Good afternoon, ladies and gentlemen, and welcome to the 8x8 second quarter fiscal 2018 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference is being recorded. I would now like to turn the conference over to Joan Pacelli, Director of Investor Relations.
Thank you, operator. Welcome everyone to our call. Today, I'm joined by 8x8 Chief Executive Officer, Vikram Verma, and our Chief Financial Officer, Mary Ellen Genovese, to discuss 8x8 second quarter fiscal 2018 financial results for the period ended September 30, 2017. The earnings press release, which was issued today after market close, conference call script, and accompanying slide presentation are available on the investors section of 8x8's website at www.8x8.com. Following our comments, there will be an opportunity for questions. Before I turn the call over to Vik, I would like to remind all participants that during this conference call, any forward-looking statements are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.
Expressions of future goals, including financial guidance and similar expressions using the terminology, "may," "will," "believe," "expect," "plans," "anticipate," "predict," "forecast," and expressions which reflect something other than historical facts, are intended to identify forward-looking statements. These forward-looking statements involve a number of risks and uncertainties, including factors discussed in the Risk Factors sections of our annual report on Form 10-K, in our quarterly reports on Form 10-Q, in our other SEC filings and company releases. Our actual results may differ materially from any forward-looking statements due to such risks and uncertainties. The company undertakes no obligation to revise or update any forward-looking statements in order to reflect events or circumstances that may arise after this conference call, except as required by law.
I would also like to note that during this call, we will provide financial information that has not been prepared in accordance with generally accepted accounting principles, in addition to our GAAP results. Management uses these non-GAAP financial measures internally to analyze our financial results and believe they are useful to investors as a supplement to GAAP measures in evaluating the company's ongoing operational performance. Please refer to today's press release for a reconciliation of GAAP to non-GAAP financial performance and additional disclosures regarding these measures. I'd now like to turn the call over to Vikram Verma, Chief Executive Officer of 8x8.
Thank you, Joan, and thank you all for joining us on our second quarter fiscal 2018 earnings conference call. This has been a very busy and productive quarter for 8x8. I'm pleased to report that we have made significant progress implementing the strategic initiatives we laid out last quarter. I'll review this progress shortly, but let me first begin with a high-level summary of our financial performance during the quarter. 8x8 posted solid top and bottom-line results for our second fiscal quarter, with an 18% increase in service revenue to $68.1 million and a 15% increase in overall revenue to $72.5 million. Service revenue from mid-market and enterprise customers, those billing greater than $1,000 in monthly recurring revenue, increased 28% and now represents 58% of total service revenue. Our non-GAAP pre-tax net income was $4.2 million, or 6% of revenue, and service margins remained strong at 83%.
The market continues to inflect, we see tremendous opportunities for accelerated growth across the core customer segments we serve, from small business to mid-market and enterprise. Our goal is to drive revenue growth across our entire business with a continued focus on mid-market and enterprise customers, along with new initiatives to accelerate revenue growth from small business customers. In order to position ourselves most effectively for our next phase of growth, we have identified and have begun to execute on several strategic initiatives. First, we are aligning global business units around our core market segment to optimize for growth. At the beginning of October, we segmented our internal sales operations into two separate business units. Small business and e-commerce, aimed at businesses with 1 to 99 employees, and mid-market and enterprise, aimed at businesses with 100-plus employees.
We determined that establishing two separate business units will enable us to unlock the growth potential of each unit and allow us to optimize our sales and marketing strategies around the specific needs of each customer segment. These business units will align sales and delivery and be tightly coupled with demand generation, service and support to drive segment revenue growth and profitability globally. Small business and e-commerce will focus on our high-volume transactional business with an aim to accelerate growth and productivity through e-commerce and self-service. Mid-market and enterprise will focus on both creating and leveraging channel relationships building our direct sales force to drive a consultative approach to a land and expand strategy for larger accounts in the U.S., EMEA, and APAC.
Second, we've appointed top industry talent to newly created executive leadership positions in our marketing and sales organization to align with our new business unit and accelerate adoption of our solutions across all market segments. With these changes, we're aggressively gearing up to accelerate growth. Third, we've expanded our global field sales organization with both mid-market and enterprise sales executives and channel development managers. Our field sales executives work directly with customer prospects to understand and customize the optimal solution for their business, while channel development managers are responsible for recruiting and enabling partners in their respective territory, evangelizing the 8x8 brand, and growing the sales pipeline with partners. In Q2, we had 21 new partners participating in our channel enablement program, with six of them already bringing us deals in the August and September timeframe.
Five of our top 10 deals in the September quarter were brought in by our channel partners. Our unique differentiation in the market, driven by our internally owned voice, collaboration, contact center, and analytic technologies, makes us a highly desired vendor partner to master agent and VARs that are rapidly evolving their business models to accommodate the transition from legacy to cloud communications that is occurring today. Fourth, we laid the groundwork for some new marketing, branding, and lead generation initiatives designed to highlight the true value of our solutions over those of both legacy vendors and cloud competitors. 8x8 has the most comprehensive set of cloud communications, contact center, and analytic capabilities in the industry. Over the past several years, we have created, assembled, and expanded the building blocks to reinvent the business communications market.
We have transformed our core Virtual Office communications platform into an open platform with APIs, Scribe, extensive integration, and the leading global voice quality in the industry. In parallel, we have added a full spectrum of contact center and customer engagement capabilities with the acquisitions of Contactual, which brought us high-end contact center capabilities, and DXI, with their innovative, easy-to-use contact center functionality for business teams. With the acquisition of Quality Software and Sameroom and their leading-edge technologies, we're ready to further leapfrog the industry with speech analytics for everybody and next-generation collaboration capabilities. This has enabled us to further disrupt the market with a new suite of products that unifies cloud communications, collaboration, online meeting, and contact center solutions with an end-to-end data analytics platform.
Representing a combination of technologies from years of continuous innovation from 8x8, this launch signifies a new age of truly unified cloud communications. In early October, we launched our new Virtual Office Editions product suite, including our groundbreaking 8x8 Virtual Office X8 Edition. Designed for easy consumption by small and mid-sized businesses from a pricing and packaging standpoint, VO Editions also includes three enterprise-class business communication options, provides customers with the flexibility and mix and match pricing models that's best suited for their needs. Our new 8x8 Virtual Office X8 Edition offers a unique and powerful business communication and collaboration solution, allowing employees to interact anytime from anywhere and includes easy-to-use contact center capabilities such as inbound call handling, outbound campaign dialing, and rich reporting and analytics for new business insights.
This new offering enables companies to connect everyone throughout the organization, including both contact center agents and employees, with a single unified solution. 8x8 continued to execute in the market with many sizable customer wins during the quarter, including 13 large enterprise deals. 61% of the new monthly recurring revenue booked in Q2 came from mid-market and enterprise customers. One of our largest enterprise deals, carrying a total contract value of approximately $7 million, came from our U.K. team, which continues to enjoy excellent traction in the market, specifically in the public sector with local and central government opportunities. This latest government contract with Lewisham/Brent Council calls for an initial deployment of 10,000 Virtual Office seats and 600 Virtual Contact Center seats, and potentially provides an opportunity to deploy our services to 30 additional London boroughs.
We continue to win sizable mid-market and enterprise customers with our integrated Virtual Office Virtual Contact Center solution, which was present in eight of our top 10 deals in the September quarter. A new marquee customer win in the U.S. is Lenox Corporation, a market leader in quality tabletop giftware and collectibles. For Lenox, we will be replacing a legacy on-premise system with approximately 600 Virtual Office seats and 70 Virtual Contact Center seats. 8x8 won this deal following a competitive RFP process that involved several other UCaaS and CCaaS providers. Another combination win was Standard Motor Products, a leading independent manufacturer, distributor, and marketer of replacement parts for motor vehicles, calling for a deployment of over 2,200 Virtual Office seats and 1,000 Virtual Contact Center seats. 8x8 was selected because of our integrated platform, our global reach, and our superior voice quality.
Collette Travel Services, a global travel agency, also selected 8x8 for a combined deployment of 530 Virtual Office seats and 140 Virtual Contact Center seats. Collette was upgrading to the cloud from an antiquated legacy system they had been using for 17 years and wanted to upgrade to the cloud. Our Contact Center solution was the driving factor for this global customer win. Finally, 8x8 garnered recognition as an industry leader for the sixth consecutive year in Gartner's 2017 Magic Quadrant for UC as a Service, an important validation of our continued investments to drive innovation in the cloud communication space, and an acknowledgment of the great strides we have made in delivering measurable benefits for mid-market and enterprise companies.
We were also named a challenger for the second year in the Gartner Magic Quadrant for Contact Center as a Service, and in a recent report published by Synergy Research Group, 8x8 was named the worldwide leader in both revenue and subscriber seats in the mid-market and enterprise segment of the UCaaS market. In summary, our second fiscal quarter has been one of significant changes, which I believe over time will materially alter our growth rate trajectory. We brought some amazing new talent on board, rolled out our next-generation platform, launched a highly differentiated UCaaS offering, and realigned our business by creating two distinct go-to-market vehicles that will materially improve our efficiency and win rate, all within the last 90 days. However, we anticipate that the sheer volume of these changes will take one or two quarters to bear fruit.
As such, we feel it is prudent at this time to reset the bar on our revenue expectations for fiscal 2018. I feel confident that the investments we have made keep us on track for achieving 25% service revenue growth exiting fiscal 2019. With that, I'll turn the call over to Mary Ellen for a more detailed discussion of our financial results and revised guidance.
Thank you, Vik, and thank you all for joining us on the call today. My commentary will cover financial highlights along with key operating metrics from the quarter. These measures will be based on non-GAAP results unless otherwise noted, and I remind you to please refer to the tables in today's earnings press release for a reconciliation of GAAP to non-GAAP results. Foreign exchange rate fluctuations did not have a significant impact on our comparative results this quarter, as the British pound remained flat versus prior year. None of the financial information we are presenting has been adjusted for constant currency. Total revenue in the second quarter of fiscal 2018 grew 15% year-over-year or 5% sequentially to a record $72.5 million. Adjusted for the discontinuation of the non-core voice message broadcasting segment of our DXI operations, total revenue grew 16% from the year ago period.
Turning to specific revenue line item contributions, service revenue increased 18% year-over-year or 5% sequentially to $68.1 million. On an adjusted basis, service revenue increased 19% from the year ago period. Product revenue, which constituted approximately 6% of total revenue in the quarter, declined 20% from the year ago period. Service revenue from mid-market and enterprise customers grew 28% year-over-year and 6% sequentially. 58% of our service revenue is from our mid-market and enterprise customers, compared with 53% in the prior year period and one percentage point improvement sequentially. Gross margin for the quarter was 77%, almost a two percentage point improvement year-over-year and flat sequentially. Service margin was 83%, flat over the year ago period and sequentially down one percentage point due to the increase in third-party networking service costs, which are attributed to higher usage.
Product margin was negative 17%, compared with negative 6% last year. Moving to operating expenses, sales and marketing expenses in the quarter, which includes customer service, product management, and deployment costs, were $38 million or 52% of revenue. This is up two percentage points versus the same year ago period as we continue to execute on our strategic initiatives around channel deployment and demand generation. R&D expenses were $7 million or 10% of revenue. This is up one percentage point from a year ago, as we continue to invest and execute on our commitment to develop truly unified, best-in-class communication solutions for our customers. G&A expenses were $7.1 million, or 10% of revenue. Quarterly net income before taxes was $4.2 million, or $0.04 per share, and 6% of revenue, compared with $5.4 million or $0.06 per share and 9% of revenue in the same year-ago quarter.
We saw solid improvements in key operating metrics for the quarter. The average revenue per mid-market and enterprise customer grew to $4,697, compared with $4,351 in the same year-ago period. Average revenue per business customer was $442, compared with $409 in the same period a year ago. Gross monthly service revenue churn on an organic basis, excluding DXI, was 0.4%, compared with 0.6% in the same period last year. Please note that the third fiscal quarter revenue churn may be higher than second quarter results due to the upcoming holiday season. New monthly recurring revenue, or MRR, bookings from mid-market and enterprise customers and by channel sales teams comprised 61% of the new monthly return revenue booked in the quarter on an adjusted basis. New MRR was essentially flat on an adjusted basis compared to prior year.
Sequentially, we saw positive momentum across the mid-market and enterprise channel and small business segments. Cash, cash equivalents, and investments were $167 million at September 30th, 2017, compared with $170 million one year ago. Cash flow from operating activities was $5 million in the second fiscal quarter, compared with $6.9 million the same period last year. Capital expenditures, including capitalized software, were $4.8 million in the quarter, or 7% of revenue, and increased 9% sequentially. During the quarter, we repurchased approximately 1.1 million shares at a price of $13.23, for a total of $14.1 million. We currently have about $11 million available for share repurchase under our current program, which goes through May 2018. 8x8 has a clear capital allocation strategy of investing cash to grow our business organically, through acquisitions and strategic partnerships, and returning cash to shareholders through share buybacks.
This approach is a strategy we have been and remain committed to. Looking ahead to the second half of the fiscal year, we continue to recruit world-class talent, primarily in sales, marketing, and our research and development teams, while enabling our channel programs to enhance demand generation and support our global brand. To better model third and fourth fiscal quarters, operating expense growth is expected to be in the low to mid-double digit range versus the first half of the year. Q4 is expected to be sequentially higher than Q3 and the highest quarter of spend for the full year. Specifically, sales and marketing expenses will increase from added headcount, channel enablement execution, commissions, and advertising spend to support the brand and go-to-market strategic initiatives on the mid-market and enterprise.
As a percentage of total revenue, we expect sales and marketing to be in the range of 55%-56% during the second half of the fiscal year, with Q4 being the highest sales and marketing expense quarter. As a reminder, product management, customer support, and deployment services is included in our sales and marketing expenses and represents approximately 14% of revenue. R&D will increase modestly in absolute dollars to support the development of unified solutions in our cross-platform real-time analytics, but will remain stable as a percentage of revenue from previous quarter. As a percentage of total revenue, we expect G&A expenses to be approximately 11% during the second half of the year. We also anticipate our quarterly service margin to decline slightly from the second quarter level in the second half of the year due to additional expenses related to the amortization of previously capitalized software.
In addition, we will continue to invest and deploy our capital to execute on our strategic business initiatives while taking a very disciplined approach to share repurchases. Having said all this, we are modifying our revenue outlook for the full year due to three primary factors. The first factor is attributable to our U.K. 8x8 ContactNow product. During the first half of the year, service revenue from the product was largely in line with our expectations. However, due to our strategic decision to integrate the core technology into our recent Virtual Office X8 product launch, we are now de-emphasizing selling the standalone product. The underlying technology is strong and has tremendous value to the business as part of an integrated platform. The second factor is related to a large enterprise client that has revised its timeline for a major rollout of services due to constraints on their end.
Lastly, we have recently realigned our global sales and marketing leadership teams and operating structure to support our strategic initiatives to generate revenue growth and support sales execution. We have streamlined these two important corporate business units to generate demand, accelerate bookings growth, and respond more quickly to customer needs. We will also continue to build out global functions to strengthen our leadership position in the unified communication space. Although we have made good progress to date in our strategic initiatives, we may need another quarter or two to see improved bookings. Taking all these factors into account, we have revised our outlook for the fiscal full year. Total revenue in the $262 million-$294 million range, representing approximately 15%-16% year-over-year increase. Service revenue in the $275 million-$277 million range, representing approximately 17% year-over-year increase.
Adjusting for the discontinued revenue from the non-core voice message broadcasting segment of our DXI operations, service revenue growth in the range of 17%-18%, and total revenue growth in the range of 16%-17%. We continue to expect fiscal 2018 outlook of non-GAAP pre-tax income to be approximately $9 million or 3% of revenue. Our estimated non-GAAP effective tax rate is expected to be approximately 36%. Cash taxes are expected to be less than $1 million. Taking into consideration our increased investment in the business, our market-leading position, and the market opportunity, we continue to expect that service revenue growth will begin to accelerate in fiscal 2019 with an exit growth rate of approximately 25% in the fourth quarter of fiscal 2019. To clarify, for guidance, total revenue is expected to be between $292 million and $294 million.
The series of strategic investments and initiatives mentioned earlier are all contemplated in our financial outlook. We believe this is the right time and prudent use of our capital to increase future growth for fiscal 2019 and beyond. We are on the right path and taking action for the long-term success of our company. We are investing in our brand, employees, product innovation, demand generation, and channel to enable our global clients to grow their business and reduce their costs. We've made good progress on this front with many of our partners, and this is a long-standing commitment on our part. Before we begin our questions and answer session, I have one more topic. During the summer, Joan informed me of her decision to retire at the end of this month.
On behalf of 8x8's management team, I would like to thank Joan for her 13 years of contributions to the company. Joan built the investor relations department and established and nurtured relationships with all of you over the years. We wish Joan all the best in her future endeavors. I'd also like to introduce Victoria Hyde-Dunn. She joined 8x8 four weeks ago from Visa and will be your investor relations contact going forward. With that, operator, we are ready for questions.
Ladies and gentlemen, if you have a question at this time, please press star and then the number one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Your first question comes from Meta Marshall with Morgan Stanley. Your line is open.
Hi. Thanks for the question. I was wondering if you could just talk about how you decided now is the time for the reorganization, because as it seems as if a couple of quarters ago, you identified that you needed to increase branding efforts, then a quarter or two after that, you decided you wanted to increase sales and marketing, then you're making more changes. I just wonder how you decided on the timing and the rollout of some of these changes, particularly with there being other disruptions in this space as far as M&A or bankruptcies. Just why not make all the changes at once? What led to the timeline of the changes that have been made? Thanks.
Okay. No, it's a very good question, Amanda. Let me clarify that one. I think we talked about it last quarter where I think that was the comment, which is why did we decide to materially increase our investment? We got the sense that the market was inflecting. We wanted to get the right people in place in marketing before we needed to go out and really emphasize that we were willing to go out and really ramp up our marketing expenses. As part of that, as we talked about it, we telegraphed to you that essentially our business is two parts. We have our small business, which has been growing essentially as a drag on our business, particularly our micro business, then our mid-market enterprise that is growing pretty healthily.
As I went through and really did a detailed review, it became increasingly obvious to me that what we had done is we had made a nice foundation of sales, what we needed to do was essentially get specialists. The person who's very good at growing a very fast-paced, essentially self-service, low-end business is very different than the person that builds a large enterprise mid-market business. We felt bifurcating the business was critical. The other part that became more and more obvious to us is we have a unique asset which we have essentially paid for in blood, which is we have all core technologies that constitute voice, video, text, contact center, essentially on one roof.
Became obvious to us as we were using our new management team who's coming in and looking at it with fresh eyes as to why do we have to live with other people's definition of what constitutes contact center and what constitutes Virtual Office? We have the ability to mix and match. As we've combined all of these things together, we made three very clear decisions. One is, let's take our ContactNow product, which is essentially a very easy-to-use contact center, and why don't we integrate that essentially as part of our Virtual Office solution? Now, in essence, as built into your core PBX for essentially the same price, you have the core simplified functionality of contact center, so people who didn't even know there were contact centers as part of their phone system can get that.
We think that gives us non-trivial differentiation, and we think that gives us a very significant opportunity to almost create a category for people who are literally saying, "Hey, I bought a phone system, and my phone systems comes with the ability to prioritize who I should answer, to keep records of everybody who called, to route calls where I can get other people involved to address a particular problem and have a complete record of all of those things that contact centers consider part and parcel." We're now going to bundle into a VO, which we think gives us something significantly disruptive. We're starting to see our enterprise market take off. The thing that is fascinating about our enterprise market is they're looking more and more at APIs.
Where, for example, with one particular customer, we're starting to do everything from two-factor authentication to literally creating workflow rules leveraging our API solutions. With all of those things, we figured this was a perfect time. We brought the head of essentially engineering in place who comes from an analytics background, so you have the ability to do cross-platform analytics. We brought on board a marketing person who also comes from an analytics background and has, in her background, spent a lot of time creating new categories. In essence, we bifurcated sales into somebody who comes from a pure e-commerce background, so the idea to do a whole series of self-services. We brought on board somebody who's the former CRO for NewVoiceMedia, but prior to that, the head of worldwide analytic sales for IBM and ran as many as 4,000 people.
With all of those things, if I might say so, we managed to do all of this in 90 days. We think the market's inflecting. We think there is an opportunity, and there's a lot of talent available. Just in the last 90 days, we've been able to add about 40-odd people to our sales and marketing group. As I said, from that perspective, we felt this gives these folks a clean slate, kill some of our, or de-emphasize some of our standalone orphan products, more and more integrate towards a series of three or four very differentiated products, and go for it.
Got it. If I could just ask one follow-up question. The decision to segment by enterprise and small business versus. I guess I'm just trying to get a sense, is there somebody dedicated to channel versus direct? Are those similar alignments just given the channel development? Who's running that at this point? Thanks.
Exactly. We see enterprise and mid-market, particularly mid-market, channel is a huge part of it. If you look at a lot of our hires, I'm sure all of you follow my various LinkedIn accounts and posts, I'm noticing more and more of the top-tier channel assets. Channel managers, BDMs, some of the very best and brightest who are joining because the idea is our problem has always been we've had the best technology, we've just not had enough feet on the street. Channel is now part and parcel of our mid-market and enterprise business unit, where in essence, channel is just a lead source. We make no distinction between having a direct sales force that sells just by itself or a channel sales force that sells to the channel. We have one common sales force and channel just becomes a lead source. That eliminates friction.
It makes it very clear that we're a very channel-friendly organization. We view that as an opportunity to really go out and do hypergrowth. Again, channel is inflecting, as you can probably guess, and the ability to get one vendor where they can get everything. Then, as I indicated, the ability for us to mix and match portions of our product because since we own every element of our technology, I can carve out portions of my contact center and make it part of our VO. That gives something disruptive. I can take portions of my APIs and give people the ability to create professional services organizations so that you can provide value-added services. That's why we've kind of bifurcated the company like this.
Increasingly, you're going to see more and more on our mid-market and enterprise, particularly enterprise, a focus on analytics. Increasingly on our small business, you're going to see the ability to go in where we will have a Virtual Office offering, but it'll have built-in contact center type functionality so that it, quote-unquote, "It won't just be a replacement PBX or a cheap phone in the cloud." It will have the ability to have a built-in contact center because essentially that's now going to get integrated as part of that solution.
Got it. Thanks. I'll pass it on.
Your next question comes from George Sutton with Craig-Hallum. Your line is open.
Thank you. Vik, I wanted to make sure I fully appreciated the new suite of products and can you give us any kind of key competitive differentiators that are going to come from this new suite?
Yep. As you know, one of the things we've done with our VO Edition, so we have had, as you do with a company which has acquired as many technologies and assets we've had, and that has been in business as long as we have, you end up with a whole series of different products. What I started to do or did is bundle them into what I call editions. VO Editions, which is essentially our Virtual Office Editions, means you bundle in three broad categories, and it required a re-engineering of our product, literally from the back office. We have to completely go away from the good old PeopleSoft CRM that we'd always had, all the way up to creating a new quote-to-cash engine to a new billing engine, and then, as I said, creating a self-service portal and fundamentally changing the user interface.
We're now starting to roll this out, both for one of our very large strategic customers that is going to use this so that every one of their customers can just do self-service, and we're also rolling this out more and more towards our small business. If you think about it, we have had our legacy small business that has been a drag on our business. Now, the ability to have a product like Editions, where literally it's A, B, or C. You can have these three options. If you want contact center built in, X8. If you want just the basic telephony, X1 or X2. We're basically making it so that it literally becomes something where people can add to it, self-provision, they can modify. Less and less support cost, less and less sales cost.
This was one of the key reasons why we wanted to do this, because it allows us to continue to not have to increase our investment in our small business, but accelerate our growth rate. You also have a common platform that now starts all across, and particularly now that we add our VCC editions, you have cross-platform analytics that nobody else can provide. We have a new product coming out called Sauron. You can probably guess my engineers named it. Sauron will basically give you analytics which will encompass voice, video, text interactions all the way to your contact center interactions in one common dashboard company-wide. That is what we mean by truly unified communication. It's been about 18 months of work, and I've kind of highlighted that it required me having to completely rejigger our back office system.
It required us to completely rejigger our provisioning system. It required us to completely change our configuration manager, and as I said, we have now started to roll all of these things out. We think, as I said, by unifying all of this, it decreases my support cost, it increases the velocity with which I can sell, and allows me to bundle stuff together where I can create disruption in the market.
Gotcha. Great. One other question on the ongoing Avaya gifts that you're getting. Where are we in that migration from your perspective? Can you just discuss some of the other M&A activity that's occurred over the quarter, the ShoreTel, Mitel, and the BroadSoft Cisco, in terms of what you think that means for you? Thanks.
Whatever M&A gods that are out there, I am on bended knees and thanking them for it. It's very easy to see you guys do a phenomenal job of channel checks as well as figuring out. We have been the beneficiary of some incredible talent from all of the people that are kind of now going through all of this stuff. We've also seen a lot of channel partners now migrate to us. The weakness and the strength of 8x8 has been we are the techie geek company with the greatest technology. Everybody said from a branding and a selling perspective, we were not world-class. I brought in world-class talent on that, and particularly in channel, you're starting to see channel gravitate to us because in essence, they view us, A, as a one-stop shop.
They are now seeing the same people they have dealt with before here, and they're seeing our commitment to massive investment in this space and that we will do whatever it takes to own this space. I think from that perspective, we think we're going to be a significant beneficiary of all that is going on. If there's a few other people that you can recommend get bought, as some of the rumors are out there, I hope all those rumors end up being true because we love it.
Perfect. Thanks for the answer.
Your next question comes from Jonathan Keyes with Summit Redstone. Your line is open.
Great. Thanks for taking my questions. I just wanted to, I guess, dig a little bit deeper in terms of the reasons for the revision. There was first the product in the U.K. that was no longer going to be sold separately, but it's now going to be integrated, the ECN. I would think if it's going to be integrated, the ARPU would go up to kind of offset the standalone sales you would get normally. Second, you had mentioned about the large enterprise customer, they pushed out their service revenues. I guess, is that implying that it's going to be pushed out to the second half, fiscal second half, or is that still a big question mark? The third one, you kind of already talked about in terms of the sales.
Yeah, fair enough. That's a very valid question. Let me take that on because ultimately, I made this call. Three things. One, we continue to sell our U.K. ECN product. It's just something we have de-emphasized. By that I mean, we're siphoning off all the resources from selling that product more and more. The existing customers we'll continue to support, but we're siphoning off.
You're starting to see a very significant drop in the product because as we take away resources from adding features and/or support and/or sales from that product and move it more towards X8, which is still early days and hasn't kicked in, you're starting to see that the new sales in that product is coming in well below plan, and it's something I'm not trying to reverse because in the end, it's coming down faster than I would've liked, but it's not one that is worth reversing. That's step one. Step two, this customer that I talked about, their plans actually have expanded. One of the key elements, they've been a great driver in creating this self-service element of the product. They had put together a very detailed schedule and rollout plan, and they have started against that rollout plan.
Just the ramp has been a little bit slower than anticipated because of resource constraints on their end. We anticipate over the next two, three months, the ramp will pick up. As you can tell with service revenue, if the ramp starts out slower, you kind of are not able to recognize the service revenue. The third, just the sheer volume of changes I've instituted. I believe it's the right thing to do, and obviously, that was why I telegraphed that I was going to change, or not telegraphed, I told you guys I was going to change my investment profile, and I was going to significantly increase my investment in sales and marketing.
As you think about it, two SVPs, one to head up sales and one to head up midmarket and enterprise, one to head up e-commerce and small business, all brought on board in the last 90 days, plus another 40 or so sales and marketing people, including probably four marketing VPs, and I can't remember, three or four sales VPs globally. All of that's happening. Part of what I want to do is take a little bit of the pressure off these guys. In other words, come on board, give them a couple of quarters to get their feet wet. I'm doing massive amounts of change, creation of all of these business units.
I wanted to kind of provide the air cover to say, "Guys, I don't think there's going to be major disruption, but there's going to be something." With these three things, I felt the right thing to do was take this guidance down and just go for it. It doesn't fundamentally affect our views on the growth rate. As a matter of fact, we feel that our growth rate accelerates, but I just don't want to give short-term pressure on people that I've just brought on board.
No, that certainly makes sense, and that's very reasonable. If I can sneak in one last question, and I'll end on a more promising note here. I just wanted to see if you can talk about your partnership with HipChat. How is that going to move the needle? I'm thinking that's going to be not exclusive because you're also partnered with their product, the Service Desk, but you're also partnered with the Zendesk Service Desk. I'm thinking this is not exclusive, but it will still contribute towards revenue growth.
Stay tuned. As I told you, we have some awesome technology, and I have spent 18 to 24 months just kind of building all of this stuff up. You're going to start to see, this is where essentially the ability to have a lead chat, which is our next generation of collaboration engine, which basically allows you to integrate with everything from Slack to HipChat to whatever. We've got some seriously cool stuff, and now we also have just brought on board a VP of strategic alliances who came from IBM, and she's got a stellar background. You're going to start seeing some more and more fascinating stuff. We have been a technology company, and I know that has been the rap on us, but there's a reason why we've been a technology company.
Build really cool stuff, then bring on board the people with all the relevant backgrounds, put some gas in the engine for executive management to provide enough air cover so that they're not being forced to do stupid things in the short term, and they have the ability to make stuff happen, and then go kick ass. That's what I think we've done.
It definitely sounds promising. Good luck. Thanks a lot.
Your next question comes from Michael Latimore with Northland Capital Markets. Your line is open.
Great. Thanks a lot. Yeah, I guess just to get to the longer-term growth goal here, what kind of growth do you need to see out of the small business segment? You talked a little bit more about, I think, improving the growth on the small business segment, does that need to be 10%, 15%? What kind of growth do you need to see there to kind of get to your longer-term targets?
I think we don't need a lot because we think we can grow the enterprise and mid-market significantly. As I said, it is always good to see our small business, which, as you know, I ring-fenced and didn't do much around. It was literally, we kind of put them in a room, we fed them pizza under the door, and just said, "Give us MRR." We're now bringing on board some seriously cool talent that's looking at every element of our process, and they're highlighting so many inefficiencies that it's almost pathetic, right? I don't need more than 10-ish% growth. I think I can get to 15-ish% growth.
Again, as I said, to a large degree, small business was this $150 million, $140 million business that has been this massive drag on our company because as we were moving more and more mid-market and enterprise, which I think we've done well. All of the changes we made to the product, including this addition, which to a large degree creates the self-service capability and the self-provisioning capability, applies just as easily to small business. Now we're bringing in people who have 21st century expertise on how to build high-velocity small businesses and also up-level existing customer base, which is pretty darn incredible. I said, from that perspective, we think we can see significantly greater than projections growth on small business. Long term, I don't anticipate it's going to be a drag on our business.
I think it won't grow anywhere close to how our mid-market and enterprise is going to be, I think it's not going to be a drag on our business at all.
You talked about hiring a lot of salespeople and business development people. Do you have a rough sense of what % growth you'll see in those types of employees this year?
I mean, Mary Ellen?
Yeah, no, that's one of the critical things that we're hiring for is for the channel. Channel enablement, business development managers. We want folks that can help us bring in the best of the best channel partners, enable those channel partners, and get more feet on the street so that we can accelerate our growth. Like Vik said earlier, the mid-market is almost all from the channel. It's a great lead source for us, and we have the right people out in the field to help them close the deals. We would expect it will continue. As we said, there were 40 sales and marketing new employees this quarter, including a couple SVPs. We would expect that to continue, that rate of hiring will continue in Q3 and Q4.
I'll just give you color. I apologize because I know I'm lowering guidance, but at the same time, I am a little bit of a proud papa. We do an onboarding process out here, and we make it pretty comprehensive. We do between three to five days where every employee in the company, whether it's the receptionist all the way up to an SVP, goes through an onboarding exercise where they have to learn every element of our product as well as they go through and spend time with every one of my direct reports. It culminates with a dinner in my house, where they have to make a presentation in four-person teams of something new that they can introduce to the company or something that they think that they can do to improve the company. This most recent dinner was October, middle or late October.
There were 53 people that showed up, plus another 15 or so of their managers. Let's just say, if this keeps going, I'm going to need a bigger house. Just the caliber of people we're getting is just awesome. Some amazing people are joining us.
Just last question on this deal where it sounded like it was a 1,000-seat contact center deal, plus the 2,200 Virtual Office. Can you just talk a little bit about the competitive landscape there? Was the main competition on-premise guys, or were they in a mixture of cloud PBX and separately cloud contacts? What was the competitor dynamic on that deal?
Right. Those were on-premise guys, I will tell you, again, it has taken a lot of effort and a lot of pain, but our contact center standalone is now competitive, right? We all look at Gartner, but even there, we're not quite in the leader's quadrant on contact center, but we definitely moved up and to the right. We're getting to the point that with our contact center, I think we're starting very close and maybe we're a year or two away, but we'll be in the leader's quadrant, but it's standalone is seriously cool and can stand on its own. Couple that with our VO, you've got a Virtual Office and a Virtual Contact Center that wins us these very large deals.
Now for the mid-market, which is traditionally the ones that if you remember, I told you, they tend not to buy a lot of contact center seats. I've now introduced an integrated contact center as part of our Virtual Office offering. I can kill that category, right? In particularly mid-market, literally, you buy a Virtual Office and I have a low-end contact center built in as part of my X8. Game on. That's why I said, I think at the high end, I can start to win with my VO VCC because I've got two best-of-breed products. Not yet best of breed on contact center, but getting there. Then I've integrated our Virtual Office by adding all of these features. From my perspective, our problem has always been feet on the street. Our problem has always been coverage. Our problem has always been brand.
We just hired the president of Grey North America, or sorry, Grey San Francisco, as our VP of brand. He comes in, same thing. You're starting to now see people from across some very interesting segments are coming in here because they see an opportunity with our core technology to kill a category. I have, as I said, we've got a lot of dry powder. I don't need to do major acquisitions because to a large degree, we have made all of these very unique tuck-in acquisitions. We have combined them all together. I have a guy who's basically built really big engineering organizations, now I have guy in mid-market who's built very big sales organizations. We just have to give them time to, as I said, make stuff happen.
Okay. Thank you.
Your next question comes from Dmitry Netis with William Blair. Your line is open.
Thanks for taking my question. Certainly appreciate the guide and how you kind of gave yourself some headroom here to execute. I think it's the right move. Also, I just wanted to confirm a couple of things. The new bookings MRR was flat, you said? Just to confirm that. -
The service revenue exiting fourth quarter of 2019 will grow at 25% versus the prior full year of 2019 growing at 25%. Is that-
Correct.
Those are
That's-
Okay.
That's correct. Dmitry, that's the same as what we had said last quarter as well, that we expect that our fourth fiscal quarter will grow at approximately 25% year-over-year in fiscal 2019.
Okay. All right, good. A couple of also quick ones here. On the channel side, how did that segment grow? You had, I think you said 15 of five of top 10 deals with channel, then you said you had 13 enterprise-
Yep
deals maybe how many of those 13 came through channel, how fast did the channel grow?
Yeah. I don't have the exact number because as you know, now channel is integrated with my direct, all sales are essentially being funneled. More and more of all my core deals are coming from the channel. Channel is the most interesting and fastest growing segment, as I indicated to you before. What we're finding is, particularly now that we've removed friction from the system, which was a non-trivial reorg that we did last quarter, where we've eliminated essentially a team that sold direct and a team that sold through channel and combined it into one common team, and channel is basically a source to a skill-based sales team.
More and more you'll see a bigger emphasis on the channel, and we view that as our fastest growing segment, which is where, as you can see, we have almost doubled and tripled the number of BDMs that we've brought on board that can go out and really service the channel.
Okay. Thanks, Vik. It sounds like the inflection in sales force productivity, you expect a couple of quarters here, one to two, let's assume it's the March quarter when you will be firing, let's say, on all cylinders.
Yeah. 100%.
The productivity will be top-shelf, where
Yeah. You got it. That was the thing. To some extent, as I said, part of executive leadership is to do the right thing for the team you bring on place. I want to give these guys a chance. These really are killers. You can see their resumes. You can see how much in demand some of these guys were. I want to give them the air cover to really go in and kick ass. I think it'll take them one to two quarters to come up to speed. They're a pretty aggressive group. I'm actually quite excited. I think FY 2019 Q1, I'll start to feel very good about where we are. I think Q4 of FY 2019, my job is to put my feet up on my desk and just watch the money roll in.
Okay. Maybe last question, guys. This was asked before, but I just want to confirm the date on this, the big large enterprise customer. I'm going to connect the dots here. Tell me if I'm wrong. You did expect the inflection outreach, which you signed, and you had a press release out there, for them to start deploying in the second half of the year. I think October 1st was the license to sell date. Did that shift now? What is the new date on that deployment? Maybe double-click a little bit to tell us exactly what happened with that contract. Why did it slip? Maybe even, if you could, what's the capacity per quarter number of seats that you could deploy with that customer? Is there a number there, or is that sort of infinite?
Yeah. A couple of things. I won't comment on a specific customer because I just won't comment on a specific customer. Let's just say customers like this. It literally is they needed to get a bunch of infrastructure in place. They've already started the process of deploying. Now, as I indicated, they initially had 14, 15 countries. They are now talking about expanding the scope even much beyond that. They're also now expanding the scope where they want to start selling, which is where the self-service part comes in, reselling it beyond just deployments to their customers. They want to basically create an offering where anybody that uses their facilities can also buy all of the stuff. The scope keeps expanding. They're an amazing customer.
I won't comment on a particular customer, but I would urge you to. There was a very interesting talk that was given by the CIO of this particular customer, where he laid out all of his vision and his plan that he and the CEO have come up with. I think you will find that fascinating.
When will it deploy, Vik? Is there a date?
It's started.
Yes.
It's started. The ramp is slower.
Right.
The deployment has started.
That's it.
The ramp is just a little slower.
Got it.
The deployment has started.
Got it. Thank you very much. I'll take the rest offline. Good luck with the changes you're making and everything you do. Thank you.
Thanks, Dmitry.
Your next question comes from Charlie Erlikh with R.W. Baird. Your line is open.
Hey, thanks for taking my question. I was just wondering if you've seen any meaningful competitive changes this quarter. Are you seeing anything different from Microsoft or Google? Almost seems like Microsoft's kind of stepping off the gas pedal, so to speak. Any comments there would be helpful. Thanks.
No, I think actually I'm seeing the competitive landscape. That's part of why I'm really turning on the gas. I'm seeing the market play out essentially as anticipated. As you know, Cisco was hot and heavy on Spark. It's unclear exactly how all of this is going to play out, but BroadSoft is an interesting acquisition for them, and probably a very good one. Microsoft and the integration of Teams and Skype is going to be interesting. I view this as more and more, I think, you think about it, all the major contact center players have been taken out. We're the only one that has our own contact center. We have our own, essentially, collaboration engine.
We have our own chat engine, and we have our own voice and telephony, and we have started to do these aggressive investments, because by building these platforms, we have the ability to mix and match. Where we have been probably a little timid, is probably one word, is over the last year and a half, I probably could have started my investment cycle a little bit earlier, but I wanted to have the right people in place. You can see just in the last 90 days how much we've amped up in some of these hirings, as well as some of our developments and making some of these tough decisions about de-emphasizing orphan products and going after some of our core products.
We think that positions us very well for this market, and I do think the market's inflecting, and I don't think any of the big boys are going to be there for a while.
Got you. Thanks for the color.
Your next question comes from Catharine Trebnick with Dougherty. Your line is open.
Hi, thanks for taking my call. I just have a housekeeping question. You had said you added 20 new partners this quarter. Is that just domestic or does that include international?
No, we actually said that we enabled 21 new channel partners this quarter. We enabled them. We have brand-new training for our channel partners, where the SEs and the sales representatives come to 8x8, and they learn all about our products, and we teach them everything they need to know to sell. That's enabling our channel partners, which we think that's another big part of this investment program that we have put in place to enable our channel partners to win more and more deals on the behalf of 8x8.
All right. Of that 20 that were enabled.
If I may add, Catharine, to build on that.
Yeah. Oh, definitely.
Yes, primarily U.S., but we are seeing amazing growth in U.K. as well as now Western Europe as well. Again, I think the fact that we own every element of our technology and the fact that it, probably from a security compliance, et cetera, we're top of the world, then our entire core engineering team is essentially employees. I think those are things that channel partners like because it gives them a level of comfort that we'll be around. We're seeing very strong growth, particularly in the U.K. public sector as well, including some huge wins, including Ministry of Justice and others. The more you win, the more channel partners are coming to us, and my job is to make sure I enable channel partners so they can make a lot of money. The more money they make, the happier I am.
All right. Six of these enabled partners started delivering revenue this quarter, correct? I heard that right.
Yeah, actually, that's exactly right. Some of these new partners that we've been able to recruit since the beginning of our fiscal year are now bringing us deals, and we're closing those deals with those partners. It's been very good.
One of the things I get confused on with this huge investment that you're going forward to get back to the 25% year-over-year growth in services, and we can take this offline, too. When someone brings a deal in from your new business development person, does the channel and the business development individual or the channel partner that you've assigned both get compensated?
It's a single compensation model. The business development managers have a different responsibility. Their responsibility is to recruit the new partners, enable the new partners, and to help them develop their pipeline. The actual leads that come from these channel partners go to either our enterprise team in the field or our mid-market team in the field, depending on what size deal it is. It goes to the best person in that territory to close the deal. It's the account executive who actually gets compensated for that. The BDMs have a different structure.
Yeah. No, I was wondering if the channel also got compensated if you brought.
Oh, yes. Oh, absolutely. The channel's going to definitely get compensated. Any channel partner that brings us a deal that we close will be compensated, absolutely.
All right. Sorry to make you go through the mechanics. I just wanted to make sure I understood. Thank you.
You're welcome.
Your next question comes from Nikolay Beliov with Bank of America. Your line is open.
Hi. Thanks for taking my questions. I'm trying to reconcile the continuing strength in mid-market and enterprise deal wins, stable churn, and when I look at new MRR, mid-market enterprise channel for the last four quarters, it's been flattish.
Yep.
You guys facing much easier comps in the second half of the year.
Yep.
I would have thought, based on your expectations in the past, that as we get closer to anniversarying of the implementation timelines and whatnot, we would start seeing acceleration in new MRR. Can you please update us on the puts and takes, what's happening under the covers here?
No, I think you got it. Look, what's happening under the covers is a company goes through a process. We did a good job laying out the overall foundation vis-à-vis our sales, we had essentially a sales team that basically serviced, and sales leadership that serviced everybody from one line all the way to 10, 20, 30,000 lines. Did a nice job of laying the foundation. It became increasingly clear that we needed to build on that foundation and bring on board specialists. Bookings have been flattish. It's not necessarily the perfect proxy, as I've indicated, because larger enterprise customers. Just to give you a perspective, this quarter, three very large enterprise customers closed a week and a half after the quarter ended. It is what it is. Enterprise customers tend to close in their timeframe, so be it.
The idea was the reason I'm making all of these changes in the sales team to basically upgrade the talent in terms of specialists is for a reason. The reason is market's growing fast. My bookings aren't growing the way they should. Ultimately, you have to do whatever's necessary. I'm upgrading marketing, now, as I said, I'm really ramping up sales, I'm trying to make sure we have enough feet on the street, we have enough opportunities. Those are the changes. That's the puts and takes.
Okay. When we think about fiscal year 2019, we appreciate the guidance on subscription revenue growth rate. How should we think, at least qualitatively, about pre-tax margins for fiscal year 2019?
A good question, Nikolay. We do not expect to show leverage next fiscal year. We still believe that we'll be investing in the business. It's a very large market, as you know. It's under-penetrated, we have some, as Vik had explained earlier, we have some very new interest in disruptive products that are coming to market. We will be investing next year. We want to be profitable from a full-year perspective on a non-GAAP basis because we believe that that shows good discipline management, we're not going to increase over the 3% that we had this year, at least at this point. We haven't finalized our numbers, at this point, we don't expect to show leverage for fiscal 2019. Growth, that's where we're.
Yeah, it's all about growth.
It's all about growth.
We have managed a company balance between growth and profitability. The market inflected. I'm bringing in everything necessary to really upgrade the company from one end to the other to manage in a hyper-growth environment. I feel like I did the right thing. Silicon Valley companies always do stuff backwards. First, they hire sales, marketing, and then they try and build the product. We built the product. We then integrated the product, and now what we're doing is we're bringing in that next layer of sales, marketing, branding, feet on the street, and we're going to invest in it. The bias for me right now is growth.
My last question is around, you've spoken about U.S. and U.K. sales and go-to-market. How are you addressing with these new sales and management changes in addition to the rest of the world outside of the U.S. and the U.K.?
Oh, tightly integrated. I believe in global teams. There's a global small business and e-commerce team and a global mid-market and enterprise team. Again, as I said, look at the people and their backgrounds. Scott Sampson, that comes on board as the head of mid-market and enterprise globally, was the former head or CRO for NewVoiceMedia, which is a U.K.-headquartered company. Prior to that, he was worldwide analytics for IBM with about, I think, 4,000 or so people reporting into him. We've also brought on board the head of Interactive Intelligence, APAC. He's on board. We have promoted a person to run all of EMEA. The idea is to build a completely integrated organization, common set of products, and then we're going through all this local language capability.
This is where some of our amazing customers have been the front end going out, and they have been the ones kind of adopting our products in multiple countries, and that has been a great way to vet the product everywhere.
Thank you.
Your last question comes from Mike Crawford with B. Riley Securities. Your line is open.
Thanks. With the channel, are you seeing a handful of the same channel partners being the top channel partners that are bringing you deals quarter in and quarter out? Ancillary to that is, are you exclusive with any of those?
No. It's actually a trend. That's a great question, Mike. Initially, and telco is like this, and we're trying to get people's mindset to change that this is not telco, it's SaaS. The original set of channel partners tend to be, okay, we'll introduce you, and we'll introduce a couple of your competitors, and so you need to make sure you have face time with them. We're now starting to increasingly see VARs, that is why we're investing in them in terms of enablement and other things, that are starting to be semi-exclusive. In other words, they'll lead with us, and if they fail with us, then they have the right to go with somebody else or something like that. Eventually, as I said, we may end up with getting more and more exclusive.
I'm willing to invest in channel partners, but I'm not just willing to invest in channel partners which are just going to be bringing multiple people. I will do whatever is necessary to earn their business, but you're going to see an inordinate amount of my energy, effort, dollars, time, and just free information about product going more and more to those loyal channel partners because I'm trying to create that as a category. ShoreTel and Avaya had done that very well, which is why those companies survived through some very tough times. I think we have the opportunity to do that.
Okay. Thank you. Last question is, as you are more and more a one-stop shop for unified communications needs, are you still not seeing anyone that's asking you about network as well?
No. Network, we don't get asked, because that's the one thing that is interesting. More and more people are liking this over-the-top stuff. Because I've got so much analytics, we're a pure software player, right? You do your network. Our stuff is an app that rides on top of your network. We have not seen that. That tends to be something that really low-end customers ask for. The customers we're dealing with more and more are, "I got my own network infrastructure. You're just the over-the-top provider." The fact that you have analytics that allows me to get cross-network information, so it's not just in-network information about the health of my network, that's a huge differentiator.
Then, as I indicated, because of the way we've architected our solution, because of our engineering team and the way they are compensated, and the fact that the majority are employees, security compliance is something that we are world-class at.
Okay, great. Thank you.
Laura?
I'm showing no further questions at this time. I'd like to turn the call back over to Vik, Vikram, your CEO.
Sorry, Vik Verma, by the way. Closing remarks for me is very simple. Me in particular, we're going to be very active on conferences and non-deal roadshows, and we'll be telling you about some of our new products, some of our new activities. I think there's a lot of exciting stuff going on. I think expect to see several of you, and I think there's Joan will be leaving us, but Victoria has now got me signed up for a lot of various conferences, so I'm sure I'll be seeing a lot of you over the next few weeks. With that, thank you very much.
Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.