grew approximately 44% year-over-year and now represents 28% of our total monthly recurring revenue excluding DXI revenue. Due to this rapid growth, we made a conscious decision in the fourth quarter to accelerate our business spend and hiring plan. We hired more talent across all levels of our organization in the fourth quarter than at any time in our history. And the quality of the talent that has joined the organization is awesome. This accelerated hiring, together with strategic marketing investments in brand awareness and demand generation, resulted in a non-GAAP pre-tax net income that was lower than our guidance. As you know, we manage the business for long term shareholder gain and will make decisions in the short term that we are convinced will achieve that goal in the medium to long term. Now, I would like to share our strategy for fiscal 2019 and beyond. There are three key elements which continue to underpin our strategy. First, as previously mentioned, we believe our overall market is inflecting and adopting cloud at an even more rapid pace than previously expected. Second, we are the only pure-cloud provider with our own core technology for phone, contact center, conferencing, and collaboration. Third and most critically, our vision of this industry differs from the vision that has been articulated by our peers. We see the industry ultimately standardizing on one seamless integrated solution which will provide all cloud communications in and out of a company. This is what we refer to as a system of engagement. The adoption of a unified system of engagement will not only maximize the cost savings and convenience associated with a transition to the cloud, but will also unlock another layer of critical business insights and analytics, what we call the system of intelligence. As I mentioned earlier, this strategy has culminated in our X Series suite of solutions, which we believe will be a game changer for 8x8. Consider how valuable the information that our X Series platform captures can be for an enterprise. Imagine the impact on time to resolution and customer satisfaction if a frontline agent could instantly have all the relevant recent phone calls, emails, and support interactions summarized and prioritized based on customer persona, or think about the efficiency that can be gained by analyzing the communication patterns within a business unit, including not just phone calls but also chat, email, and other modes of communication. And team collaboration is also part of this integrated suite. X Series integrates with over 30 team collaboration platforms, including Slack, Cisco Spark, and Atlassian Stride. As mentioned earlier, AI and machine learning are foundational elements to our X Series solutions. Our commitment to this vision has led to several notable recent investments and key hires, including our recently announced acquisition of MarianaIQ. We are excited about leveraging both their technology and their talent to deliver one System of Intelligence through our X Series solutions. This vision has also informed our fiscal 2019 plan. While we are proud of what we have accomplished in fiscal 2018, we have concluded that the market in which we are participating represents a once in a decade business and value creation opportunity. $40 billion markets that are 10% penetrated and in which we are uniquely positioned do not come along very often. In order to fully leverage this market opportunity, we are expanding investments in engineering, marketing, sales, deployment, and customer support. We are adopting this strategy in order to deliver the most comprehensive, integrated system of engagement and intelligence to the market. We believe strongly that this strategy and the investments we are making will drive long term value creation for our shareholders. While Mary Ellen will provide detailed guidance in her section, let me say that we view service revenue growth as our most important metric, and are targeting approximately 25% for exit service revenue growth in the fiscal fourth quarter of 2019, after adjusting for DXI revenue. Our goal is to drive market adoption of our X Series solution suite, in the process reshaping our market category and accelerating long-term revenue growth past 25%. Finally, our employees are our greatest assets. We have over 1,200 employees and expect to increase this headcount by approximately 30% in fiscal 2019. Our success is predicated on retaining, hiring, and leading the talented and passionate employees at 8x8. I am very proud of our dedicated employees around the world and thank them for their success in fiscal 2018 and look forward to an exciting fiscal 2019 and beyond. With that, I’ll turn the call over to Mary Ellen.

Thank you, Vik. I will provide a more detailed review of our fourth-quarter and full-year 2018 financial performance followed by the impact of ASC 606, and guidance for fiscal 2019. Our fourth quarter and fiscal full-year 2018 are under the historical 605 accounting standard. Guidance for fiscal 2019 will be under ASC 606. We are adopting 606 starting April 1, 2018 under the modified retrospective method and have provided a table on the impact from ASC 606 on our full fiscal year 2019 outlook, which is posted on the Investor Relations website. In addition, unless otherwise indicated, all measures that follow are non-GAAP with year-over-year comparisons. A reconciliation of GAAP to non-GAAP results was provided with our earnings press release. Fourth quarter was another strong performance for 8x8. Total revenue was $79.3 million, an increase of 19% year-over year. Service revenue of $75.3 million grew 20% year-over-year. Adjusted for constant currency, service revenue grew approximately 19%. In the fourth quarter, service revenue from mid-market and enterprise customers, defined as those billing greater than $1,000 in monthly recurring revenue, grew 29% over the prior year and now represents 60% of total service revenue compared to 56% in the year ago quarter. Turning to small business, defined as 10 to 99 seats, our growth has accelerated the past two quarters by over 300 basis points and we are now growing in line with the market at 15%. Product revenue was approximately 5% of total revenue in the fourth fiscal quarter. Gross margin for the quarter was 76.7%, compared with 79.1% in the same period last year. Service margin in the fourth fiscal quarter was 83.2%, compared with 84.5% in the prior year. As expected, service margins trended down by 130 basis points, primarily due to the increase of amortization of previously capitalized software as we release new products to market. Product margin in the fourth quarter was negative 45.0%, compared with negative 9.2% same period last year, primarily due to a one-time successful promotion across our small business customer segment to deplete excess inventory. Quarterly net loss was $2.9 million, a loss of $0.03 per share, or negative 3.7% of revenue. Areas of additional investment included the following. With our new sales and marketing leadership in place and seeing the results of our demand generation activities, we accelerated our planned hiring in both sales and marketing. We also accelerated hiring for our product management and engineering teams to advance the development of new innovative products. In addition, we invested in brand awareness, targeted demand generation campaigns, and advertising and trade shows to support the launch of our new X Series solutions. As Vik mentioned, these investments will position us to capture the increasing market opportunity. Moving on to operating expenses. Sales and marketing expenses, which also include customer service and deployment costs, were $49.3 million, or 62% of revenue in the fourth fiscal quarter, compared with $34.7 million, or 52% of revenue, in the same year ago period. The increase in spend is primarily attributable to accelerated hiring and demand generation activities. In addition, we observed an increase in commissions tied to strong performance from our channel partners. Research and development expenses were $8 million, or 10% of revenue, and increased 30% year-over-year. We significantly increased spend to support the development of the upcoming launch of X Series. Turning to annual results for fiscal 2018. 8x8 posted total revenue of $296.5 million, above our guidance range of $293 million to $294 million. This represents an increase of 17% year-over-year on both an adjusted and an unadjusted basis. Service revenue for fiscal 2018 was $280 million, an increase of 19% year over year and 19% on an adjusted basis and also above our guidance range of $278 million to $279 million. Service revenue from mid-market and enterprise customers represented 58% of total service revenue and grew 29% over the prior year. Gross margin in the full-year was 77.6%, compared with 77.1% in the same period last year. Service margin in the full-year was 83.7%, compared with 83.8% in the prior year. Pre-tax net income for fiscal 2018 was $6.2 million, or 2.1% of revenue, and below our guidance of $9 million or 3% of revenue. Net income was $5.9 million, or $0.06 per share, and 2% of revenue. As we observed the market accelerating and customer adoption around our integrated platform, we concluded that we are uniquely positioned to deliver the most comprehensive, integrated system of engagement and intelligence in the market. With a strong leadership team in place we made a strategic decision to invest additional capital to accelerate our revenue growth and take advantage of this large underpenetrated market which is inflecting. Our non-GAAP effective tax rate was approximately 5% reflecting our cash taxes for fiscal 2018. Cash, cash equivalents, and investments were $153 million at March 31, 2018, compared with $175 million at the end of fiscal 2017. As part of our new lease for our San Jose headquarters, we now also have restricted cash of approximately $8 million on the balance sheet. During the full-year, we repurchased 1.4 million shares of common stock at an average price of $13.14 per share, for a total of $17.9 million, under the Company’s approved share repurchase program. We currently have about $7 million available for share repurchase under current authorization and will be opportunistic. Cash flow from operating activities was $2.7 million in the fourth fiscal quarter and capital expenditures, including capitalized software, were $6.5 million in the quarter, or 8% of revenue. For the full year, cash flow from operating activities was $22 million compared with $28.5 million in fiscal 2017. Capital expenditures, including capitalized software, were $21.7 million, or 7% of revenue, in fiscal 2018, compared with $14.4 million, or 6% of revenue, for fiscal 2017. The increase in capital expenditures was due to global expansion and support for new product initiatives including the X Series solutions. Now turning to key operating metrics for the fourth quarter. New monthly recurring revenue booked from mid-market and enterprise customers increased over 10% year-over-year and comprised 60% of total bookings. As mentioned during our third quarter earnings call, our fiscal fourth quarters of 2016 and 2017 had a number of very large enterprise deals which have made year-over-year comparisons more difficult for this quarter. The average revenue per mid-market and enterprise customer grew 9% to $4,899, compared with $4,494 in the same year ago period. Average revenue per business customer was $469, and grew 10% when compared to $426 in the same period a year ago. Gross monthly business service revenue churn on an organic basis, excluding DXI, was 0.3%, compared with 0.7% in the same period last year. Beginning next quarter, we will no longer provide a churn metric. We have low churn rates and believe a more compelling metric to measure our continued success across the business is to discuss retention. Annual retention rate was over 100% across all segments in the fourth quarter. The combination of strong upsell to existing clients and low churn rates will make a positive contribution to our accelerating growth rates. In fact, we continue to book approximately 50% of our new monthly recurring revenue from existing customers. Looking ahead to fiscal 2019, we will continue to invest to accelerate revenue growth and build a sustainable product advantage with our unified communications, contact center, data analytics, team collaboration and conferencing suite. As Vik mentioned earlier, we believe we have the right set of strategic initiatives in place and a market which is inflecting. While we have always taken a balanced approach to capital deployment including reinvestment in the business for growth, acquisitions, and share repurchases, we continue to believe that we will achieve the highest return for our shareholders by investing to drive revenue growth. Before providing guidance for fiscal 2019, I would like to cover the impact from ASC 606, which applies to us starting April 1, 2018. We have elected to use the modified retrospective approach, which means we will not revise previously reported numbers, but present fiscal 2019 data under the new rules and supplemental information for comparison. First, we do not expect a material difference to our revenue and year-over-year growth between ASC 606 and ASC 605. Second, we estimate that our fiscal 2019 non-GAAP operating expenses will be between $11 million to $13 million lower under ASC 606 due to the capitalization of a significant portion of commission expense rather than recording it at the time of sale. Under ASC 606, certain sales commissions will be capitalized and amortized over the expected customer life. The impact of this change will result primarily in a decrease to sales and marketing expenses. Third, we estimate that the adoption will increase retained earnings as of April 1, 2018 between $35 million and $40 million due to the capitalization of commissions from prior years. As a reminder, this new standard is an accounting change only and has no impact on our operating or free cash flow. Before I speak to our fiscal 2019 guidance, as a reminder, in early fiscal 2018, we made the strategic decision to integrate DXI’s core technology into our new X Series platform and have deemphasized selling the standalone DXI EasyContactNow product. We expect this product revenue to decline by approximately 50% in fiscal 2019. Now moving on to our outlook. For the fiscal full-year 2019 guidance under ASC 606, we expect service revenue in the range of $333 million to $338 million, representing approximately 19% to 21% year-over-year increases; excluding DXI revenue, service revenue growth in the range of 21% to 22%; total revenue in the range of $347 million to $352 million, representing approximately 17% to 19% year-over-year increase; our non-GAAP pre-tax loss in the range of $13 million to $17 million. In addition to full-year guidance, the Company introduces new quarterly guidance. For the first quarter of 2019 under ASC 606, we expect service revenue in the range of $77 million to $78 million, representing approximately 18% to 20% year-over-year increase. Excluding DXI revenue, we expect service revenue growth in the range of 20% to 21%; non-GAAP pre-tax loss in the range of $4 million to $5 million. I'll add some additional color to help you with your models for the full fiscal year. We are targeting service revenue exit growth in fiscal fourth quarter of 2019 to be approximately 25%, after adjusting for DXI revenue. Excluding the micro business, defined as 1 to 9 seats, and DXI revenue, our core business service revenue in the fourth quarter is already exceeding 25% year-over-year growth. We expect our full-year non-GAAP operating expense growth, as a percentage of revenue, to increase by approximately 8 to 10 percentage points. We expect research and development expenses, net of software capitalization, as a percent of revenue, to be approximately 13% to 14%. We expect sales and marketing expenses, which includes customer support and deployment, as a percentage of revenue, to be approximately 60% to 62%. Lastly, general and administrative expenses, as a percentage of revenue, to be approximately 11%. We anticipate moving into our new San Jose office in April 2019. While we work on the build-out of our new corporate headquarters, which starts this current quarter, we will incur quarterly non-cash accounting charges of approximately $1.2 million. We will exclude this from non-GAAP income since we are not currently occupying the building. We expect full-year capital expenditures to be between $6 million and $7 million, excluding tenant improvements associated with our new facility. We expect to capitalize software development between $20 million to $22 million. We estimate our tax expense to be approximately $150,000 each quarter. Due to the full valuation allowance against deferred tax assets, our tax expense reflects the current cash taxes in certain United States and foreign jurisdictions. We expect shares to be approximately 95 million on average for the full year 2019. In closing, it has been a very busy and productive year. To recap, we are clearly seeing a large market opportunity which is inflecting, we hired top-industry talent, we strengthened our cloud offerings to mid-market and enterprise customers, and we expanded our global footprint. For fiscal 2019 we have a business plan in place to achieve our full-year guidance and our target of approximately 25% exit service revenue growth in the fourth quarter excluding DXI. Our demand generation initiatives are bearing fruit with fiscal Q3 and Q4 pipeline cohorts validating our fiscal 2019 demand generation assumptions. We met our fourth quarter pipeline targets and we are currently on track with our first fiscal quarter targets. Our channel initiatives and our sales capacity plan are also meeting our expected targets. With that said, we now believe this is the right time to invest to accelerate our revenue growth. We believe these investments will position us for sustainable growth beyond fiscal 2019 as we continue to build value for our customers and shareholders. With that, operator, we are ready for questions.

[Operator Instructions] Your first question comes from Tim Horan with Oppenheimer. Your line is open.

Thanks, guys. What was the real catalyst? What did you see in the market to accelerate spending so much? Maybe give a little bit more color on the thinking process throughout the quarter and what really drove you over the edge?

Yes. So, I think, we have been chatting about this for a while that we feel that the market has been taking up which is why we did the major refresh in bringing really world-class talent kind to go for it. In the past, I see this as a completely unconstrained market opportunity. And the biggest constraint to me is the ability to bring onboard top tier talent and then make sure that you've got the capacity and the capability on-boarded et cetera. Particularly now, I'm finding that we can hire pretty much anybody and we’re getting the best and the brightest, and we're going to able to hire them in significant numbers. So for me that was a key catalyst. Second part of it which is just as critical is if you really think about it, here through a combination of organic development as well as acquisitions over the years, I have essentially the equivalent of two public companies of core technologies that make up two public companies already under one roof. I also now have the management team that can basically take that to the next level. That management team has been able to hire best and brightest, particularly in sales, engineering et cetera. And now, we're starting to see large enterprises really inflect. In Q4, as I indicated, you saw a 44% increase in the large deals, which is 10k monthly recurring revenue year-over-year. It's a $40 billion market opportunity. They don’t come along very often, and we find ourselves uniquely positioned. And I'm now feeling more and more comfortable that this is the time that you really turn on the gas and you go for it. I think X Series for us is going to be a game changer.

Your next question comes from Will Power with Baird. Your line is open.

Great, thanks. I guess, a couple of questions, maybe starting on enterprise. I think, you indicated that enterprise revenue grew 44% year-over-year. I wondered if you could just talk about competitively what you're seeing. Have you seen any renewed activity from the buyout coming out of bankruptcy? And then, I guess the second part of that is, you just called out a new channel head. I think, channel was just really the top 10 deals in the quarter. What type of accelerant do you expect, I guess? And what are you doing specifically to kind of ramp that channel piece of enterprise even further?

Okay. So, enterprise, which is deals defined as greater than 10k monthly recurring revenue is now 28% of our revenue, and that's growing at that 44% as of Q4. The part that is interesting, Bill has been here about 4.5, 5 weeks. He was the head of channel and alliances for CenturyLink and ran I think a $3 billion business there. The great thing is he comes on board, he has done a series of channel checks and basic takeaway is channel likes us, they like our product, they just haven’t seen enough of us that there is just not that coverage. And so, he believes and I do to that there is significant opportunity, untapped potential in channel which can be huge for us. Second, Rani and her team, which is the marketing team, you can start to see that demand generation engine is starting to chug, chug, chug, [ph] and it’s starting to beat plan. So, you combined those two things together, what’s starting to becoming more and more interesting for us is untapped market where we are now starting to feel like we will get more and more seat at the table. And then on top of that what we are seeing is that a lot of the legacy providers are struggling. You have seen recent acquisitions, people coming out of bankruptcy, people going private, all of this is hugely disruptive. And so for us, we see the channel as right and we have brought [ph] in the people that can help leverage that. We see enterprise as right and we have brought of the people that can leverage that and that’s not even counting the fact that international is starting to take off. And as I said -- for me, $40 billion market opportunities don’t come along very often. and larger and larger customers are going cloud first, which is why when you think about it, our biggest constraint has been sales coverage. I think people would acknowledge our product is solid across the board, most comprehensive in the industry. Our ability to basically hire sales people, get our word out that’s been the constraint. So, we feel this is the perfect time with the team in place where you turn on the gas.

Your next question comes from the line of Meta Marshall with Morgan Stanley. Your line is open.

I just wanted to kind of get a sense of -- given how much you are raising OpEx assumptions, like when you would expect to see the benefit of that? Because if you are not raising kind of fiscal ‘19 expectations, is it something where you would expect to see those benefits in 12 months out, just a sense of timeline of the increased investments?

Absolutely, Meta. As you can probably understand, we are building pipeline today for Q3, Q4 and for fiscal 2020. A lot of these investments are absolutely going to be geared towards 2020 because they will come on and they’ll help us continue to build pipeline into 2020 Q1, Q2. Normally an enterprise sales cycle could be anywhere from three months up to almost 12 months, right? A mid-market pipeline or a sales cycle could be anywhere from three months to six months. So, we definitely believe that it will provide growth for 2020. And as the past [ph] companies, we are not going to be satisfied with just 25% revenue growth. We continue to want to improve on that. So, stay tuned. But this is all about 2020.

And then, maybe just a follow-up on gross margins. There is just a small tick down in service gross margin this quarter. Is that just normal seasonality or kind of things that you mentioned as clearing out some inventory or just how should we think about that?

Yes. So, there are two things. One thing was a one-time issue which was the excess inventory promo that we did for our small business team and that was very successful, both on a newer generation as well as depleting that excess inventory. So, you saw a higher margin subsidy than you had in the past. The other thing is an ongoing, which is under service margin. As we had mentioned last quarter, we expect now about 130 basis points increase to our service costs as we start to amortize previously capitalized software for engineering -- from engineering initiatives as we release these products to market.

Your next question comes from the line of Nikolay Beliov with Bank of America. Your line is open.

Did I hear correctly? You said, you’re going to be increasing your total company headcount by 30% this fiscal year.

Yes.

Yes.

Okay. Mary, I just wanted to understand one of the metrics you gave. 10% growth in monthly recurring revenues from the mid-market and the enterprise, and that’s off of minus 7% last year. So, I’m just trying to understand your comment about large scale as tough comps last year. I mean, the comps don’t look tough to me. I’m just trying to understand it slightly better.

Yes. No. I understand how -- when you look at it, it doesn’t look like 2017 Q4 would have been a difficult comp. But you have to go back to 2016 in the fourth fiscal quarter where we had an outrageously fantastic quarter where we had four very large enterprise whale sorts of deals. So, even though our Q4 of ‘17 was also very good, it didn’t look very good compared to phenomenal Q4 2016. So, this Q4 was actually good as well and is up from last quarter. But you’re not going to see it in the numbers. But, I think, all that is behind us now and you’ll start to see real acceleration as we go into fiscal 2019 in our mid-market bookings, mid-market and enterprise bookings.

And I guess, that’s why to help us, you gave this new metric, the 44% growth of the 10,000-plus more customers, correct? That’s a brand new metric, right?

That’s exactly right.

Can you comment on the trajectory of that metric throughout the year?

That’s not something that we will actually comment on. But, as you know, we have been investing in the mid-market and enterprise. And on these large enterprise deals, it can by lumpy from quarter-over-quarter. And by the way, the other thing with enterprise deals is that in many times, some wanted to deploy it immediately, others wanted to deploy over some period of time, and that period of time could be nine months or it could be over a year. So, we do expect that we will continue to grow, both our mid-market and our enterprise business faster than what Gartner says the market is growing at. And in both cases, we are doing that today. And by the way, the other nice thing is that the small business now which was growing smaller than market is growing in line with market.

Your next question comes from the line of Zack Turcotte [ph] with Dougherty. Your line is open.

Hey, guys. Zack on for Catharine Trebnick. Just quick one or two on the channel. So, you said 82 partners enrolled since you expanded the channel program. Just wondering kind of how many of those are having serious contribution to revenue at this point and also what role channel partners are playing in your expansion of global footprint?

Actually quite critical a role, particularly for expansion of global footprint. Channel -- revenue from channel and bookings from channel is growing pretty quickly, actually faster than our core. And that’s before we had Bill and the rest of the team. So, Bill is already brought on broad, some other key folks that will be coming on line. Channel is huge for us. And it’s quite fascinating to me how -- we started in the channel relatively late and how quickly is it starting to accelerate. So, you will see channel become a bigger and bigger portion of our business, particularly internationally. And as I indicated, channel's booking is growing at a very healthy clip, and we expect that to actually accelerate beyond that.

Great. And then, just a quick follow-up. If you can give kind of any color on how you feel about the X Series and selling that to the channel. It feels that the advantage that you have a simplified product and that will help drive channel sales even further. I know, you said bookings were up 28% in Q4, which is pretty big as well as top 10 deals coming from there. Do you see that continuing?

Yes. So, couple of things. I actually -- and I think we have talked about it. And I think I encourage you to look at also my last earnings call. This has been an evolution. X to me is a game-changer. Because think about what we have just done. We have smashed together telephony, contact center, conferencing, collaboration into one common product suite from X1 through X8. If you want a simple phone, we can provide it for through X1. If you want a complete contact center solution with analytics, persona, call recordings, details, speech analytics et cetera, you get X8. And by the way, one common data layer for the entire enterprise and a machine learning and AI where you can basically take this data and parse it based on buyer persona, customer persona, creating rooms where you can have alerts when a particular customer of particular type is making an issue. So, we think it is fundamental. And the simplicity of it, where in essence you don't have to spend time trying to figure out are you a contact center, are you a telephony solution. The simplicity, I think, is key. And I think, we are on track for launch in the June-July timeframe. We'll start a soft launch in June accelerating over the summer. But again, this X Series for us has been a culmination of four, five years of work acquiring a couple of contact center companies, acquiring Sameroom for the collaboration engine, acquiring Quality Rocket for the speech analytics as well as just overall quality monitoring and analytics. And now most recently, MarianaIQ. And check up on them. that's an amazing, amazing capability that we brought all together. So, I really think X simplifies everything, it blurs the line between contact center as well as telephony and video conferencing. And it allows you to leverage that data so you create one system of engagement, one system of intelligence. That's what we've been working towards.

Your next question comes from the Dmitry Netis with William Blair. Your line is open.

Thank you very much for taking the question. So, I mean going back to the bookings number, guys. I now, you said 10% new on our books, growth was 10%. That's relatively to 40% growth last quarter. So, it does seem like the bookings which is 50% of your total bookings, decelerated here. So, I'm try to understand exactly, is it people dragging feet in anticipation of the new product launch, is there something else going on, is it just the momentum isn't quite there yet as you know of target the channel? And also trying to understand the channel commissions, channel partner commission statements you've mentioned. It seems like there has been some kind of an inflation there in the channel. How are you viewing that as far as sustainability of that. Is it you think will normalize eventually or is it continue to tick up as you try to bring in these partners and try to woo them name on your side of the pond, if you will.

Okay. So, let's take the first one on the -- we grew 10% on the mid-market bookings -- mid-market and enterprise bookings. First of all, I want to remind everybody that we did mention that in our last earnings call that we do not expect to repeat the same growth rate in our fourth fiscal quarter as we had in our third fiscal quarter. Our third fiscal quarter was very strong, came in ahead of plan, and that’s a great thing. Our Q4 was also -- this past quarter was also very strong with 21 large enterprise deals over 1k in new monthly recurring revenue. If just so happened that our Q4 in the last two quarters had been also very good, right? I think the fourth quarter of 2016 having four super whales [ph] impacted the growth that you saw in our fourth fiscal quarter of 2017, which impacted our growth rate here from a year-over-year comparison perspective. But, we are very pleased with what we booked in our fourth fiscal quarter. We have been managing very well through our plan. We have a detailed plan in place from demand generation to pipeline build and we are hitting all of those targets. And we will expect now as we move into fiscal ‘19 we are going to start seeing that accelerate. So we are very pleased on what we have here. And we also have our sales team is ramping, our sales capacity. We hired more than we had expected to hire from a sales perspective in our fourth fiscal quarter where you have the channel support. And we have a seat at the table now. I mean, this is a very, very large market and we expect that we are going to get much more than our fair share.

And on the channel partner commissions?

And on the second part -- the second part was on the channel commissions that you had asked, absolutely. So, we did see growth. The numbers that I had said as far as the increase in sales and marketing is a year-over-year comparison for channel revenue year-over-year by more than 20%, 28% in the fourth fiscal quarter. We would expect -- I know you are saying as far as the inflation, it’s a very competitive area. But we are still on board; it’s very targeted; we have strong commitment from our channel partners. That’s the whole idea of this Channel Enablement Program. They have to get skin in the game. They come to 8x8, they learn all about how to sell our products, they learn how to do the tech support as well as the implementation. So, they have skin in the game. And so, we really do believe that we have a strong channel partner -- channel partners and we are still on board that will start to accelerate.

Can I ask one more question on the ASC? Thank you very much for the color on the bookings and the channel. But as far as ASC 606, 605 accounting goes, I think, you mentioned there is something on the website. Without us looking at it, would you be able to give us kind of a comparative 605 number of what the service revenue would have looked like on a fiscal ‘19 basis? I think, you are calling for 20% at the midpoint growth on the ASC 606 basis. So, I am just trying to understand what it would be on a 605 basis? And similarly, for the OpEx side of the equation, it does sound like you are getting the benefit there of 11 million to 13 million, yet you are investing additional 13 million to 17 million. So, all-in, it sounds like you are investing $24 million to $30 million off in OpEx to drive this accelerated growth. I am just trying to reconcile that that is the correct math.

Yes. On the revenue -- on a service revenue perspective, we don’t believe that there is any change or a very small material change between ASC 605 and ASC 606. We might see a slight improvement on the product margin under ASC 606 versus ASC 606 -- ASC 606 versus ASC 605, but no impact on the service revenue. As it relates to the operating expenses, yes, we will in fact have a favorable somewhere between $11 million to $13 million of favorable OpEx that will be capitalized and amortized over the next five years. And yes, we do expect a non-GAAP pre-tax income of 13 to $17 million. So, your numbers are correct. This is the time, as we had said we really believe that we have a very strong position right now in the marketplace. We believe that the market is inflecting. We believe that with our current products, as well as with our X Series products that we’re in a strong position to capture a significant portion of this. And $40 billion market that are less than 10% penetrated don’t come around every day. So, it’s either accelerate growth now or wait. And we’re building for the long-term. These investments as I mentioned before are mostly for growth to continue to accelerate beyond our 25% exit rate and into fiscal 2020 as accelerated rates.

Your next question comes from the line of Mike Latimore with Northland Capital. Your line is open.

Just wanted to think of two things you mentioned. I think, you mentioned that you’re seeing the market at an inflective point, but then you also said, I believe that you met your pipeline number for the fourth quarter. So, I guess, can you just sort of think that up out of sight, you might have been in your pipeline number for market, [ph] it was inflecting more?

So, the issue is less around the market, the more it’s around capacity. So, for example, -- capacity as in people bringing onboard. Rani joined us about a year ago. She started building her demand generation team over the last six months. So, they are ahead of plan with -- and I’m talking about our detailed plan that we put together for FY19. Bill has been onboard for 4.5 weeks and he’s starting to kind of -- stuff is already starting to happen out there. Our issue is not the market. Our issue is the capacity and the people that we’ve had in here. And that’s part of why -- I mean even you’ve known us for a long time. We have always run the company in a very prudent, almost GRP [ph] way. We are seeing an opportunity to take this market into high growth mode and we think, we’ve got the right products that we have built up over the right time. And our constraint in the past was the ability to bring onboard all the people that we need and we are finding now people are coming to us and we’re being able to bring them on board, on-board them and this is the time.

And I know last quarter, you talk about this March quarter being a sort of tougher bookings comp. Any just general kind of qualitative commentary about the June quarter bookings comp?

We don’t -- I mean, it’s looking better and better. So, the main point is that is why I want to make sure that what we think is over the long-term, you’re going to continue to see our bookings continue to accelerate. You’ll always see some level of fluctuation, because a couple of big deals here they’re everywhere, depending on how they happen, can kind of shift to one quarter to the other. But we predicted exactly what Q4 bookings are going to be and we had kind of telegraphed exactly that in our last earnings call, and we came an exactly where we expected.

And then just last on the, sort of clearing out of old inventory, like you said for the small business market. Are you just seeing like a new version of phones come to the market that you want to sell? Is that the thing or can you explain that a little bit more?

Exactly.

That’s exactly. Yes.

Yes. There is a bunch of phones that if we kept them much longer, the next generation would have been out. It was good to get them all out and hallelujah.

Yes. We were able to use it to generate some solid monthly recurring revenue for our small business team.

Your next question comes from George Sutton with Craig Hallum. Your line is open.

Thank you. Vik, my perception of this market is it’s much more fragmented and we need to see consolidation. And I’d kind of debate the concept of a winner take all mentality. So, I'm just kind a curious with that as a backdrop, your thoughts relative to the competitive landscape.

So, interesting way of asking it. But basically I have had a consistent vision since I've been here over the last four years, which is in the end, it will become one core communications platform, which is why if you think about it, we bought Contactual, we bought DXI, we bought Sameroom, we bought Quality Rocket and now MarianaIQ. So, we can create all our core technology under one roof. We think that is critical because then you control your destiny. Ultimately, this is about that core communication platform that does any form of communication and it's that underlying data because that is hugely valuable where particularly when you put AI, ML on top of it that data. What is the core communication data? Any form of real time interaction that happens in a company happens on our platform. That's huge. And I build the technology where it’s our platform, it's not somebody else's I don't have to share stuff, I don't have to worry about somebody having their own ambitions. We are the masters of our own destiny. So that's part of why, as I said what we have, essentially, we have the equivalent of the core technology of two public companies all under one roof. Constraint in the past has been having the right amount of people as well as the right caliber of talent at the sales and marketing level. I got it now, which is why you turn on the gas.

Last question for me. Relative to -- at Enterprise Connect, you are very suggestive of opportunity on the data side. In fact, I think at one point saying people may end up characterizing us as a data company. There really wasn't any discussion of that today. I'm wondering if you're making any progress there.

Actually, I mean the most relevant progress I made I bought MarianaIQ and announced that about a week ago. We've also made very significant hires in AI, ML. And we are now starting to kind of leverage that, let’s start with us where we have the ability inside the Company to create for key customers common rooms where any global interaction we're able to basically look -- use AI, ML to basically parse those global interactions on order of priority. This is something coming from a very senior executive from our customer that may have gone to Tier 2 agent somewhere need to respond it to instantly. These other ones are more run-of-the-mill. So that's how having that data combined with AI, ML is going to be a game-changer. But MarianaIQ is a -- I mean check up on the company. It's very much, I think the two best acquisitions I've made are Quality Rocket and Sameroom. And this one I think is going to be right up there.

[Operator Instructions] Your next question comes from Jonathan Kees with Summit Insights Group. Your line is open.

Great. Thanks for taking my questions. I just wanted to I guess dig a little deeper and tie things together. You talked about 30% more hiring in fiscal year ‘19. And you kind gave the OpEx ranges and also some of that's going -- there is some OpEx that's going to capitalize. I guess, I'm trying to pull all together and try to guess since the puts and takes, and maybe the best thing to do is step back and ask where do you see most of the hiring going to be in that 30% in those OpEx areas? And are you still -- I am assuming that you are spending less now on brand awareness, which took a lot of your S&M in the past?

Okay. So, on the increased headcount that will be across the board. Okay? It will be across the board. We do have a fairly significant increase in R&D and there will be significant heads that we will hire across the board in our US operations here in San Jose and our UK facility as well as in our Cluj [ph] facility. Second is, there will continuous hires in the sales and marketing side. We’ve built out most of our marketing team. There will be a couple of more that we will additional. But certainly on the sales side, we will continue to add capacity again to make sure that we have the right team in place and ramp ready for the acceleration of growth into fiscal 2020. We will also hire in G&A, we didn’t talk about that but we will also hire in G&A. We are building out our HR team and continuing to build out a legal team. As we continue to move up market, it’s very necessary to have the right in place to being able to review and do contracts very, very quickly with these enterprise customers. So, it will be across the board also from a deployment perspective with all the new business that we are bringing on board. Key metric to us is -- definitely we said service revenue growth is a key metric to us, new more bookings is a key metric to us but time to revenue is a very important metric to us. We will be building out our customer deployment team, customer service in addition. We will be looking for the ways to continue to adopt our technology, which we have adopted inside our company to continue to bring the best information to our customers. So that will be across the board from a spend and from a hiring perspective. We still expect absolutely that we will spend in demand gen but we are looking for now that we have actually gone to market and we have a lot of data on what’s working, where we are generating the most by what programs, we can now really focus in on and put -- turn the dials plus or minus on the ones that are really generating the best pipeline for us. So, it’s very targeted. We are learning a lot about our markets. We are learning a lot about the customers that we are selling to and we are learning a lot about which campaigns are working or not working and we will be able to fine tune and continue to target then. So, you won’t see big billboards, right? You won’t see jingles on your radar stations but we will invest in ways to generate new leads and continue to build our pipeline.

And then, just a follow-up. Are you still looking to bring on channel partners at same rate or accelerated rate from what you did in fiscal 2018?

Significantly accelerated rate, Bill -- every time we bring on board very senior executive. Again, remember Bill’s span of control. Bill was head of channels and alliances for CenturyLink and ran a very big operation. He knows every person in our space, quote, his view is we are just at the very tip of the channel and that with particularly X and the simplicity of X and the ability to basically provision X and then with the kind of investments we have made in back office infrastructure in his mind channel is right to pop. So, you’ll see -- if you think about it at a macro level bucket, I am going to invest a lot in engineering because I think I’ve got a differentiated product, I own it. And to some extent, I am going to put a lot of work behind it so I can make sure it continues to be differentiated and as a matter of fact becomes game changing. Second, we are going to invest a heck of a lot in channel because in essence we’ve got now the right people who have done it before who are looking at us, telling us that channel can pop, and then continue to invest in sales capacity across the board. So, that’s three key core areas of investment. And again, it’s because, as I culmination of a lot of years that for us where we feel comfortable in making those kind of investments right now.

There are no further questions at this time. I will now turn the call back over to the presenters.

Thank you. In conclusion, we are excited about fiscal 2019. And we look forward to seeing many of you guys at upcoming investor conferences. Also, on behalf of the Board, executive management team and everyone at 8x8, we would invite you to tune in to June 19, where we will be ringing the opening bell at the New York Stock Exchange. We are honored to have 8x8 employees and clients with us in the New York Stock Exchange to celebrate this important occasion and a milestone in the Company’s history. Thank you very much.

This concludes today’s conference call. You may now disconnect.