8X8 INC /DE/ - Quarter Report: 2019 December (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM | 10-Q | ||
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2019
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 001-38312
8X8, INC.
(Exact name of Registrant as Specified in its Charter)
Delaware | 77-0142404 |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification Number) |
2125 O'Nel Drive
San Jose, CA 95131
(Address of Principal Executive Offices)
(408) 727-1885
(Registrant's Telephone Number, including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol | Name of each exchange on which registered |
COMMON STOCK, PAR VALUE $.001 PER SHARE | EGHT | New York Stock Exchange |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☒ | Accelerated filer | ☐ | Non-accelerated filer | ☐ | Smaller reporting company | ☐ | Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ The number of shares of the Registrant's Common Stock outstanding as of January 30, 2020 was 102,458,236.
FORM 10-Q
TABLE OF CONTENTS
Page No. | |
Forward-Looking Statements and Risk Factors
Statements contained in this quarterly report on Form 10-Q, or Quarterly Report, regarding our expectations, beliefs, estimates, intentions or strategies are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, words such as "may," "will," "should," "estimates," "predicts," "potential," "continue," "strategy," "believes," "anticipates," "plans," "expects," "intends," and similar expressions are intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Actual results and trends may differ materially from historical results and those projected in any such forward-looking statements depending on a variety of factors. These factors include, but are not limited to:
• | market acceptance of new or existing services and features we may offer from time to time; |
• | customer acceptance and demand for our cloud communication and collaboration services, including voice, contact center, video, messaging, and communication APIs; |
• | competitive market pressures, and any changes in the competitive dynamics of the markets in which we compete; |
• | the quality and reliability of our services; |
• | customer cancellations and rate of customer churn; |
• | our ability to scale our business; |
• | customer acquisition costs; |
• | our reliance on infrastructure of third-party network services providers; |
• | risk of failure in our physical infrastructure; |
• | risk of defects or bugs in our software; |
• | our ability to maintain the compatibility of our software with third-party applications and mobile platforms; |
• | continued compliance with industry standards and regulatory, including privacy, requirements in the United States and foreign countries in which we make our cloud software and services solutions available, and the costs of such compliance; |
• | risks relating to the acquisition and integration of businesses we have acquired (for example, Wavecell Pte. Ltd.) or may acquire in the future, particularly if the acquired business operates in a different product market space from us or is based in a region where we do not have significant operations; |
• | the amount and timing of costs associated with recruiting, training and integrating new employees; |
• | timing and extent of improvements in operating results from increased spending in marketing, sales, and research and development; |
• | upfront investments, including the cost to support new strategic initiatives such as our cloud migration program with Poly and Scansource, to acquire more customers may not result in additional revenue from new or existing customers; |
• | introduction and adoption of our cloud software solutions in markets outside of the United States; |
• | risk of cybersecurity breaches; |
• | risks related to our senior convertible notes and the related capped call transactions; |
• | general economic conditions that could adversely affect our business and operating results; |
• | implementation and effects of new accounting standards and policies in our reported financial results; and |
• | potential future intellectual property infringement claims and other litigation that could adversely impact our business and operating results. |
Please refer to the "Risk Factors" section of our annual report on Form 10-K for the fiscal year ended March 31, 2019, and subsequent Securities and Exchange Commission ("SEC") filings for additional factors that could materially affect our financial performance. All forward-looking statements included in this Quarterly Report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Readers are urged to carefully review and consider the various disclosures made in this Quarterly Report, which attempts to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.
Our fiscal year ends on March 31 of each calendar year. Each reference to a fiscal year in this Quarterly Report, refers to the fiscal year ended March 31 of the calendar year indicated (for example, fiscal 2020 refers to the fiscal
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year ended March 31, 2020). Unless the context requires otherwise, references to "we," "us," "our," "8x8" and the "Company" refer to 8x8, Inc. and its consolidated subsidiaries.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
8X8, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
December 31, 2019 | March 31, 2019 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 184,794 | $ | 276,583 | ||||
Restricted cash, current | 3,459 | — | ||||||
Short-term investments | 30,283 | 69,899 | ||||||
Accounts receivable, net | 37,384 | 20,181 | ||||||
Deferred sales commission costs | 20,749 | 15,601 | ||||||
Other current assets | 25,712 | 15,127 | ||||||
Total current assets | 302,381 | 397,391 | ||||||
Property and equipment, net | 89,776 | 52,835 | ||||||
Operating lease, right-of-use assets | 77,062 | — | ||||||
Intangible assets, net | 26,455 | 11,680 | ||||||
Goodwill | 131,000 | 39,694 | ||||||
Long-term investments | 20,126 | — | ||||||
Restricted cash, non-current | 15,558 | 8,100 | ||||||
Deferred sales commission costs, non-current | 48,656 | 33,693 | ||||||
Other assets | 21,485 | 2,965 | ||||||
Total assets | $ | 732,499 | $ | 546,358 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 50,334 | $ | 32,280 | ||||
Accrued compensation | 24,392 | 18,437 | ||||||
Accrued taxes | 11,670 | 13,862 | ||||||
Operating lease liabilities, current | 4,320 | — | ||||||
Deferred revenue | 7,216 | 3,336 | ||||||
Other accrued liabilities | 23,704 | 6,790 | ||||||
Total current liabilities | 121,636 | 74,705 | ||||||
Operating lease liabilities, non-current | 86,187 | — | ||||||
Convertible senior notes, net | 287,464 | 216,035 | ||||||
Other liabilities, non-current | 17,721 | 6,228 | ||||||
Total liabilities | 513,008 | 296,968 | ||||||
Commitments and contingencies (Note 8) | ||||||||
Stockholders' equity: | ||||||||
Common stock | 101 | 96 | ||||||
Additional paid-in capital | 598,525 | 506,949 | ||||||
Accumulated other comprehensive loss | (6,565 | ) | (7,353 | ) | ||||
Accumulated deficit | (372,570 | ) | (250,302 | ) | ||||
Total stockholders' equity | 219,491 | 249,390 | ||||||
Total liabilities and stockholders' equity | $ | 732,499 | $ | 546,358 | ||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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8X8, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts; unaudited)
Three Months Ended December 31, | Nine Months Ended December 31, | |||||||||||||||
2019 | 2018 | 2019 | 2018 | |||||||||||||
Service revenue | $ | 113,566 | $ | 85,911 | $ | 310,467 | $ | 245,378 | ||||||||
Product revenue | 5,001 | 4,001 | 14,292 | 13,441 | ||||||||||||
Total revenue | 118,567 | 89,912 | 324,759 | 258,819 | ||||||||||||
Cost of revenue and operating expenses: | ||||||||||||||||
Cost of service revenue | 49,326 | 27,632 | 124,488 | 78,383 | ||||||||||||
Cost of product revenue | 6,893 | 5,318 | 19,119 | 16,996 | ||||||||||||
Research and development | 19,870 | 16,886 | 57,635 | 43,999 | ||||||||||||
Sales and marketing | 63,099 | 46,276 | 174,593 | 128,451 | ||||||||||||
General and administrative | 22,547 | 18,038 | 62,589 | 53,198 | ||||||||||||
Total operating expenses | 161,735 | 114,150 | 438,424 | 321,027 | ||||||||||||
Loss from operations | (43,168 | ) | (24,238 | ) | (113,665 | ) | (62,208 | ) | ||||||||
Other (expense) income, net | (3,623 | ) | 579 | (7,919 | ) | 1,933 | ||||||||||
Loss before provision for income taxes | (46,791 | ) | (23,659 | ) | (121,584 | ) | (60,275 | ) | ||||||||
Provision for income taxes | 280 | 112 | 684 | 333 | ||||||||||||
Net loss | $ | (47,071 | ) | $ | (23,771 | ) | $ | (122,268 | ) | $ | (60,608 | ) | ||||
Net loss per share: | ||||||||||||||||
Basic and diluted | $ | (0.47 | ) | $ | (0.25 | ) | $ | (1.23 | ) | $ | (0.64 | ) | ||||
Weighted-average common shares outstanding: | ||||||||||||||||
Basic and diluted | 99,922 | 95,370 | 99,082 | 94,093 | ||||||||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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8X8, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands, unaudited)
Three Months Ended December 31, | Nine Months Ended December 31, | |||||||||||||||
2019 | 2018 | 2019 | 2018 | |||||||||||||
Net loss | $ | (47,071 | ) | $ | (23,771 | ) | $ | (122,268 | ) | $ | (60,608 | ) | ||||
Other comprehensive income (loss), net of tax | ||||||||||||||||
Unrealized gain (loss) on investments in securities | (12 | ) | (101 | ) | 106 | 160 | ||||||||||
Foreign currency translation adjustment | 4,587 | (549 | ) | 682 | (2,600 | ) | ||||||||||
Comprehensive loss | $ | (42,496 | ) | $ | (24,421 | ) | $ | (121,480 | ) | $ | (63,048 | ) | ||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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8X8, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except shares, unaudited)
Common Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Loss | Accumulated Deficit | Total | |||||||||||||
Shares | Amount | ||||||||||||||||
Balance at March 31, 2019 | 96,119,888 | $ | 96 | $ | 506,949 | $ | (7,353 | ) | $ | (250,302 | ) | $ | 249,390 | ||||
Issuance of common stock under stock plans, less withholding | 451,308 | 1 | 1,493 | — | — | 1,494 | |||||||||||
Stock-based compensation expense | — | — | 14,059 | — | — | 14,059 | |||||||||||
Unrealized investment gain | — | — | — | 121 | — | 121 | |||||||||||
Foreign currency translation adjustment | — | — | — | (652 | ) | — | (652 | ) | |||||||||
Net loss | — | — | — | — | (34,265 | ) | (34,265 | ) | |||||||||
Balance at June 30, 2019 | 96,571,196 | 97 | 522,501 | (7,884 | ) | (284,567 | ) | 230,147 | |||||||||
Issuance of common stock under stock plans, less withholding | 1,761,483 | 2 | (790 | ) | — | — | (788 | ) | |||||||||
Stock-based compensation expense | — | — | 17,867 | — | — | 17,867 | |||||||||||
Issuance of common stock related to acquisitions | 1,476,009 | 1 | 35,838 | — | — | 35,839 | |||||||||||
Unrealized investment loss | — | — | — | (3 | ) | — | (3 | ) | |||||||||
Foreign currency translation adjustment | — | — | — | (3,253 | ) | — | (3,253 | ) | |||||||||
Net loss | — | — | — | — | (40,932 | ) | (40,932 | ) | |||||||||
Balance at September 30, 2019 | 99,808,688 | 100 | 575,416 | (11,140 | ) | (325,499 | ) | 238,877 | |||||||||
Issuance of common stock under stock plans, less withholding | 976,272 | 1 | 139 | — | — | 140 | |||||||||||
Stock-based compensation expense | — | — | 19,881 | — | — | 19,881 | |||||||||||
Equity component of convertible senior notes, net of issuance costs | — | — | 3,089 | — | — | 3,089 | |||||||||||
Unrealized investment loss | — | — | — | (12 | ) | — | (12 | ) | |||||||||
Foreign currency translation adjustment | — | — | — | 4,587 | — | 4,587 | |||||||||||
Net loss | — | — | — | — | (47,071 | ) | (47,071 | ) | |||||||||
Balance at December 31, 2019 | 100,784,960 | $ | 101 | $ | 598,525 | $ | (6,565 | ) | $ | (372,570 | ) | $ | 219,491 | ||||
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Common Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Loss | Accumulated Deficit | Total | |||||||||||||
Shares | Amount | ||||||||||||||||
Balance at March 31, 2018 | 92,847,354 | $ | 93 | $ | 425,790 | $ | (5,645 | ) | $ | (201,464 | ) | $ | 218,774 | ||||
Issuance of common stock under stock plans, less withholding | 403,377 | — | 777 | — | — | 777 | |||||||||||
Stock-based compensation expense | — | — | 9,304 | — | — | 9,304 | |||||||||||
Unrealized investment gain | — | — | — | 113 | — | 113 | |||||||||||
Foreign currency translation adjustment | — | — | — | (1,672 | ) | — | (1,672 | ) | |||||||||
Adjustment from adoption of ASU 2016-9 | — | — | — | — | 39,901 | 39,901 | |||||||||||
Net loss | — | — | — | — | (15,355 | ) | (15,355 | ) | |||||||||
Balance at June 30, 2018 | 93,250,731 | 93 | 435,871 | (7,204 | ) | (176,918 | ) | 251,842 | |||||||||
Issuance of common stock under stock plans, less withholding | 1,840,387 | 1 | (596 | ) | — | — | (595 | ) | |||||||||
Stock-based compensation expense | — | — | 9,829 | — | — | 9,829 | |||||||||||
Unrealized investment gain | — | — | — | 149 | — | 149 | |||||||||||
Foreign currency translation adjustment | — | — | — | (379 | ) | — | (379 | ) | |||||||||
Net loss | — | — | — | — | (21,482 | ) | (21,482 | ) | |||||||||
Balance at September 30, 2018 | 95,091,118 | 94 | 445,104 | (7,434 | ) | (198,400 | ) | 239,364 | |||||||||
Issuance of common stock under stock plans, less withholding | 418,105 | 1 | (281 | ) | — | — | (280 | ) | |||||||||
Stock-based compensation expense | — | — | 13,066 | — | — | 13,066 | |||||||||||
Unrealized investment loss | — | — | — | (101 | ) | — | (101 | ) | |||||||||
Foreign currency translation adjustment | — | — | — | (549 | ) | — | (549 | ) | |||||||||
Net loss | — | — | — | — | (23,771 | ) | (23,771 | ) | |||||||||
Balance at December 31, 2018 | 95,509,223 | $ | 95 | $ | 457,889 | $ | (8,084 | ) | $ | (222,171 | ) | $ | 227,729 | ||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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8X8, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
Nine Months Ended December 31, | ||||||||
2019 | 2018 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (122,268 | ) | $ | (60,608 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Depreciation | 6,801 | 6,464 | ||||||
Amortization of intangible assets | 6,149 | 4,551 | ||||||
Amortization of capitalized software | 13,263 | 6,452 | ||||||
Amortization of debt discount and issuance costs | 9,987 | — | ||||||
Amortization of deferred sales commission costs | 13,805 | — | ||||||
Operating lease expense, net of accretion | 10,676 | — | ||||||
Non-cash lease expenses | — | 3,601 | ||||||
Stock-based compensation | 50,305 | 31,574 | ||||||
Other | 2,671 | 873 | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable, net | (8,776 | ) | (3,965 | ) | ||||
Deferred sales commission costs | (33,651 | ) | (7,234 | ) | ||||
Other current and non-current assets | (24,780 | ) | (2,565 | ) | ||||
Accounts payable and accruals | 7,876 | 13,198 | ||||||
Deferred revenue | 5,106 | 986 | ||||||
Net cash used in operating activities | (62,836 | ) | (6,673 | ) | ||||
Cash flows from investing activities: | ||||||||
Purchases of property and equipment | (22,853 | ) | (5,778 | ) | ||||
Purchase of businesses | (58,853 | ) | (5,625 | ) | ||||
Capitalized software development costs | (22,784 | ) | (18,210 | ) | ||||
Proceeds from maturities of investments | 16,195 | 44,850 | ||||||
Proceeds from sales of investments | 33,117 | 41,780 | ||||||
Purchases of investments | (29,658 | ) | (52,353 | ) | ||||
Net cash (used in) provided by investing activities | (84,836 | ) | 4,664 | |||||
Cash flows from financing activities: | ||||||||
Finance lease payments | (312 | ) | (771 | ) | ||||
Tax-related withholding of common stock | (6,186 | ) | (7,631 | ) | ||||
Proceeds from issuance of common stock under employee stock plans | 7,035 | 7,372 | ||||||
Net proceeds from issuance of convertible senior notes | 65,305 | — | ||||||
Net cash provided by (used in) financing activities | 65,842 | (1,030 | ) | |||||
Effect of exchange rate changes on cash | 958 | (339 | ) | |||||
Net decrease in cash and cash equivalents, and restricted cash | (80,872 | ) | (3,378 | ) | ||||
Cash, cash equivalents, and restricted cash at the beginning of the period | 284,683 | 39,803 | ||||||
Cash, cash equivalents, and restricted cash at the end of the period | $ | 203,811 | $ | 36,425 | ||||
Supplemental cash flow information | ||||||||
Income taxes paid | $ | 719 | $ | 290 | ||||
Interest paid | 647 | — | ||||||
Right of use assets obtained in exchange for new operating lease liabilities | 64,869 | — | ||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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8X8, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
8x8, Inc. ("8x8" or the "Company") was incorporated in California in February 1987 and was reincorporated in Delaware in December 1996. The unaudited interim condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The Company conducts its operations through one reportable segment.
The Company is a leading cloud provider of enterprise Software-as-a-Service ("SaaS") communications solutions, that enable businesses of all sizes to communicate faster and smarter across voice, contact center, video meetings, messaging, and communication APIs, transforming both employee and customer experiences with communications that work simply, integrate seamlessly, and perform reliably. From one proprietary cloud technology platform, customers have access to unified communications, team collaboration, video conferencing, contact center, data and analytics, communication APIs, and other services. Since fiscal 2004, substantially all revenue has been generated from the sale of communications services and related hardware. Prior to fiscal 2003, the Company's main business was Voice over Internet Protocol semiconductors.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND CONSOLIDATION
The Company's fiscal year ends on March 31 of each calendar year. Each reference to a fiscal year in these notes to the condensed consolidated financial statements refers to the fiscal year ended March 31 of the calendar year indicated (for example, fiscal 2020 refers to the fiscal year ending March 31, 2020).
The accompanying interim condensed consolidated financial statements are unaudited and have been prepared on substantially the same basis as our annual consolidated financial statements for the fiscal year ended March 31, 2019 with the exception of new lease accounting guidance discussed in the recently adopted accounting principles section below. Certain information and note disclosures normally included in the financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") have been condensed or omitted pursuant to the rules and regulations of the SEC, regarding interim financial reporting.
In the opinion of the Company's management, these interim condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement of our financial position, results of operations, and cash flows for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from these estimates.
The March 31, 2019 year-end condensed consolidated balance sheet data in this document were derived from audited consolidated financial statements and does not include all of the disclosures required by GAAP. These condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements as of and for the fiscal year ended March 31, 2019 and notes thereto included in the Company's fiscal 2019 Annual Report on Form 10-K.
The results of operations and cash flows for the interim periods included in these condensed consolidated financial statements are not necessarily indicative of the results to be expected for any future period or the entire fiscal year.
USE OF ESTIMATES
The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and equity and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates, including, but not limited to, those related to bad debts, returns reserve for expected cancellations, fair value of and/or potential impairment of goodwill and intangible assets, capitalization of internally developed software, benefit period for deferred commissions, stock-based compensation, discount rate used to calculate operating lease liabilities, income and sales tax liabilities, convertible senior notes fair value, litigation, and other contingencies. The Company bases its estimates on known facts and circumstances, historical experience, and various other assumptions. Actual results could differ from those estimates under different assumptions or conditions.
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RECLASSIFICATIONS AND OTHER CHANGES
Certain prior year amounts in the statements of cash flows have been reclassified to conform with current year presentation.
SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies used in preparation of these condensed consolidated financial statements are disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2019 filed with the SEC on May 21, 2019, and there have been no changes to the Company's significant accounting policies during the three and nine months ended December 31, 2019 except for the accounting policies described below that were updated as a result of adopting Accounting Standards Update ("ASU") 2016-02, Leases. All amounts and disclosures set forth herein are in compliance with this standard.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
Effective April 1, 2019, the Company adopted ASU No. 2016-02 (“ASU 2016-02”), Leases using the modified retrospective transition approach utilizing the effective date as the date of initial application. ASU 2016-02 establishes a new lease accounting model for leases, which requires lessees to recognize right-of-use assets and lease liabilities on the balance sheet, but lease expense will be recognized on the income statement in a manner similar to previous requirements. Prior years presented have not been adjusted for ASU 2016-02 and continue to be reported in accordance with our historical accounting policy.
The new standard provides a number of optional practical expedients in transition. The Company has elected certain practical expedients permitted under the new lease standard, which among other things, allows the carryforward of the historical lease classification. As a result, there was no impact to opening retained earnings. The new standard also provides a practical expedient for an entity’s ongoing accounting. The Company has elected such practical expedient to not separate lease and non-lease components for all leases. It also made an accounting policy election to not recognize right-of-use assets and lease liabilities on the balance sheet for leases with a term of 12 months or less and will recognize lease payments as an expense on a straight-line basis over the lease term.
The adoption of the new lease standard resulted in the recognition of right-of-use assets and lease liabilities of approximately $20.0 million and $21.4 million, respectively, for existing operating leases. The Company does not have significant finance lease right-of-use assets or liabilities. The adoption of the new lease standard did not have a material impact on the Company's accumulated deficit as of April 1, 2019. For additional information on leases and the impact of the new lease standard, refer to Note 7.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2019, the Financial Accounting Standards Board (the "FASB") issued ASU 2019-02, Income Taxes (Topic 740), which enhances and simplifies various aspects of the income tax accounting guidance, including requirements such as tax basis step-up in goodwill obtained in a transaction that is not a business combination, ownership changes in investments, and interim-period accounting for enacted changes in tax law. The amendment will be effective for public companies with fiscal years beginning after December 15, 2020, which is fiscal 2022 for the Company; early adoption is permitted. The Company is currently assessing the impact of this pronouncement to its consolidated financial statements.
In November 2019, the FASB issued ASU 2019-08, Compensation - Stock Compensation (Topic 718). The amendment requires that an entity measure and classify share-based payment awards granted to a customer by applying the guidance in Topic 718. The amount recorded as a reduction of the transaction price is required to be measured on the basis of the grant-date fair value of the share-based payment award in accordance with Topic 718. The amendments in this update are effective for fiscal years beginning after December 15, 2019, which is fiscal 2021 for the Company; early adoption is permitted. The Company is currently assessing the impact of this pronouncement to its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820), which makes modifications to disclosure requirements on fair value measurements. The amendment is effective for public companies with fiscal years beginning after December 15, 2019, which is fiscal 2021 for the Company; early adoption is permitted. The Company is currently assessing the impact of this pronouncement to its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal Use Software (Subtopic 350-40), which reduces complexity for the accounting for costs of implementing a cloud computing service arrangement. The amendment is effective for public companies with fiscal years beginning after December 15,
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2019, which is fiscal 2021 for the Company; early adoption is permitted. The Company is currently assessing the impact of this pronouncement to its consolidated financial statements.
In June 2016, the FASB issued ASU 2016‑13, Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. The new model uses a forward‑looking expected loss method, which will generally result in earlier recognition of allowances for losses. In November 2018, the FASB issued ASU 2018‑19, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, which clarifies that receivables arising from operating leases are not within the scope of Topic 326, Financial Instruments—Credit Losses. Instead, impairment of receivables arising from operating leases should be accounted for in accordance with Topic 842, Leases. In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which clarifies treatment of certain credit losses. In May 2019, the FASB issued ASU 2019-05, Financial Instruments — Credit Losses (Topic 326): Targeted Transition Relief, which permits an entity, upon adoption of ASU 2016-13, to irrevocably elect the fair value option (on an instrument-by-instrument basis) for eligible financial assets measured at amortized cost basis. In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, which included various narrow-scope improvements and clarifications. In November 2019, FASB issued ASU No. 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). These ASUs are effective for annual and interim periods beginning after December 15, 2019, which is fiscal 2021 for the Company; early adoption is permitted. The Company is currently assessing the impact of this pronouncement to its consolidated financial statements.
3. REVENUE RECOGNITION
Revenue Recognition
The Company recognizes service revenue, mainly from subscription services to its cloud-based voice, contact center, video, collaboration and communication APIs solutions using the five-step model as prescribed by ASC 606, Revenue from Contracts with Customers:
• | Identification of the contract, or contracts, with a customer; |
• | Identification of the performance obligations in the contract; |
• | Determination of the transaction price; |
• | Allocation of the transaction price to the performance obligations in the contract; and |
• | Recognition of revenue when or as the Company satisfies a performance obligation. |
The Company identifies performance obligations in contracts with customers, which may include subscription services and related usage, products, and professional services. The transaction price is determined based on the amount the Company expects to be entitled to receive in exchange for transferring the promised services or products to the customer. The transaction price in the contract is allocated to each distinct performance obligation in an amount that represents the relative amount of consideration expected to be received in exchange for satisfying each performance obligation. Revenue is recognized when performance obligations are satisfied. Revenues are recorded based on the transaction price, excluding amounts collected on behalf of third parties such as sales and telecommunication taxes, which are collected on behalf of and remitted to governmental authorities. The Company usually bills its customers on a monthly basis. Contracts typically range from annual to multi-year agreements with payment terms of net 30-days or less. The Company occasionally allows a 30-day period to cancel a subscription and return products shipped for a full refund.
Judgments and Estimates
The estimation of variable consideration for each performance obligation requires the Company to make subjective judgments. The Company has service-level agreements with customers warranting defined levels of uptime reliability and performance. Customers may get credits or refunds if the Company fails to meet such levels. If the services do not meet certain criteria, fees are subject to adjustment or refund representing a form of variable consideration. The Company may impose minimum revenue commitments ("MRC") on its customers at the inception of the contract. Thus, in estimating variable consideration for each of these performance obligations, the Company assesses both the probability of MRC occurring and the collectability of the MRC, of which both represent a form of variable consideration.
The Company enters into contracts with customers that regularly include promises to transfer multiple services and products, such as subscriptions, products, and professional services. For arrangements with multiple services, the
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Company evaluates whether the individual services qualify as distinct performance obligations. In its assessment of whether a service is a distinct performance obligation, the Company determines whether the customer can benefit from the service on its own or with other readily available resources, and whether the service is separately identifiable from other services in the contract. This evaluation requires the Company to assess the nature of each individual service offering and how the services are provided in the context of the contract, including whether the services are significantly integrated, highly interrelated, or significantly modify each other, which may require judgment based on the facts and circumstances of the contract.
When agreements involve multiple distinct performance obligations, the Company allocates arrangement consideration to all performance obligations at the inception of an arrangement based on the relative standalone selling prices ("SSP") of each performance obligation. Usage fees deemed to be variable consideration meet the allocation exception for variable consideration. Where the Company has standalone sales data for its performance obligations which are indicative of the price at which the Company sells a promised good or service separately to a customer, such data is used to establish SSP. In instances where standalone sales data is not available for a particular performance obligation, the Company estimates SSP by the use of observable market and cost-based inputs. The Company continues to review the factors used to establish list price and will adjust standalone selling price methodologies as necessary on a prospective basis.
Service Revenue
Service revenue from subscriptions to the Company's cloud-based technology platform is recognized over time on a ratable basis over the contractual subscription term beginning on the date that the platform is made available to the customer. Payments received in advance of subscription services being rendered are recorded as a deferred revenue. Usage fees from our unified communications as a service ("UCaaS") and contact center as a service ("CCaaS") offerings, either bundled or not bundled, are recognized as revenue when earned. Usage fees for our communication platform as a service ("CPaaS") offerings are typically invoiced monthly in arrears and recognized as revenues when earned. Professional services for configuration, system integration, optimization, customer training or education are primarily billed on a fixed-fee basis and are performed by the Company directly or, alternatively, customers may also choose to perform these services themselves or engage their own third-party service providers. Professional services revenue is recognized over time as the services are rendered.
When a contract with a customer is signed, the Company assesses whether collection of the fees under the arrangement is probable. The Company estimates the amount to reserve for uncollectible amounts based on the aging of the contract balance, current and historical customer trends, and communications with its customers. These reserves are recorded as operating expenses against the contract asset (Accounts Receivable). In the normal course of business, the Company records revenue reductions for customer credits.
Product Revenue
The Company recognizes product revenue for telephony equipment at a point in time, when transfer of control has occurred, which is generally upon shipment. Sales returns are recorded as a reduction to revenue estimated based on historical experience.
Contract Assets
Contract assets are recorded for those parts of the contract consideration not yet invoiced but for which the performance obligations are completed. The revenue is recognized when the customer receives services or equipment for a reduced consideration at the onset of an arrangement, for example, when the initial month's services or equipment are discounted. Contract assets are included in other current or non-current assets in the condensed consolidated balance sheets, depending on if their reduction will be recognized during the succeeding twelve-month period or beyond.
Deferred Revenue
Deferred revenues represent billings or payments received in advance of revenue recognition and is recognized upon transfer of control. Balances consist primarily of annual plan subscription services and professional and training services not yet provided as of the balance sheet date. Deferred revenues that will be recognized during the succeeding twelve-month period are recorded as current deferred revenues in the condensed consolidated balance sheets, with the remainder recorded as other non-current liabilities in the condensed consolidated balance sheets.
Costs to Obtain a Customer Contract
Sales commissions and related expenses are considered incremental and recoverable costs of acquiring customer contracts. These costs are capitalized as current or non-current assets and amortized on a straight-line basis over the anticipated benefit period, which is five years. The benefit period was estimated by taking into consideration the
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length of customer contracts, technology lifecycle, and other factors. This amortization expense is recorded in sales and marketing expense within the Company's condensed consolidated statement of operations.
Disaggregation of Revenue
The Company disaggregates its revenue by geographic region. See Note 13 for more information.
Contract Balances
The following table provides information about receivables, contract assets and deferred revenues from contracts with customers (in thousands):
December 31, 2019 | |||
Accounts receivable, net | $ | 37,384 | |
Contract assets - current | $ | 10,507 | |
Contract assets - non-current | $ | 8,413 | |
Deferred revenue - current | $ | 7,216 | |
Deferred revenue - non-current | $ | 1,411 | |
Changes in the contract assets and the deferred revenue balances during the nine months ended December 31, 2019 are as follows (in thousands):
December 31, 2019 | March 31, 2019 | $ Change | ||||||||||
Contract assets | $ | 18,920 | $ | 5,717 | $ | 13,203 | ||||||
Deferred revenue | $ | 8,627 | $ | 3,342 | $ | 5,285 | ||||||
The change in contract assets was primarily driven by the recognition of revenue that has not yet been billed, net of amounts billed during the period. The increase in deferred revenues was due to billings in advance of performance obligations being satisfied, net of revenue recognized for services rendered during the period. Revenues of $2.9 million were recognized during the nine months ended December 31, 2019, of which were included in the deferred revenues balance at the beginning of the period, which was offset by additional deferrals during the period.
Remaining Performance Obligations
The Company's subscription terms typically range from one to four years. Contract revenue as of December 31, 2019 that has not yet been recognized was approximately $245.0 million. This excludes contracts with an original expected length of one year or less. The Company expects to recognize revenue on most of the remaining performance obligation over the next 36 months.
4. FAIR VALUE MEASUREMENTS
Cash, cash equivalents, and available-for-sale investments (in thousands):
Amortized | Gross Unrealized | Gross Unrealized | Estimated | Cash and Cash | Short-Term | Long-Term | |||||||||||||||
As of December 31, 2019 | Costs | Gain | Loss | Fair Value | Equivalents | Investments | Investments | ||||||||||||||
Cash | $ | 22,722 | $ | — | $ | — | $ | 22,722 | $ | 22,722 | $ | — | $ | — | |||||||
Level 1: | |||||||||||||||||||||
Money market funds | 157,401 | — | — | 157,401 | 157,401 | — | — | ||||||||||||||
Treasury securities | 6,498 | 13 | — | 6,511 | — | — | 6,511 | ||||||||||||||
Subtotal | 186,621 | 13 | — | 186,634 | 180,123 | — | 6,511 | ||||||||||||||
Level 2: | |||||||||||||||||||||
Corporate bonds | 36,181 | 93 | — | 36,274 | — | 22,659 | 13,615 | ||||||||||||||
Commercial paper | 8,835 | 1 | — | 8,836 | 4,671 | 4,165 | — | ||||||||||||||
Municipal securities | 1,345 | — | — | 1,345 | — | 1,345 | — | ||||||||||||||
Agency bonds | 2,099 | 15 | — | 2,114 | — | 2,114 | — | ||||||||||||||
Subtotal | 48,460 | 109 | — | 48,569 | 4,671 | 30,283 | 13,615 | ||||||||||||||
Total assets | $ | 235,081 | $ | 122 | $ | — | $ | 235,203 | $ | 184,794 | $ | 30,283 | $ | 20,126 | |||||||
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Amortized | Gross Unrealized | Gross Unrealized | Estimated | Cash and Cash | Short-Term | |||||||||||||
As of March 31, 2019 | Costs | Gain | Loss | Fair Value | Equivalents | Investments | ||||||||||||
Cash | $ | 25,364 | $ | — | $ | — | $ | 25,364 | $ | 25,364 | $ | — | ||||||
Level 1: | ||||||||||||||||||
Money market funds | 251,219 | — | — | 251,219 | 251,219 | — | ||||||||||||
Subtotal | 276,583 | — | — | 276,583 | 276,583 | — | ||||||||||||
Level 2: | ||||||||||||||||||
Corporate debt | 46,516 | 51 | (29 | ) | 46,538 | — | 46,538 | |||||||||||
Municipal securities | 5,511 | 17 | — | 5,528 | — | 5,528 | ||||||||||||
Asset backed securities | 13,596 | 9 | (17 | ) | 13,588 | — | 13,588 | |||||||||||
Agency bonds | 4,260 | — | (15 | ) | 4,245 | — | 4,245 | |||||||||||
Subtotal | 69,883 | 77 | (61 | ) | 69,899 | — | 69,899 | |||||||||||
Total assets | $ | 346,466 | $ | 77 | $ | (61 | ) | $ | 346,482 | $ | 276,583 | $ | 69,899 | |||||
Historically, the Company had maintained all investments as short-term investments on its balance sheet, as the Company could liquidate these investments at any time and did not limit its liquidation of investments by contractual maturity date. Given the recent issuance of the convertible senior notes, and the associated increased cash, cash equivalents and investment balances, the Company expects to hold certain investments for at least 12 months from the reporting date and records these investments in long-term investments in accordance with the contractual maturity dates.
As of December 31, 2019, the estimated fair value of the Company's outstanding convertible senior notes ("the Notes") was $362.3 million. The estimated fair value of the Notes was determined based on the closing price for the Notes on the last trading day of the reporting period and is considered as Level 2 in the fair value hierarchy.
5. BUSINESS COMBINATIONS
Wavecell Acquisition
On July 17, 2019, the Company entered into a Share Purchase Agreement (the “Share Purchase Agreement”) with Wavecell Pte. Ltd., a corporation incorporated under the laws of the Republic of Singapore (“Wavecell”), the equity holders of Wavecell (collectively, the “Sellers”), and Qualgro Partners Pte. Ltd., in its capacity as the representative of the equity holders of Wavecell. Pursuant to the Share Purchase Agreement, the Company acquired all of the outstanding shares and other equity interests of Wavecell (the “Transaction”). This Transaction extends 8x8’s technology advantage as a fully-owned, cloud technology platform with UCaaS, CCaaS, video communication as a service ("VCaaS") and CPaaS solutions able to natively offer pre-packaged communications, contact center and video solutions and open APIs to embed these and other communications into an organization’s core business processes.
The total fair value of the purchase consideration of approximately $117.1 million was comprised of approximately $72.8 million in cash and $44.3 million in shares of common stock of the Company, of which approximately $10.4 million in cash and $8.5 million in equity have been heldback to cover potential indemnity claims made by the Company after the closing date. One-third of these heldback amounts are eligible to be released in twelve months from the date of the Transaction and the remainder in eighteen months from the date of the Transaction. The heldback cash of $3.5 million and $6.9 million are recorded in restricted cash, current and restricted cash, non-current, respectively and other accrued liabilities and other liabilities, non-current, respectively, in the Company's condensed consolidated balance sheet. The holdback of $8.5 million in equity, of which $2.8 million is included in current other accrued liabilities, and $5.7 million is included in other liabilities, non-current, is reflected in the Company's condensed consolidated balance sheet. Additionally, in connection with the Transaction, the Company issued $13.2 million in time-based restricted stock awards and $6.6 million in performance based restricted stock awards all of which vest over the next three years, and which the Company will expense over the same such period.
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The major classes of assets and liabilities to which the Company has preliminarily allocated the fair value of purchase consideration were as follows (in thousands):
July 17, 2019 | ||||
Cash | $ | 4,473 | ||
Accounts receivable | 9,438 | |||
Intangible assets | 21,010 | |||
Other assets | 787 | |||
Goodwill | 91,060 | |||
Accounts payable | (9,548 | ) | ||
Deferred revenue | (90 | ) | ||
Total consideration | $ | 117,130 | ||
The acquisition has been accounted for as a business combination under the acquisition method and, accordingly, the total purchase price is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair value on the acquisition date. The fair value of assets acquired and liabilities assumed from the acquisition of Wavecell is based on a preliminary valuation and, as such, the Company's estimates and allocations to certain assets, liabilities, and tax estimates are subject to change within the measurement period as additional information becomes available. The goodwill recognized was primarily attributed to increased synergies that are expected to be achieved from the integration of Wavecell and is not expected to be deductible for income tax purposes.
The preliminary value of the acquired intangible assets acquired are as follows (in thousands):
Fair Value | Useful life (in Years) | |||||
Trade and domain names | $ | 990 | 3 | |||
Developed technology | 13,830 | 7 | ||||
Customer relationships | 6,190 | 7 | ||||
Total intangible assets | $ | 21,010 | ||||
The Company incurred costs related to this acquisition of approximately $1.8 million during the nine months ended December 31, 2019. All acquisition related costs were expensed as incurred and have been recorded in general and administrative expenses in the accompanying consolidated statements of operations.
The revenue and earnings of the acquired business have been included in the Company’s results since the acquisition date and are not material to the Company’s condensed consolidated financial results. Pro forma results of operations for this acquisition have not been presented, as the financial impact to the Company’s condensed consolidated financial statements is not material.
Jitsi Acquisition
On October 29, 2018, the Company entered into an Asset Purchase Agreement with Atlassian Corporation PLC ("Atlassian") through which the Company purchased certain assets from Atlassian. The asset purchase from Atlassian did not contribute materially to revenue or net loss from the date of acquisition to December 31, 2018.
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6. INTANGIBLE ASSETS AND GOODWILL
The carrying value of intangible assets consisted of the following (in thousands):
December 31, 2019 | March 31, 2019 | |||||||||||||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||||||
Developed technology | $ | 33,685 | $ | (14,497 | ) | $ | 19,188 | $ | 25,702 | $ | (15,409 | ) | $ | 10,293 | ||||||||||
Customer relationships | 11,601 | (5,297 | ) | 6,304 | 9,467 | (8,080 | ) | 1,387 | ||||||||||||||||
Trade and domain names | 1,128 | (165 | ) | 963 | 2,108 | (2,108 | ) | — | ||||||||||||||||
Total acquired identifiable intangible assets | $ | 46,414 | $ | (19,959 | ) | $ | 26,455 | $ | 37,277 | $ | (25,597 | ) | $ | 11,680 | ||||||||||
At December 31, 2019, annual amortization of intangible assets, based upon our existing intangible assets and current useful lives, is estimated to be the following (in thousands):
Amount | |||
Remaining 2020 | $ | 2,326 | |
2021 | 6,755 | ||
2022 | 4,946 | ||
2023 | 3,162 | ||
2024 | 2,851 | ||
Thereafter | 6,415 | ||
Total | $ | 26,455 | |
The following table provides a summary of the changes in the carrying amounts of goodwill (in thousands):
Total | |||
Balance at March 31, 2019 | $ | 39,694 | |
Additions due to acquisitions | 91,060 | ||
Foreign currency translation | 246 | ||
Balance at December 31, 2019 | $ | 131,000 | |
7. RIGHT-OF-USE ASSETS AND LEASES
The Company primarily leases facilities for office and data center space under non-cancellable operating leases for its U.S. and international locations that expire at various dates through 2030. For leases with a term greater than 12 months, the Company recognizes a right-of-use asset and a lease liability based on the present value of lease payments over the lease term. Variable lease payments are not included in the lease payments to measure the lease liability and are expensed as incurred. The Company’s leases have remaining terms of one to eleven years and some of the leases include a Company option to extend the lease term for less than twelve months to five years, or more, which if reasonably certain to exercise, the Company includes in the determination of lease payments. The lease agreements do not contain any material residual value guarantees or material restrictive covenants.
As most of the Company's leases do not provide a readily determinable implicit rate, the Company uses the incremental borrowing rate at lease commencement, which was determined using a portfolio approach, based on the rate of interest that the Company would have to pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. The Company uses the implicit rate when a rate is readily determinable. Operating lease expense is recognized on a straight-line basis over the lease term.
Leases with an initial term of 12 months or less are not recognized on the balance sheet and the expense for these short-term leases is recognized on a straight-line basis over the lease term. Common area maintenance fees (or CAMs) and other charges related to these leases continue to be expensed as incurred. The following table provides
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balance sheet information related to leases as of December 31, 2019 (in thousands):
December 31, 2019 | ||||
Assets | ||||
Operating lease, right-of-use assets | $ | 77,062 | ||
Liabilities | ||||
Operating lease liabilities, current | $ | 4,320 | ||
Operating lease liabilities, non-current | 86,187 | |||
Total operating lease liabilities | $ | 90,507 | ||
During the three and nine months ended December 31, 2019, operating lease expense was approximately $4.4 million and $10.7 million, respectively. Variable lease cost and short-term lease cost were immaterial during the three and nine months ended December 31, 2019.
The following table presents supplemental information for the nine months ended December 31, 2019 (in thousands, except for weighted average):
Weighted average remaining lease term | 9.2 years | |||
Weighted average discount rate | 4.0 | % | ||
Cash paid for amounts included in the measurement of lease liabilities | $ | 7,207 | ||
Operating cash flow from operating leases | $ | 7,207 | ||
The following table presents maturity of lease liabilities under the Company's non-cancellable operating leases as of December 31, 2019 (in thousands):
Remaining 2020 | $ | 2,674 | ||
2021 | 8,609 | |||
2022 | 14,324 | |||
2023 | 11,724 | |||
2024 | 11,765 | |||
Thereafter | 69,554 | |||
Total lease payments | $ | 118,650 | ||
Less: imputed interest | (22,003 | ) | ||
Less: lease incentives receivable | (6,140 | ) | ||
Present value of lease liabilities | $ | 90,507 | ||
The Company entered into an operating lease for an office space that has not yet commenced and as such, have not yet been recognized on the Company's condensed consolidated balance sheet as of December 31, 2019. The contractual obligation for this lease is $2.9 million.
The Company's lease agreement (the "Agreement") with CAP Phase I, a Delaware limited liability company (the "Landlord") for the Coleman property is not included in the right-of-use assets and operating lease liabilities as of December 31, 2019. On April 30, 2019, the Company entered into an assignment and assumption of the Company's previously executed lease agreement with the Landlord, and Roku Inc., a Delaware corporation ("Roku"), whereby the Company assigned to Roku this lease that had been executed between the Company and the Landlord on January 23, 2018. Pursuant to the Agreement, the Company expects to be released from all of its obligations under the lease and related standby letter of credit by the end of the Company’s fiscal year ending March 31, 2022, or shortly thereafter.
On July 3, 2019, the Company entered into a lease for a new company headquarters to rent 177,815 square feet of office space as the sole tenant in a new five-story office building located in Campbell, California.
The lease is for a 132-month term that started on January 1, 2020. The Company has the option to extend the lease for two additional five-year terms, on substantially the same terms and conditions as the prior term, with the base rent rate adjusted to fair market value at that time.
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Base rent is approximately $0.7 million per month for the first 12 months of the lease, with the rate increasing by approximately 3% on each anniversary of the lease. The Company is responsible for paying its share of building and common area expenses. The Company is entitled to full rent abatement during the first 12 months of the lease term. The Company is also entitled to a tenant improvement allowance of approximately $15.4 million. The Company paid to the landlord a security deposit in the amount of $2.0 million, which may be drawn down in the event the Company defaults under the lease. The Company recognized an operating lease right-of-use asset and operating lease liability during second quarter of fiscal 2020, when the Company was given full access to the leased property. This new lease increased our operating lease right-of-use assets by $56.8 million and our operating lease liabilities by $56.1 million.
8. COMMITMENTS AND CONTINGENCIES
Other Commitments, Indemnifications and Contingencies
From time to time the Company receives inquiries from various state and municipal taxing agencies with respect to the remittance of sales, use, telecommunications, excise, and income taxes. Several jurisdictions currently are conducting tax audits of the Company's records. The Company collects from its customers or has accrued for taxes that it believes are required to be remitted. The amounts that have been remitted have historically been within the accruals established by the Company. The Company adjusts its accrued taxes when facts relating to specific exposures warrant such adjustment.
Legal Proceedings
The Company from time to time may be involved in a variety of claims, lawsuits, investigations and other proceedings, including patent infringement claims, employment litigation, regulatory compliance matters and contractual disputes, that can arise in the normal course of the Company's operations. The Company accrues a liability when management believes information available prior to the issuance of the financial statements indicates it is probable a loss has been incurred as of the date of the financial statements and the amount of loss can be reasonably estimated. The Company adjusts its accruals to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Legal costs are expensed as incurred.
As of December 31, 2019, the Company does not have any material provisions for any such lawsuits, claims and proceedings and believes it is not probable that a loss had been incurred. Litigation is inherently unpredictable and subject to significant uncertainties. While there can be no assurances that favorable final outcomes will be obtained, the Company believes it has valid defenses with respect to legal matters pending against it. Future litigation could be costly to defend, could impose significant burdens on employees and cause the diversion of management's attention, and could upon resolution have a material adverse effect on the Company's business, results of operations, financial condition and cash flows.
9. CONVERTIBLE SENIOR NOTES AND CAPPED CALL
Convertible Senior Notes
In February 2019, the Company issued $287.5 million aggregate principal amount of 0.50% convertible senior notes (the "Initial Notes") due 2024 in a private placement, including the exercise in full of the initial purchasers' option to purchase additional notes. The Initial Notes are senior unsecured obligations of the Company and interest is payable semiannually in arrears on February 1 and August 1 of each year, beginning on August 1, 2019. The Initial Notes will mature on February 1, 2024, unless earlier repurchased, redeemed, or converted. The total net proceeds from the debt offering, after deducting initial purchase discounts, debt issuance costs, and costs of the capped call transactions described below, were approximately $245.8 million.
In November 2019, the Company issued an additional $75 million aggregate principal amount of 0.50% convertible senior notes (the "Additional Notes" and together with the Initial Notes, the "Notes") due 2024 in a registered offering under the same indenture as the Initial Notes. The total net proceeds from the Additional Notes, after deducting underwriting discounts, debt issuance costs, and costs of the capped call transactions described below, were approximately $64.6 million. The Additional Notes constitute a further issuance of, and form a single series with, the Company’s outstanding 0.50% convertible senior notes due 2024 issued in February 2019 in the aggregate principal amount of $287.5 million. Immediately after giving effect to the issuance of the Additional Notes, the Company has $362.5 million aggregate principal amount of convertible senior notes.
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The Notes are senior unsecured obligations of the Company and interest is payable semiannually in arrears on February 1 and August 1 of each year, beginning on February 1, 2020. The Notes will mature on February 1, 2024, unless earlier repurchased, redeemed, or converted.
Each $1,000 principal amount of the Notes are initially convertible into 38.9484 shares of the Company’s common stock, par value $0.001, which is equivalent to an initial conversion price of approximately $25.68 per share. The conversion rate is subject to adjustment upon the occurrence of certain specified events but will not be adjusted for any accrued and unpaid interest. In addition, upon the occurrence of certain corporate events that occur prior to the maturity date or following the Company's issuance of a notice of redemption, in each case as described in the Indenture, the Company will, in certain circumstances, increase the conversion rate for a holder that elects to convert its Notes in connection with such a corporate event or during the relevant redemption period.
The Notes will be convertible at certain times and upon the occurrence of certain events in the future. Further, on or after October 1, 2023, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or any portion of their Notes, regardless of the foregoing circumstances.
Upon conversion, the Company will satisfy its conversion obligation by paying or delivering, as the case may be, cash, shares of common stock, or a combination of cash and shares of common stock, at the Company's election. The Company’s current intent is to settle the principal amount of the Notes in cash upon conversion.
During the three and nine months ended December 31, 2019, the conditions allowing holders of the Notes to convert were not met.
The Company may not redeem the Notes prior to February 4, 2022. On or after February 4, 2022, the Company may redeem for cash all or part of the Notes, at the redemption price equal to 100% of the principal amount thereof, plus accrued and unpaid interest, if the last reported sale price of the common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which the Company provides a redemption notice. If a fundamental change (as defined in the indenture governing the notes) occurs at any time, holders of Notes may require the Company to repurchase for cash all or any portion of their Notes at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date.
The Notes are senior unsecured obligations and will rank senior in right of payment to any of the Company’s indebtedness that is expressly subordinated in right of payment to the Notes, equal in right of payment with the Company’s existing and future liabilities that are not so subordinated, effectively junior in right of payment to any of the Company’s secured indebtedness to the extent of the value of the assets securing such indebtedness, and structurally junior to all indebtedness and other liabilities (including trade payables) of current or future subsidiaries of the Company.
The net carrying amount of the liability component of the Notes was as follows (in thousands):
Interest expense related to the Notes was as follows (in thousands):
December 31, 2019 | March 31, 2019 | |||||||
Principal | $ | 362,500 | $ | 287,500 | ||||
Unamortized premium | 1,323 | — | ||||||
Unamortized debt discount | (75,315 | ) | (70,876 | ) | ||||
Unamortized issuance costs | (1,043 | ) | (589 | ) | ||||
Net carrying amount | $ | 287,465 | $ | 216,035 | ||||
Three Months Ended | Nine Months Ended | |||||||
December 31, 2019 | December 31, 2019 | |||||||
Contractual interest expense | $ | 400 | $ | 1,119 | ||||
Amortization of debt premium | (31 | ) | — | |||||
Amortization of debt discount | 3,582 | 9,926 | ||||||
Amortization of issuance costs | 40 | 92 | ||||||
Total interest expense | $ | 3,991 | $ | 11,137 | ||||
Capped Call
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In connection with the pricing of the Initial Notes and Additional Notes, the Company entered into privately negotiated capped call transactions ("Capped Calls") with certain counterparties. The Capped Calls each have an initial strike price of approximately $25.68 per share, subject to certain adjustments, which corresponds to the initial conversion price of the Notes. The Capped Calls have initial cap prices of $39.50 per share, subject to certain adjustments. The Capped Calls are expected to partially offset the potential dilution to the Company’s Common Stock upon any conversion of the Notes, with such offset subject to a cap based on the cap price. The Capped Calls cover, subject to anti-dilution adjustments, approximately 14.1 million shares of the Company’s Common Stock. The Capped Calls are subject to adjustment upon the occurrence of specified extraordinary events affecting the Company, including merger events, tender offers and announcement events. In addition, the Capped Calls are subject to certain specified additional disruption events that may give rise to a termination of the Capped Calls, including nationalization, insolvency or delisting, changes in law, failures to deliver, insolvency filings and hedging disruptions. For accounting purposes, the Capped Calls are separate transactions, and not part of the terms of the Notes. As these transactions meet certain accounting criteria, the Capped Calls are recorded in stockholders' equity and are not accounted for as derivatives. The cost of $33.7 million incurred to purchase the Capped Calls in connection with the Initial Notes and $9.3 million in connection with the Additional Notes were recorded as a reduction to additional paid-in capital and will not be remeasured.
10. STOCK-BASED COMPENSATION
The following tables summarize information pertaining to the stock-based compensation expense from stock options and stock awards (in thousands, except weighted-average grant-date fair value and recognition period):
Three Months Ended December 31, | Nine Months Ended December 31, | |||||||||||||||
2019 | 2018 | 2019 | 2018 | |||||||||||||
Cost of service revenue | $ | 2,226 | $ | 1,562 | $ | 5,896 | $ | 3,967 | ||||||||
Research and development | 5,535 | 3,570 | 13,616 | 8,587 | ||||||||||||
Sales and marketing | 5,197 | 3,798 | 14,458 | 8,402 | ||||||||||||
General and administrative | 6,359 | 3,605 | 16,335 | 10,619 | ||||||||||||
Total | $ | 19,317 | $ | 12,535 | $ | 50,305 | $ | 31,575 | ||||||||
Nine Months Ended December 31, | ||||||||
2019 | 2018 | |||||||
Stock options outstanding at the beginning of the period: | 3,114 | 3,998 | ||||||
Options granted | — | 222 | ||||||
Options exercised | (391 | ) | (641 | ) | ||||
Options canceled and forfeited | (55 | ) | (192 | ) | ||||
Options outstanding at the end of the period: | 2,668 | 3,387 | ||||||
Weighted-average fair value of grants during the period | $ | — | $ | 8.27 | ||||
Total intrinsic value of options exercised during the period | $ | 4,844 | $ | 9,148 | ||||
Weighted-average remaining recognition period at period-end (in years) | 2.16 | 2.53 | ||||||
Stock awards outstanding at the beginning of the period: | 7,820 | 5,939 | ||||||
Stock awards granted | 5,886 | 4,993 | ||||||
Stock awards vested | (2,860 | ) | (2,123 | ) | ||||
Stock awards canceled and forfeited | (1,056 | ) | (700 | ) | ||||
Stock awards outstanding at the end of the period: | 9,790 | 8,109 | ||||||
Weighted-average fair value of grants during the period | $ | 22.35 | $ | 20.05 | ||||
Weighted-average remaining recognition period at period-end (in years) | 2.13 | 2.40 | ||||||
Total unrecognized compensation expense at period-end | $ | 143,593 | $ | 112,970 | ||||
Stock Repurchases
In May 2017, the Company's board of directors authorized the Company to purchase up to $25.0 million of its common stock from time to time (the "2017 Repurchase Plan"). The 2017 Repurchase Plan expires when the maximum purchase amount is reached, or upon the earlier revocation or termination by the board of directors. The remaining amount available under the 2017 Repurchase Plan at December 31, 2019 was approximately $7.1
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million. There were no stock repurchases under the 2017 Repurchase Plan during the three and nine months ended December 31, 2019.
11. INCOME TAXES
The Company's effective tax rate was (0.6)% and (0.5)% for the three months ended December 31, 2019 and 2018, and (0.6)% and for each of the nine months ended December 31, 2019 and 2018. The difference in the effective tax rate and the U.S. federal statutory rate was primarily due to the full valuation allowance the Company continues to maintain against its deferred tax assets. The effective tax rate is calculated by dividing the income tax provision by net loss before income tax expense.
12. NET LOSS PER SHARE
The following table summarizes the computation of basic and diluted net loss per share (in thousands, except share and per share data):
Three Months Ended December 31, | Nine Months Ended December 31, | |||||||||||||||
2019 | 2018 | 2019 | 2018 | |||||||||||||
Numerator: | ||||||||||||||||
Net loss available to common stockholders | $ | (47,071 | ) | $ | (23,771 | ) | $ | (122,268 | ) | $ | (60,608 | ) | ||||
Denominator: | ||||||||||||||||
Common shares - basic and diluted | 99,922 | 95,370 | 99,082 | 94,093 | ||||||||||||
Net loss per share | ||||||||||||||||
Basic and diluted | $ | (0.47 | ) | $ | (0.25 | ) | $ | (1.23 | ) | $ | (0.64 | ) | ||||
The following shares attributable to outstanding stock options and stock awards were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive (in thousands):
Three Months Ended December 31, | Nine Months Ended December 31, | |||||||||||
2019 | 2018 | 2019 | 2018 | |||||||||
Stock options | 2,668 | 3,387 | 2,668 | 3,387 | ||||||||
Stock awards | 9,790 | 8,109 | 9,790 | 8,109 | ||||||||
Contingently issuable shares (hold-back shares) | 350 | — | 350 | — | ||||||||
Potential shares to be issued from ESPP | 387 | — | 387 | — | ||||||||
Total anti-dilutive shares | 13,195 | 11,496 | 13,195 | 11,496 | ||||||||
13. GEOGRAPHICAL INFORMATION
The following tables set forth the geographic information for each period (in thousands):
Three Months Ended December 31, | Nine Months Ended December 31, | |||||||||||||||
2019 | 2018 | 2019 | 2018 | |||||||||||||
Revenue by geographic area: | ||||||||||||||||
United States | $ | 90,171 | $ | 77,606 | $ | 258,847 | $ | 223,690 | ||||||||
International | 28,396 | 12,306 | 65,912 | 35,129 | ||||||||||||
$ | 118,567 | $ | 89,912 | $ | 324,759 | $ | 258,819 | |||||||||
December 31, 2019 | March 31, 2019 | |||||||
Property and equipment by geographic area: | ||||||||
United States | $ | 82,790 | $ | 45,639 | ||||
International | 6,986 | 7,196 | ||||||
$ | 89,776 | $ | 52,835 | |||||
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. As discussed in the section titled “Forward-Looking Statements,” the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this report, particularly those incorporated by reference into this Quarterly Report on Form 10-Q in the section entitled “Risk Factors” discussed under Part II, Item 1A below.
BUSINESS OVERVIEW
We are a leading software-as-a-service (“SaaS”) provider of voice, video, chat, contact center, and enterprise-class API solutions powered by one global cloud communications platform. From our proprietary cloud technology platform, organizations across all their locations and employees have access to unified communications, team collaboration, video conferencing, contact center, data and analytics, communication APIs, and other services, enabling them to be more productive and responsive to their customers.
Our customers range from small businesses to large enterprises and their users are spread across more than 150 countries. In recent years, we have increased our up-market focus on the mid-market and enterprise customer sectors.
We have a portfolio of cloud-based offerings that are subscription based, made available at different rates varying by the specific functionalities, services and number of users. We generate service revenue from software service subscriptions, platform usage, and professional services. We generate product revenues from the sale of office phones and other hardware equipment. We define a “customer” as one or more legal entities to which we provide services pursuant to a single contractual arrangement. In some cases, we may have multiple billing relationships with a single customer (for example, where we establish separate billing accounts for a parent company and each of its subsidiaries).
Our flagship service is our 8x8 X Series, a next generation suite of UCaaS and CCaaS solutions, which consist of service plans designated X1, X2, etc., through X8. With 8x8 X Series, we provide global voice, chat, video and contact center functionalities from a single platform, with a single interface, in the high-end set of our service plans (X5 through X8). We also offer more basic, cost-efficient UCaaS in X1 through X4 and a stand-alone CCaaS offering called 8x8 Contact Center. In July 2019, we acquired Wavecell Pte. Ltd., an Asian-based global CPaaS provider of SMS, messaging, voice and video APIs to enterprises. Also in July 2019, we launched a new self-service e-commerce platform called 8x8 Express.
Prior to the launch of 8x8 X Series in 2018, our customers subscribed to Virtual Office and Virtual Contact Center solutions. We have now begun migrating these customers from these legacy solutions to our 8x8 X Series product suite, and we intend to accelerate the pace of migrations during the remainder of fiscal 2020 and into fiscal 2021. These migrations may require us to incur professional services costs that we may not be able to recover from our customers, but we believe we will realize other benefits by reducing the number of platforms that we are required to support.
SUMMARY AND OUTLOOK
Our third quarter fiscal 2020 results illustrate the fundamental strength in our cloud communications service revenue, which for the quarter was $113.6 million, including revenue from our CPaaS offerings, and reflects growth of 32.2% year-over-year. We continued to show an increase in our average annual service revenue per customer, as we are selling more to mid-market and enterprise customers.
In the second half of fiscal 2018, we de-emphasized profitability as a short-term corporate goal focused instead on making investments necessary to accelerate revenue growth. This decision was based, in part, on our belief that the communications market is at an inflection point in the shift of businesses from legacy on-premise solutions to cloud-based services. We believe that this industry trend will continue in fiscal 2020 and beyond. Accordingly, we believe that it is in the Company's interest to continue to invest in our business to drive revenue growth. With recent successes driving growth in the business, we are also now focused on managing the business to achieve operating efficiencies. We believe that this enables the Company to scale and capture market share during this phase of industry disruption in a cost effective way and support the Company in pursuit of its path to profitability.
We plan to continue making significant investments in activities to acquire more customers, including investing in our direct marketing efforts, sales force, e-commerce, and outbound marketing efforts. We also intend to continue investing in our indirect channel to acquire more third-party selling agents to help sell our solutions, including
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investments in our value added resellers ("VARs") and master agent programs. Should these upfront investments not result in additional revenue from new or existing customers, and/or these cost reduction and efficiency efforts not result in meaningful savings, our operating results may be adversely impacted.
COMPONENTS OF RESULTS OF OPERATIONS
Service Revenue
Service revenue consists of software service subscriptions, platform usage revenue, and professional services revenue from our UCaaS, CCaaS and CPaaS offerings.
We plan to continue to drive our business to increase service revenue through a combination of increased sales and marketing efforts, geographic expansion of our customer base outside the United States, and through strategic acquisitions of technologies and businesses.
Product Revenue
Product revenue consists primarily of revenues from hardware sales of IP telephones in conjunction with our cloud telephony service. Product revenue is dependent on the number of customers who choose to purchase an IP telephone in conjunction with our service instead of using the solution on their cell phone, computer or other compatible devices.
Cost of Service Revenue
Cost of service revenue consists primarily of costs associated with network operations and related personnel, technology licenses, amortization of internally developed software, and other costs such as customer service, deployment and technical support costs. Cost of service revenue also includes other communication origination and termination services provided by third-party carriers and outsourced customer service call center operations. We also allocate overhead costs such as facilities and IT to cost of service, as well as to each of the operating expense categories. Our facilities costs primarily include lease and related expenses and IT costs include costs for IT infrastructure and compensation of IT personnel. We expect that cost of service revenue will increase in absolute dollars in future periods and vary from period-to-period as a percentage of revenue.
Cost of Product Revenue
Cost of product revenue consists primarily of IP telephones, estimated warranty obligations and direct and indirect costs associated with product purchasing, scheduling, shipping and handling.
Research and Development
Research and development expenses consist primarily of personnel and related costs, consulting, third-party development work and equipment costs necessary for us to conduct our development and engineering efforts.
We plan to continue to hire employees to support our research and development efforts to expand the capabilities and scope of our platform and enhance the user experience. While we expect to continue to improve our cost structure and achieve operational efficiencies, we expect that research and development expenses will increase in absolute dollars in future periods and vary from period-to-period as a percentage of revenue.
Sales and Marketing
Sales and marketing expenses consist primarily of personnel and related costs, sales commissions, trade shows, advertising and other marketing, demand generation, channel, and promotional expenses. We plan to continue to invest in sales and marketing to attract and retain customers on our platform and increase our brand awareness. While we expect to continue to improve our cost structure and achieve operational efficiencies, we expect that sales and marketing expenses will increase in absolute dollars in future periods and vary from period-to-period as a percentage of revenue.
General and Administrative
General and administrative expenses consist primarily of personnel and related costs for finance, human resources, legal and general management, as well as professional fees. While we expect to continue to improve our cost structure and achieve operational efficiencies, we expect that our general and administrative expenses will increase in absolute dollars in future periods as we grow our business and vary from period-to-period as a percentage of revenue.
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Other (Expense) Income, net
Other (expense) income, net, consists primarily of interest expense related to the convertible notes, offset by income earned on our cash, cash equivalents and investments.
Provision for Income Taxes
Provision for income taxes consists primarily of state minimum taxes in the United States. As we expand the scale of our international business activities, any changes in the U.S. and foreign taxation of such activities may increase our overall provision for income taxes in the future. We have a valuation allowance for our U.S. deferred tax assets, including federal and state net operating loss carryforwards, or NOLs. We expect to maintain this valuation allowance until it becomes more likely than not that the benefit of our federal and state deferred tax assets will be realized by way of expected future taxable income in the United States.
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our condensed consolidated financial statements and the notes thereto.
Revenue
December 31, | Dollar | Percent | |||||||||||||
Service revenue | 2019 | 2018 | Change | Change | |||||||||||
(dollar amounts in thousands) | |||||||||||||||
Three months ended | $ | 113,566 | $ | 85,911 | $ | 27,655 | 32.2 | % | |||||||
Percentage of total revenue | 95.8 | % | 95.6 | % | |||||||||||
Nine months ended | $ | 310,467 | $ | 245,378 | $ | 65,089 | 26.5 | % | |||||||
Percentage of total revenue | 95.6 | % | 94.8 | % | |||||||||||
Service revenue increased for the three and nine months ended December 31, 2019 compared with the same periods of the previous fiscal year primarily due to an increase in our business customer subscriber base (net of customer churn), an increase in the average service revenue from each customer on a monthly basis and, to a lesser extent, revenue associated with our newly acquired products as compared to the same prior year period.
December 31, | Dollar | Percent | |||||||||||||
Product revenue | 2019 | 2018 | Change | Change | |||||||||||
(dollar amounts in thousands) | |||||||||||||||
Three months ended | $ | 5,001 | $ | 4,001 | $ | 1,000 | 25.0 | % | |||||||
Percentage of total revenue | 4.2 | % | 4.4 | % | |||||||||||
Nine months ended | $ | 14,292 | $ | 13,441 | $ | 851 | 6.3 | % | |||||||
Percentage of total revenue | 4.4 | % | 5.2 | % | |||||||||||
Product revenue increased during the three and nine months ended December 31, 2019 compared with the same period in the prior fiscal year primarily due to increased equipment unit sales to customers during the three months ended December 31, 2019.
No customer represented greater than 10% of the Company's total revenue for the three and nine months ended December 31, 2019 or 2018.
Cost of Revenue
December 31, | Dollar | Percent | |||||||||||||
Cost of service revenue | 2019 | 2018 | Change | Change | |||||||||||
(dollar amounts in thousands) | |||||||||||||||
Three months ended | $ | 49,326 | $ | 27,632 | $ | 21,694 | 78.5 | % | |||||||
Percentage of service revenue | 43.4 | % | 32.2 | % | |||||||||||
Nine months ended | $ | 124,488 | $ | 78,383 | $ | 46,105 | 58.8 | % | |||||||
Percentage of service revenue | 40.1 | % | 31.9 | % | |||||||||||
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Cost of service revenue for the three months ended December 31, 2019 increased over the same prior year period and faster than revenue growth due to increases related to our newly acquired CPaaS products combined with increased overhead allocation expense, as well as a $2.5 million increase in personnel and related costs, a $2.3 million increase in amortization of intangibles and capitalized software expenses and a $0.6 million increase in stock-based compensation costs, as well as other smaller increases.
Cost of service revenue for the nine months ended December 31, 2019 increased over the same prior year period and faster than revenue growth due to increases related to our newly acquired CPaaS products combined with increased overhead allocation expense, a $7.4 million increase in personnel and related costs, a $6.4 million increase in amortization of intangibles and capitalized software expenses, a $1.7 million increase in stock-based compensation costs, and a $1.6 million increase in consulting and outside services, as well as other smaller increases.
December 31, | Dollar | Percent | |||||||||||||
Cost of product revenue | 2019 | 2018 | Change | Change | |||||||||||
(dollar amounts in thousands) | |||||||||||||||
Three months ended | $ | 6,893 | $ | 5,318 | $ | 1,575 | 29.6 | % | |||||||
Percentage of product revenue | 137.8 | % | 132.9 | % | |||||||||||
Nine months ended | $ | 19,119 | $ | 16,996 | $ | 2,123 | 12.5 | % | |||||||
Percentage of product revenue | 133.8 | % | 126.4 | % | |||||||||||
Cost of product revenue for the three and nine months ended December 31, 2019 increased over the same prior year periods primarily due to the increase in the number of telephones shipped to customers. The increase in negative margin was due to the product discounts and promotions during the three and nine months ended December 31, 2019.
Operating Expenses
December 31, | Dollar | Percent | |||||||||||||
Research and development | 2019 | 2018 | Change | Change | |||||||||||
(dollar amounts in thousands) | |||||||||||||||
Three months ended | $ | 19,870 | $ | 16,886 | $ | 2,984 | 17.7 | % | |||||||
Percentage of total revenue | 16.8 | % | 18.8 | % | |||||||||||
Nine months ended | $ | 57,635 | $ | 43,999 | $ | 13,636 | 31.0 | % | |||||||
Percentage of total revenue | 17.7 | % | 17.0 | % | |||||||||||
Research and development expenses for the three months ended December 31, 2019 increased over the same prior year period primarily due to a $2.3 million increase in stock-based compensation expense, a $1.0 million increase in personnel and related costs, and a $0.5 million increase in amortization of capitalized software expenses. These increases were partially offset by capitalization of internally developed software costs.
Research and development expenses for the nine months ended December 31, 2019 increased over the same prior year period primarily due to a $7.4 million increase in personnel and related costs, a $5.9 million increase in stock-based compensation expense, and a $1.8 million increase in amortization of capitalized software expenses, as well as other smaller cost increases. These increases were partially offset by capitalization of internally developed software costs.
December 31, | Dollar | Percent | |||||||||||||
Sales and marketing | 2019 | 2018 | Change | Change | |||||||||||
(dollar amounts in thousands) | |||||||||||||||
Three months ended | $ | 63,099 | $ | 46,276 | $ | 16,823 | 36.4 | % | |||||||
Percentage of total revenue | 53.2 | % | 51.5 | % | |||||||||||
Nine months ended | $ | 174,593 | $ | 128,451 | $ | 46,142 | 35.9 | % | |||||||
Percentage of total revenue | 53.8 | % | 49.6 | % | |||||||||||
Sales and marketing expenses for the three months ended December 31, 2019 increased over the same prior year period primarily due to a $5.4 million increase in third-party commission expenses, a $4.5 million increase in personnel and related costs, a $4.4 million increase in advertising and marketing expenses, and a $1.2 million
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increase in stock-based compensation costs, as well as other smaller cost increases. These cost increases were partially offset by $4.6 million in commission costs that were capitalized.
Sales and marketing expenses for the nine months ended December 31, 2019 increased over the same prior year period primarily due to a $15.7 million increase in advertising and marketing expenses, a $14.3 million increase in third-party commission expenses, a $9.3 million increase in personnel and related costs, and a $5.4 million increase in stock-based compensation costs, as well as other smaller cost increases. These cost increases were partially offset by $13.6 million in commission costs that were capitalized.
December 31, | Dollar | Percent | |||||||||||||
General and administrative | 2019 | 2018 | Change | Change | |||||||||||
(dollar amounts in thousands) | |||||||||||||||
Three months ended | $ | 22,547 | $ | 18,038 | $ | 4,509 | 25.0 | % | |||||||
Percentage of total revenue | 19.0 | % | 20.1 | % | |||||||||||
Nine months ended | $ | 62,589 | $ | 53,198 | $ | 9,391 | 17.7 | % | |||||||
Percentage of total revenue | 19.3 | % | 20.6 | % | |||||||||||
General and administrative expenses for the three months ended December 31, 2019 increased slightly as compared to the same prior year period due to a $3.0 million increase in personnel and related costs, a $2.7 million increase in stock-based compensation costs, and a $0.5 million increase in consulting and outside services, as well as other smaller increases. These increases were partially offset by a reduction in sales and use tax expenses of $1.5 million that the Company recognized in the three months ended December 31, 2018, as well as other smaller decreases.
General and administrative expenses for the nine months ended December 31, 2019 increased over the same prior year period primarily due to a $9.1 million increase related to personnel and related costs, a $5.7 million increase in stock-based compensation costs, a $1.8 million increase in costs associated with our recent acquisition, and a $0.5 million increase in consulting and outside services, as well as other smaller increases. These increases were partially offset by a reduction in sales and use tax expenses of $6.5 million that the Company recognized in the nine months ended December 31, 2018, as well as other smaller decreases.
December 31, | Dollar | Percent | |||||||||||||
Other (expense) income, net | 2019 | 2018 | Change | Change | |||||||||||
(dollar amounts in thousands) | |||||||||||||||
Three months ended | $ | (3,623 | ) | $ | 579 | $ | (4,202 | ) | (725.7 | )% | |||||
Percentage of total revenue | (3.1 | )% | 0.6 | % | |||||||||||
Nine months ended | $ | (7,919 | ) | $ | 1,933 | $ | (9,852 | ) | (509.7 | )% | |||||
Percentage of total revenue | (2.4 | )% | 0.7 | % | |||||||||||
Other (expense) income, net changed for the three and nine months ended December 31, 2019 over the same prior year periods primarily due to an increase of $3.9 million and $11.1 million, respectively, related to contractual interest expense, amortization of debt discount, and amortization of issuance costs associated with our convertible Initial and Additional Notes issued in February 2019 and November 2019, respectively. These increases were partially offset by an increase in interest income. Refer to Part 1, Note 9 of Notes to Unaudited Condensed Consolidated Financial Statements. We had no such similar costs in the same prior year period.
December 31, | Dollar | |||||||||||
Provision for income taxes | 2019 | 2018 | Change | |||||||||
(dollar amounts in thousands) | ||||||||||||
Three months ended | $ | 280 | $ | 112 | $ | 168 | ||||||
Percentage of loss before provision for income taxes | (0.6 | )% | (0.5 | )% | ||||||||
Nine months ended | $ | 684 | $ | 333 | $ | 351 | ||||||
Percentage of loss before provision for income taxes | (0.6 | )% | (0.6 | )% | ||||||||
For the three months ended December 31, 2019 and 2018, we recorded income tax expense of $0.3 million and $0.1 million, respectively. For the nine months ended December 31, 2019 and 2018, we recorded income tax expense of $0.7 million and $0.3 million, respectively. These taxes were related to state minimum taxes and income taxes from our foreign operations.
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Our effective tax rate was (0.6)% and (0.5)% for the three months ended December 31, 2019 and 2018, respectively, and (0.6)% each of the nine months ended December 31, 2019 and 2018.
We estimate our annual effective tax rate at the end of each quarter. In estimating the annual effective tax rate, we consider, among other things, annual pre-tax income, permanent tax differences, the geographic mix of pre-tax income and the application and interpretations of existing tax laws. We record the tax effect of certain discrete items, which are unusual or occur infrequently, in the interim period in which they occur, including changes in judgment about deferred tax valuation allowances. The determination of the effective tax rate reflects tax expense and benefit generated in certain domestic and foreign jurisdictions. However, jurisdictions with a year-to-date loss where no tax benefit can be recognized are excluded from the annual effective tax rate.
Liquidity and Capital Resources
As of December 31, 2019, we had $235.2 million of cash, cash equivalents and investments. In addition, we had $19.0 million as restricted cash, $8.6 million in support of letter of credits securing leases for office facilities in California and New York, and $10.4 million held in escrow for our recent acquisition of Wavecell, pursuant to the terms of the acquisition agreement. By comparison, at March 31, 2019, we had $346.5 million of cash, cash equivalents and investments as well as a $8.1 million in deposit as restricted cash. We believe that our existing cash, cash equivalents, and investment balances, and our anticipated cash flows from operations will be sufficient to meet our working capital and expenditure requirements for the next 12 months.
Historically, the Company maintained all investments as short-term investments on its balance sheet, as the Company could liquidate these investments at any time and did not limit its liquidation of investments by contractual maturity date. Given the recent issuance of the convertible senior notes, and the associated increased cash, cash equivalents and investment balances, the Company expects to hold certain investments for at least 12 months from the reporting date and records these investments in long-term investments in alignment with the contractual maturity dates.
Period-over-Period Changes
Net cash used in operating activities for the nine months ended December 31, 2019 was $62.8 million, primarily due to making investments necessary to accelerate revenue growth. For comparison, $6.7 million was used in operating activities for the nine months ended December 31, 2018. Cash used in operating activities has historically been affected by:
•the amount of net income or loss;
• | the amount of non-cash expense items such as depreciation and amortization; |
• | the amortization associated with deferred sales commissions, debt discount and issuance costs; |
•the expense associated with stock options and stock-based awards; and
• | changes in working capital accounts, particularly in the timing of collections from receivable and payments of obligations. |
Net cash used in investing activities was $84.8 million in the nine months ended December 31, 2019, compared with $4.7 million provided by investing activities in nine months ended December 31, 2018. The cash used in investing activities during the nine months ended December 31, 2019 was primarily related to $58.9 million used in the acquisition of Wavecell, a $0.9 million payment released from escrow held for MarianalQ acquisition in the first quarter of fiscal 2019, combined with purchases of $22.9 million of property and equipment investments and capitalized internal software development costs of $22.8 million. These amounts were partially offset by $19.7 million of proceeds from sales and maturities of investments, net of purchases of investments.
Net cash provided by financing activities was $65.8 million in the nine months ended December 31, 2019, compared with $1.0 million used by financing activities in the nine months ended December 31, 2018. Our financing activities for the nine months ended December 31, 2019 provided cash of $65.3 million from the issuance of convertible debt, and $7.0 million from the issuance of common stock under employee incentive plans. These inflows were partially offset by $6.2 million of deemed repurchases of our common stock related to shares withheld for payroll taxes combined with $0.3 million in payments for finance lease obligations.
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Contractual Obligations
Payments due by Period | |||||||||||||||
Contractual Obligations | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||
Senior convertible notes | $ | 362,500 | $ | — | $ | — | $ | 362,500 | $ | — | |||||
Interest on senior convertible notes | 8,156 | 1,813 | 3,625 | 2,718 | — | ||||||||||
Operating leases | 121,508 | 8,801 | 28,192 | 23,594 | 60,921 | ||||||||||
Total Contractual Obligations | $ | 492,164 | $ | 10,614 | $ | 31,817 | $ | 388,812 | $ | 60,921 | |||||
CRITICAL ACCOUNTING POLICIES & ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
There have been no significant changes during the three and nine months ended December 31, 2019 to our critical accounting policies and estimates previously disclosed in our Form 10-K for the fiscal year ended March 31, 2019, except for our adoption of ASU 2016-02 as discussed in Notes 2 and 7 of the Notes to the Unaudited Condensed Consolidated Financial Statements.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
See Item 1 of Part I, "Notes to Unaudited Condensed Consolidated Financial Statements - Note 2 - Summary of Significant Accounting Policies."
RECENT ACCOUNTING PRONOUNCEMENTS
See Item 1 of Part I, "Notes to Unaudited Condensed Consolidated Financial Statements - Note 2 - Summary of Significant Accounting Policies."
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Fluctuation Risk
The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. Some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we may maintain our portfolio of cash equivalents and investments of short durations in a variety of securities, including commercial paper, money market funds, debt securities and certificates of deposit.
As of December 31, 2019, we had $287.5 million outstanding on our 0.50% convertible senior notes due 2024. The values of the Notes are exposed to interest rate risk. Generally, the fair market value of our fixed interest rate Notes will increase as interest rates fall and decrease as interest rates rise. In addition, the fair market value of the Notes is affected by our stock price. The fair market value of the Notes will generally increase as our common stock price increases and will generally decrease as our common stock price declines in value. However, we carry the Notes at face value less unamortized discount on our balance sheet, and we present the fair value for required disclosure purposes only.
We do not believe that a hypothetical 10% change in interest rates would have a material impact on our interest income or expenses, convertible senior notes, or financial statements for any periods presented.
Foreign Currency Exchange Risk
We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the British Pound, causing both our revenue and our operating results to be impacted by fluctuations in the exchange rates.
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Gains or losses from the translation of certain cash balances, accounts receivable balances and intercompany balances that are denominated in these currencies impact our other comprehensive income. A hypothetical decrease in all foreign currencies against the US dollar of 10%, would not result in a material foreign currency loss on foreign-denominated balances, at December 31, 2019. As our foreign operations expand, our results may be more impacted by fluctuations in the exchange rates of the currencies in which we do business.
At this time, we do not, but we may in the future, enter into financial instruments to hedge our foreign currency exchange risk.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Effectiveness of Disclosure Controls and Procedures
We maintain disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (Disclosure Controls) that are designed to ensure that information we are required to disclose in reports filed or submitted under the Securities and Exchange Act of 1934 is accumulated and communicated to management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure, and that such information is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
As of the end of the period covered by this Quarterly Report on Form 10-Q, under the supervision of our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of our Disclosure Controls. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our Disclosure Controls were effective as of December 31, 2019.
Limitations on the Effectiveness of Controls
Our management, including the Chief Executive Officer and Chief Financial Officer, do not expect that our Disclosure Controls or internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
Changes in Internal Control over Financial Reporting
During the third quarter of fiscal year 2020, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information set forth in Note 8, “Legal Proceedings” of Notes to Unaudited Condensed Consolidated Financial Statements under ITEM 1. FINANCIAL STATEMENTS of PART I is incorporated by reference in response to this item.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors previously disclosed in our annual report on Form 10-K for the fiscal year ended March 31, 2019 and our quarterly reports on Form 10-Q for the quarterly period ended June 30, 2019 and September 30, 2019.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
Purchases of Equity Securities.
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Period | (a) Total Number of shares repurchased (1) | (b) Average Price Paid Per Share | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | (d) Maximum Number (or Approximate Dollar Value) of Shares that May Yet be Purchased Under the Plans or Programs | ||||||
October 1, 2019 through October 31, 2019 | — | $ | — | — | $ | 7,065,978 | ||||
November 1, 2019 through November 30, 2019 | 4,088 | $ | 20.82 | — | $ | 7,065,978 | ||||
December 1, 2019 through December 31, 2019 | — | $ | — | — | $ | 7,065,978 | ||||
(1) The 4,088 shares purchased represent shares surrendered to the Company to pay the exercise price in connection with the exercise of employee stock options pursuant to the Company's Amended & Restated 2012 Equity Incentive Plan.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
None.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS
Exhibit Number | Description | |
1.1 | ||
4.1 | ||
10.1 | ||
31.1 | ||
31.2 | ||
32.1 | ||
32.2 | ||
101 | The following materials from the 8x8, Inc. Quarterly Report on Form 10-Q for the quarter ended December 31, 2019, formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets as of December 31, 2019 and March 31, 2019; (ii) Condensed Consolidated Statements of Operations for the three and nine months ended December 31, 2019 and 2018; (iii) Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended December 31, 2019 and 2018; (iv) Condensed Consolidated Statements of Stockholders' Equity for the three and nine months ended December 31, 2019 and 2018; (v) Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2019 and 2018; and (vi) notes to unaudited condensed consolidated financial statements. | |
104 | Cover Page Interactive Data File, formatted in iXBRL and contained in Exhibit 101. | |
* | Management contract or compensatory plan or arrangement. |
+ | Furnished herewith. |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: February 5, 2020
8X8, INC. | |
(Registrant) | |
By: /s/ Steven Gatoff | |
Steven Gatoff | |
Chief Financial Officer (Principal Financial and Duly Authorized Officer) | |
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