Good day, ladies and gentlemen, welcome to the 8x8 Inc. Q3 2017 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during this conference, please press star then zero on your touchtone telephone to reach an operator. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Joan Citelli, Director of Investor Relations. Please go ahead.
Thank you, Charlotte, and welcome everyone to our call. Today, I'm joined by 8x8's Chief Executive Officer, Vik Verma, and our Chief Financial Officer, Mary Ellen Genovese, to discuss 8x8's third fiscal quarter of 2017 financial results for the period ended December 31st, 2016. The earnings press release, which was issued today after market close, is 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, anticipates, predicts, forecasts, and expressions which reflect something other than historical fact, are intended to identify forward-looking statements. These forward-looking statements involve a number of risks and uncertainties, including factors discussed in the Risk Factor sections of our annual report on Form 10-K, in our quarterly reports on Form 10-Q, and in our other SEC filings and company releases. Our actual results may differ materially from any forward-looking statements due to such risks and uncertainties. The company undertakes no obligation to revise or update any forward-looking statements in order to reflect events or circumstances that may arise after this conference call, except as required by law.
I would also like to note that during this call, we will provide financial information that has not been prepared in accordance with generally accepted accounting principles, in addition to our GAAP results. Management uses these non-GAAP financial measures internally in analyzing our financial results and believes they are useful to investors as a supplement to GAAP measures in evaluating the company's ongoing operational performance. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures. This reconciliation has been provided on the financial statement tables included on our earnings press release. With that, I'll turn the call over to Vik Verma, Chief Executive Officer of 8x8.
Thank you, Joan, and thank you everyone for joining us today. Our financial results for the third quarter of fiscal 2017 were strong, with a 23% increase in service revenue to $60.1 million and a 20% increase in total revenue to $63.7 million. Adjusting for constant currency and the previously reported discontinued segment of our U.K. operations, service revenue grew 28% and total revenue grew 24%. Non-GAAP net income was $5.8 million or 9% of revenue. This is the 27th consecutive quarter that 8x8 has been profitable on a non-GAAP net income basis. Along with these solid top and bottom-line results, we've made very good progress during the quarter executing on the strategic initiatives we've outlined for continued growth. These include, 1, increasing adoption by mid-market and enterprise customers. 2, building an effective worldwide channel organization. 3, enriching our product portfolio with new features and services.
4, enhancing our global systems to support our multinational customers and partners. First, looking at our progress moving upmarket, I'm pleased to report that during the third quarter of fiscal 2017, service revenue from mid-market and enterprise customers grew 36% year-over-year and now represents 55% of total service revenue. We're now seeing a steady flow of mid-market customers adopting cloud communication solutions similar to what we saw in the SMB segment a few years ago, and enterprises are steadily beginning to come on board. 60% of the new monthly recurring revenue booked during this quarter came from mid-market and enterprise customers and our channel sales team. Our differentiated suite of integrated unified communication, contact center, and analytics services, combined with our superior deployment capabilities and reliable high-quality global network, are the reasons cited most often by larger customers who choose 8x8 over competitive vendors.
Of our top 20 customers, 15 subscribe to both our unified communications and contact center solutions, and 19 utilize our analytics capabilities to improve productivity and gain insight from their day-to-day communications activity. Also, we're now seeing the enterprise market moving beyond early adopters to more mainstream customers. These customers tend to use the same traditional procurement methods that drive other corporate buying decisions and are increasingly employing a land-and-expand deployment strategy, initially committing to a subset of their organization, and subsequently adding new locations and users. For example, this quarter, we added to our enterprise customer list a division of a large, well-known Fortune 50 company that is a good illustration of this land-and-expand strategy.
Brought in by our direct sales team, this high-profile healthcare company selected 8x8 as its vendor to transition over 400 offices of the various client medical practices it manages onto a single cloud-based communication system. Our selection followed an extensive 12-month RFP process involving more than a dozen vendors and a rigid proof-of-concept testing, culminating in a master service agreement with this customer. Under the agreement, 8x8 will provide Virtual Office and Virtual Contact Center services to an initial set of designated locations, and we anticipate that the remaining locations will follow. 8x8 successfully went live at the first set of medical practices earlier this month, and we are currently finalizing plans to deploy a large practice with 12 locations consisting of 750 Virtual Office extensions and 60 Virtual Contact Center seats in the coming month.
By becoming the chosen cloud vendor for this division, we were granted access to a captive market of over 400 medical practices and approximately 10,000 users. In addition, the division with which we contracted is one of many divisions that make autonomous buying decisions but who tend to give weight to the buying decisions and previous vetting of vendors by other peer divisions. We now have a proverbial foot in the door of what is essentially a new channel with a partner whom we expect to be a zealous advocate within the larger organization, provided we execute to our abilities. The time and resources we invested to become the chosen vendor of one division was substantial, and the initial commitment was low, but the opportunity is large, up to $9 million in contract value for this division alone.
By comparison, many of our previous early adopter enterprise customers placed an initial order for most or all of their locations, resulting in large initial bookings, but with gradual deployments generating revenue recognition over subsequent quarters. These recent enterprise customers have represented comparatively smaller initial bookings and new MRR in this section, the sector was essentially flat this quarter, we expect them to deploy additional locations at a rate similar to other enterprise customers and do not anticipate an adverse long-term revenue impact. We also continued to add sizable mid-market accounts during the quarter, including a leading manufacturer of turnkey sorting and packing solutions for the fresh produce industry with approximately 500 Virtual Office and Virtual Office Analytics seats, and a provider of products serving the food service and food packaging industry with nearly 600 Virtual Office seats across 12 locations.
In addition to new logos being added by our sales team, we are seeing consistently strong expansion revenue each quarter, with over 50% of new monthly recurring revenue coming from existing customers in the form of additional seats and services. Some examples of these expansion deals from the third quarter of fiscal 2017 include Regis with an additional 850 Virtual Office and Virtual Contact Center seats, NetSuite with over 500 Virtual Office seats, TrueBlue with over 400 new seats, Social Finance and Patterson Medical Products, each with over 300 Virtual Office and Virtual Contact Center seats, and a leading media company based in Los Angeles with over 1,100 additional Virtual Office seats. Second, our channel continues to grow and perform well, bringing us five of our top 10 deals in the third fiscal quarter.
One of those deals is a rapidly growing enterprise retail customer that, when fully deployed, will encompass over 10,000 Virtual Office extensions in 3,500 locations across 49 U.S. This customer selected 8x8 because of our excellent reputation in the retail space, experience deploying large customers in an efficient and timely manner, deep analytics capability, and ability to provide service internationally as they expand outside of the U.S. The channel also brought us a combined Virtual Office and Virtual Contact Center customer, a cemetery and mortuary business with 700-plus seat deployment. This customer chose 8x8 following a successful proof-of-concept trial deployment that demonstrated how 8x8's integrated offering would streamline communications and customer engagements across all of their locations. Another combined Virtual Office and Virtual Contact Center customer that came through the channel is a leading manufacturer and e-commerce retailer of point-of-sale displays.
Our single unified communications and contact center platform, along with the customer's need to be up and running with all users in less than 45 days, were two of the reasons they selected 8x8 for this 200-seat deployment. This customer is using mobile and soft phone only, demonstrating the growing trend we're seeing away from physical desk phones. We announced several new channel partners during the quarter, along with our new Partner Connect Global Portal, enhanced sales and technical training, and expanded channel enablement offerings, including marketing and demand generation support. 8x8's global channel team has doubled over the past year, with employees now in North America, Europe, and Australia. Third, on the product innovation front, our recent investments in the contact center capabilities of our platform, including global tenants, analytics, and quality management, are beginning to show good results.
Revenue from Virtual Contact Center grew 32% in the third quarter of fiscal 2017, compared with 16% growth in the same period last year. A Q3 deployment of our Virtual Contact Center solution for the International Red Cross by our U.K. office is a good example of how customers are able to easily deploy and utilize our powerful customer engagement solution. Completed in less than one week, this 70-seat deployment supported the Red Cross's serious request family of annual multi-day, multimedia fundraising events, which recently focused on raising awareness of pneumonia. Due in part to the swift trouble-free implementation of our solution and accompanying reliability, the campaign successfully raised nearly EUR 9 million for this cause. Our patent portfolio continues to grow with our recent notification of three new patents for a total of 120 awarded patents to date.
In addition, we're continuing to expand our resources in Romania to supplement our existing R&D and engineering operations with DevOps, NOC, and customer support professionals. We now have nearly 100 full-time employees working out of our Romania office and over 1,000 employees worldwide. With this expanded capacity, we have a rich pipeline of new products and enhancements that we will start launching this coming quarter, including open platform capabilities, new mobile and desktop apps, and more out-of-the-box integration and real-time analytics. Fourth, we made significant progress during the quarter expanding our global capabilities, including ongoing investment in our back-office infrastructure. We have completed the transition of our global sales team to a single Sales Cloud environment, and we're in the process of implementing a major refresh of our ERP system to unify financial operations across all of our regions.
Additionally, we have completed the second of three phases to roll out Service Cloud across our global support team to enable seamless 24/7 support capabilities to our mid-market and enterprise customers. With these infrastructure projects, we're rapidly preparing our business for the next stage of global growth. Finally, I'm excited to announce the completion of a small technology acquisition earlier this month that'll bring us some really innovative collaboration capabilities. We'll be providing additional details about this technology and how it fits into our global communications platform and strategy in March. Stay tuned. With that, I'll now turn the call over to our CFO, Mary Ellen Genovese.
Thank you, Vik, and thank you all for joining us today. Let's begin with some highlights from our income statement. Total revenue for the third quarter of fiscal 2017 grew 20% to $63.7 million, and service revenue grew 23% to $60.1 million. On a constant currency basis, total revenue increased 22%, and service revenue increased 25% year-over-year. Further adjusting for the discontinuation of the non-core voice message broadcasting segment of our DXI operations, which we announced last quarter, total revenue increased 24%, and service revenue increased 28%. We anticipate the continued depreciation of the British pound against the US dollar and with the discontinuation of the non-core segment of our U.K. business to have approximately a 350 basis point impact on our GAAP service revenue in our fourth fiscal quarter. On the product side, revenue declined year-over-year by 16%.
As mentioned previously, we are seeing a trend whereby customers are shifting away from desk phones in favor of mobile and soft phone apps. This is good news for us and a trend we hope continues. Given the changes in customer adoption, we also anticipate product revenue in the fourth quarter to be comparable to this quarter. Service revenue from our mid-market and enterprise customers grew 36% year-over-year, and it was 45% growth when adjusted for constant currencies and the discontinued segment of our U.K. business. 55% of our total service revenue is now coming from these larger customers, compared with 50% in the same period a year ago. My comments going forward will be based on non-GAAP results unless otherwise noted, and I remind you to refer to the tables included in today's earnings press release for a GAAP to non-GAAP reconciliation.
Gross margin during the third fiscal quarter of 2017 was 78.5%, compared with 74.8% in the same period last year. Service margin was 84.3%, compared with 83% in the same period last year. The improvement in our margins this quarter is a reflection of several factors, including the growth of professional services revenue, which is increasingly becoming a standard component of contracts with larger customers. Net income for the third quarter of fiscal 2017 was $5.8 million, representing 9% of revenue, compared with $4.3 million or 8.1% of revenue in the year ago quarter. On a constant currency basis, net income benefited by approximately 50 basis points or approximately $300,000. As Vik mentioned, this is 8x8's 27th consecutive quarter of profitability on a non-GAAP net income basis.
Sales and marketing expenses in the quarter were $32.9 million, or 52% of revenue, compared with $25.3 million or 48% of revenue in the same year ago period. As previously indicated, this is one of the areas we have been increasing our investments to build out our channel presence and capture the growing market demand we are seeing. The increase in sales and marketing expenses during the quarter was primarily due to an increase in salary and channel commissions to support our growth in channel. Continued implementation of our new internal system supporting our global sales and service organizations and the build-out of our global deployment team. Moving on to some of the key operating metrics for the quarter. Average revenue per customer was $414, compared with $369 in the same period a year ago.
Average revenue per mid-market and enterprise customer grew to $4,412, compared with $4,017 in the same year-ago period. Gross monthly business service revenue churn on an organic basis was 1%, compared with 1.2% in the same period last year. While the number has hovered around one-half of a percent over the past few quarters, we generally see this tick up a bit in the third fiscal quarter due to less usage over the holiday season. Bookings during the third fiscal quarter from mid-market and enterprise customers and by our channel sales team comprised 60% of the total new monthly recurring revenue sold, 61% on a constant currency basis, compared with 58% in the year-ago quarter. Adjusted for constant currencies and the discontinued DXI business segment, bookings from mid-market and enterprise customers and by channel sales teams grew 10% year-over-year.
As Vik mentioned, we are seeing some of our large customers use traditional procurement methods whereby they buy in tranches from a prenegotiated master service agreement. We do not anticipate this buy-in methodology to have an impact on long-term revenue growth. Expansion revenue from existing customers comprised over 50% of the total new monthly recurring revenue booked during the quarter. This remains strong quarter after quarter and is a solid testament of the value our solutions deliver and the flexibility our cloud-based technology enables to support customer expansion and growth. Cash, cash equivalents and investments were $173 million at December 31st, 2016, compared with $155 million in the same period last year. Cash flow from operating activities was $8.8 million in the third fiscal quarter, compared with $8.3 million in the same period last year.
Capital expenditures were $2.8 million, representing 4% of revenue, compared with $1.7 million or 3% of revenue one year ago.
We are maintaining our annual guidance for fiscal 2017 of revenue in the range of $251 million-$254 million, raising non-GAAP net income guidance to a range of $18 million-$20 million, representing non-GAAP net income as a percent of revenue of 7%-8%, from previously issued non-GAAP net income guidance in the range of $16 million-$20 million. As a reminder, last quarter, we increased our fiscal 2017 annual revenue guidance from a range of $249 million-$253 million, despite headwinds of approximately $4.4 million from the discontinuation of the DXI voice messaging service and the continued decline of the British pound. That concludes my prepared remarks, I will now turn the call over to Vik.
Thank you, Mary Ellen Genovese. There is no question that cloud communications adoption by the mid-market and enterprise market segment is upon us, from food producers to healthcare corporations to mortuaries, and 8x8 is favorably positioned to capture more than our fair share of this emerging demand. What's even more exciting is the strategic value these companies are already placing on their communications as a critical component of business productivity, planning, and growth. We recognized this trend several years ago when we began developing analytics tools for customers from our big data environment. Now we are committed to taking this value proposition further through what we believe will be an unprecedented move forward for the cloud communication industry. Stay tuned for more on this in March at Enterprise Connect. With that, we will be happy to take on any questions you may have for us today.
Operator, please open the line for any questions.
Certainly. Ladies and gentlemen, if you have a question at this time, please press the star, then the number 1 key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, you may press the pound key. In order to allow time for others, we ask that you please limit yourself to 1 question and 1 follow-up. Once again, to ask a question at this time, please press the star, then the number 1 key on your touch-tone telephone. Our first question comes from the line of Nandan Amladi from Deutsche Bank. Your line is now open.
Hi. Good afternoon. Thanks for taking my question. Vik, as you expand your sales channels overseas, can you highlight some of the similarities and differences on how the channel works here in North America versus in other countries?
Slightly different. The North American channel, to a large degree, is more like a referral network. Increasingly what we are seeing with international channels is they're much more value-added resellers. They tend to pick one or two vendors, typically one, and then they build a practice around them. That's actually a much better approach because then you don't mind investing significantly in basically making that channel effective. That's a decision we then tend to make on different locations. I want to make sure I have people there that can enable the channel, provide them the support, help train them. To a large degree, I don't need to have that many employees at different parts of the world because I can leverage the channel because they're essentially either exclusively or semi-exclusively selling us.
That's been one of the key areas that we see as an area of growth and a way to get leverage and yet maintain our headcount relatively steady.
How does that impact your sales and marketing spend on a, I don't know, per-unit basis, if I could frame it like that?
We've planned for this. I mean, that was always our strategy. Over time, I think we're starting to get to critical mass on sales and marketing. We'll start to see more leverage out of the sales and marketing spend over time. I do want to make sure we increase our brand recognition because I think we've now got the entire and comprehensive product portfolio. I've been somewhat reticent to go out and really do a massive branding campaign or anything else like that. I may start to tweak that up, as a % of revenue growth, I assume that sales and marketing going forward will be consistent with or maybe even slightly lower than revenue growth going forward. Engineering, I'll continue to invest. From my perspective, through a combination of luck and hard work, the team has assembled three very core technologies all under one roof.
We've got the essentially collaboration-type technology, we've got the contact center technology, and we've got the whole Virtual Office technology, and they're all on a common platform, and we're starting to expose the APIs to a complete refresh on our UI, make sure we head towards much more of a microservices architecture. I feel like that is a huge strategic weapon, and we'll continue to invest in engineering faster than the rate of revenue. Sales and marketing will either stay at the rate of revenue or start to decline in terms of investment as compared to revenue growth.
Thank you.
Thank you. Our next question comes from the line of George Sutton from Craig-Hallum. Your line is now open.
Thank you. Vik, I realize now how to make you giggle. I need to mention cemeteries and mortuaries, and I think I got it.
That was hard to read.
I wanted to take what you just said relative to getting the critical mass on sales and marketing a little bit further and speak more competitively. You have been trying to build up your direct sales force more recently to try to get after more of the opportunities. Do you feel like you're getting to the point where you're seeing the vast majority of the opportunities? And then once you are seeing those, can you just give us a sense of what you're seeing in a win rate?
No, actually we're not. That is one of the areas I think I make a comment. We are seeing a reasonable share of opportunities, but we're not a household brand. I would take our technology and put it up against anybody, and I would say we're awesome, and the fact that we have it all integrated together makes us truly differentiated. We do need to get better as a company in getting our brand out there. What's been going on with us is, I think we've built up a very strong enterprise sales team, we talked about this whole concept of whales. Our goal was to go get a couple of whales, and next thing you know 10, 12 whales all jumped on the boat. From that perspective, we do need a bigger boat.
We're starting to now put much more of a replicable machine together because we're starting to feel like we understand which of the larger customers have a much more predictable buying pattern and buying behavior. What we're trying to do is sub-segment that market and then create much more efficient teams. That's a work in progress, and I think we'll be putting much more effort into creating this level of replicability because we've had such a vast number of customers from different parts of the industry that we can start to come up with a sense of which ones go through what type of buying behavior, how do they buy, when do they buy, and which ones are the ones that are the right for basically quick wins because they all self-reference each other. We're going through that next stage of evolution as a company.
You mentioned a household brand name, and I guess it depends on the household, but Avaya is pretty well-known brand name out there. Obviously just filed for bankruptcy. I wondered if you could just address any potential opportunities you see for 8x8 through that situation.
If I had a Cessna that I could get, I was going to put a little sign on it that says, "8x8 welcomes any potential Avaya customers and/or channel partners," and fly it around Avaya headquarters. I see that as a logical evolution. You never wish anybody ill, but Avaya was traditional on-premise, and cloud is disrupting. To use your phraseology, I was actually also startled by some of the type of customers that you start to see now that are adopting cloud, and just the way they adopt cloud. If you think about it, you've got the entire circle of life, from food producers to healthcare providers to mortuary services. You've got them all covered. They're all starting to move towards cloud, and I think that's going to accelerate. Think about how much flexibility a system like ours gives to large companies.
If you're adopting an Avaya system, a large on-premise type system for a global enterprise, you have to buy the whole shebang, or nothing works. In our case, you could literally start with two, three, four offices once you negotiate the right service agreement, and then keep adding rapidly over time. That flexibility then makes it that much more easy for enterprises to start moving. I think that trend is coming. I think we have to evolve towards the fact that we are now starting to see that next wave of enterprise. These are not the techie geek type companies that really are comfortable with cloud. They view cloud as a business value and a way to move in this direction, but they're not necessarily that tech savvy.
You have to build your support and as well as your overall sales team to provide some level of education and then make it almost simple for them to use. That, as I said, is the next level of maturation that is happening for us as a company.
Thank you.
Thank you. Our next question comes from the line of Rich Valera from Needham & Company. Your line is now open.
Sorry, thank you. I was on mute. Wanted to just follow up on a question regarding the growth of your mid-market MRR, Mary Ellen. You had mentioned that, I think purchases from a master service agreement had caused that to slow relative to historical rates. I was wondering if you could just clarify that and talk about how you see that growth rate trending in the future.
Good question, Rich. This quarter, as you know, we booked a very large deal, a Fortune 50 deal that we are really very honored to win. We were up against a number of competitors, and it was a one-year process with a POC that ended up in a very long negotiated master service agreement. As part of that, there were a couple of offices that they booked this quarter. If you go back a quarter, or you go back to, let's say, our third fiscal quarter of 2016 or even the fourth fiscal quarter of 2016, we had large whales that booked their entire enterprise. They booked their entire enterprise, big deal. All of GameStop, the 4,000 stores within the United States was booked all at once. Movement Mortgage, 6,000 employees booked all at once.
Otto Europe, they wanted first just the contact center, then when they realized that the cloud savings would also help them pay for their Virtual Office, they wanted both at the same time. You deploy those over a period of anywhere from, dependent on the customer, anywhere from six months to 12 months to 18 months. You have a big booking up front, but then you deploy the revenue over six, nine, or maybe even as far out as 18 months. In this particular case, it's different. You get a small number of $ booked up front, but then you deploy the same way. They've already started to release purchase orders. We've already started to deploy these offices. It'll be the same, we think, over the six, nine, or 12 months or 18 months.
We'll get the same amount of revenue regardless of whether we booked 100% of it up front or whether we just get the small piece first and then continue to expand. It may be too early. We have a number of customers that have done this. Maybe it's too early to call it a trend, but I think moving forward, we're going to see more and more of our enterprise customers, more of these traditional enterprise customers book in that regard.
Got it. Your experience so far makes you think that the cadence of new customer additions under that agreement is likely to be similar to those customers that have historically booked the whole thing up front.
Yeah. I think we're seeing that. It is quite interesting because where previously, as you indicated, the early adopters tend to go out, and as I said, stretches out over 18 months. These guys will tend to spend a lot of time doing a proof of concept and making you either an exclusive or preferred vendor with a well-defined master service agreement, then that almost becomes like a catalog, then they start essentially adding addendum after addendum to that catalog, then they expect the deployment to happen in 30 days or 60 days. Very quick deployments. Okay, here's the contract, deploy this office 30 days from now, it's done. Next. Versus coming up with a large program plan for deployment over an 18-month period.
Got it. That makes sense. Just following up on the theme of investment, it sounds like both R&D and sales are clearly focuses here. When you look at your annual guidance for net income, it would appear that the fourth quarter you would be down versus the average for the first three, which seems a bit challenging, assuming the revenue goes up a bit. I wonder if you just put a little color around that, sort of what are some of the incremental investments in the fourth quarter that get you that pretty significant bump in OpEx that appears to be baked into your guidance? Thanks.
Okay. Well, thanks, Rich. Our fourth fiscal quarter typically is a larger investment quarter from the others for two main factors. One is you start the security clock all over again, right? All of our employees are paying a higher fringe benefit. Second is that we have a fairly big show at Enterprise Connect at the end of March, which is a big show for us. It's the biggest show of the year, and this year we expect to have a major launch of our new products. Those are two key things. In addition to that, we want to also prepare for our fiscal 2018 kickoff in April. We're hiring the team now that's going to be needed and required to meet our numbers for fiscal 2018.
We want them to be up to speed and onboarded, ramped, and being able to kick off the new year in a great way. There are those investments that we're kickstarting for the new year.
As I said, what Mary Ellen kind of alluded to, we acquired a company in the collaborative space, which we think is really innovative. We're using Enterprise Connect as a way to completely refresh our UI for all of our core products, because that was one of the areas we put emphasis on. We'll be introducing several new products into the U.S. market that we've been getting ready to launch. We think we've kind of built up critical mass across the board. We've gone through a series of learnings, we want to use that as an opportunity to really go out and show the breadth of products that we have that are all now going to be integrated together with the next generation of UI. Yeah. If you are at Enterprise Connect, we welcome you to join us.
Yeah. We invite you to come.
I think you won't be disappointed.
Thank you. Our next question comes from the line of Amir Rozwadowski from Barclays. Your line is now open.
Good afternoon. This is Matt for Amir. Just a quick question on the mid-market and enterprise customers. Obviously, that has grown from 40% a few years ago to 55% today. Do you have a target mix in mind that you would like to hit over the next two to three years?
The number I'm looking for is, ultimately our future is enterprise. We will continue to service our SMB customers. We love them. We think we can provide significant value for them. Remember, we're a cloud vendor, so anything we develop for the enterprise customers is basically provided to our SMB customers for that same low price from that perspective. Over time, I'd like to see 70%-80% of our revenue base coming from mid-market and enterprise. I'm becoming a big fan of this. Because of the fact that we have such a comprehensive product portfolio, there is an unprecedented opportunity for land and expand. Once you go in and you build up credibility with a customer by providing them their core communication platform, the ability to add contact center becomes very significant.
You can add our Virtual Meeting product, which essentially gives you essentially a Webex equivalent, a much lower end of that, but basically gives you that type of functionality. You can add your quality monitoring, which gives you speech analytics as well as the ability to do agent training. It allows us to do some of our sales analytics too. That mid-market and enterprise customers do that, and that's why you start to see land and expand become a bigger and bigger piece. Second, as I said, from a contact center perspective, we typically go into a customer with our Virtual Office and then we bring in our Virtual Contact Center. That's an area we've been putting a major amount of push into.
As a matter of fact, I'm going to keep accelerating the push into our Virtual Contact Center because that's a hidden gem. I think you saw it this time where the growth rate for Virtual Contact Center has gone from 16% a year ago to 32% this year. I think that thing is going to keep moving up. Then we've got our product in the U.K., which is a very low-end contact center, which is intended for non-traditional contact centers, which we'll be introducing into the U.S. market in the March timeframe. That whole concept of land and expand is increasingly more important to us, and that is tailor-made for mid-market and enterprise customers. Long term, a couple of years from now, I'd love for that mix to be 70%-ish of mid-market enterprise, 20%-ish, 20%-30% as SMB customers.
Just a quick modeling question. I know, Mary Ellen, you had said that the pound is going to be three, you're expecting 350 basis points of a headwind in 4Q. Can you just help us reconcile how that compares to, I believe it was $4.4 million you gave us last quarter for the full year impact?
Right. The $4.4 million was a full year impact. The 350 basis points was only for Q4. If you looked, for instance, as an example, if you look at this fiscal quarter, Q3, 23% was our revenue growth on a GAAP basis. When you correct it for constant currencies and you correct it for the discontinuation of that one business segment, non-core business segment in the U.K., we're at 28%. On an apples-to-apples basis, we would have had 28% growth rate. That's about a 500 basis points. Next quarter, we don't expect it to be as significant. It'll be approximately a 350 basis point difference.
Thanks for taking my questions.
Thank you. Our next question comes from the line of Dmitry Netis from William Blair. Your line is now open.
Thanks, guys. Just to kind of on that last question you addressed, so 500 basis points this quarter, 200 of that was FX and 300 was discontinued operations. Is that correct?
No, that's actually not correct.
Okay. Can you tell us exactly how that 500 split this quarter?
Wait a minute. Hold on. I'm sorry. It was a 23%, you're right, 23% on a GAAP basis, 25% on constant currency basis, and a 28%. That is a 300 basis point difference just on the discontinued basis and a 200 basis points for the constant currency.
Dmitry was correct.
You were correct. Sorry.
Then $350 next quarter, how much is FX versus discontinued operations?
That's a good question. I didn't actually do it that way, but you could do the same percentage cut, if you will. Yeah.
Okay. All right.
Yeah.
That makes sense. Okay. The mid-market service revenue growth of 36%, if you adjust for constant currency and exclude FX, what would that number look like? I think you might have mentioned it, but I might have missed it.
I'm sorry, which question is that? Is that for the mid-market revenue growth?
Yeah.
Yeah. It grew 36%, what would it be on a constant currency?
45.
45% versus last quarter was 40%. Is that right?
Last quarter was 40%.
Okay, excellent. I guess I wanted to also see the Virtual Contact Center's spectacular growth. It's almost doubled from a year ago. You grew, I think, 32% year-over-year. I just want to understand, is it as a result of competitive environment easing or maybe additional product capability you added?
Yes.
It means all those things. I'd love to see kind of your thoughts on that growth being sustainable going forward and maybe the line of business products, Salesforce analytics, if you can comment how that's doing in the market and whether that's going to add to growth or will retain that sort of run rate up on VCC side of things.
Yeah, no, look, our contact center is a goldmine. I mean, in essence, it's an area that we neglected in the sense that that had not been the push for the company because we've been getting such great growth from our overall core PBX. Over the last couple of years, I had come more and more to the conclusion that both Virtual Office and Virtual Contact Center belong together and kind of build on each other. Over the last year and a half, we've started to put some major investments into it. We went through and created this whole concept of a global tenant and follow the sun. We're doing a complete platform refresh, which by the way, you have not lived until you go through and do a platform refresh, and any remaining hair I had fell off.
What it allows us to do with doing this complete platform refresh, changing GUI, adding key features, is more and more, this product is starting to become a product that standalone can hold its own. It's not quite there, but we're getting very close, where what we have is we will end up with best-of-breed products. I would put our VO product against anybody, and I would be very confident in what it is. VCC traditionally has been essentially one bubble off center, but over time, we've started to now make it much more of a focus, and I actually think that that has huge growth. I'm going to put more and more emphasis on it because the more I dig into VCC, the more I see huge opportunities for that to be not just a standalone product, but an additive product with VO.
We have a third leg to that, which is our Easy Contact Now or Contact Now product for U.K., which is essentially a try, buy, and deploy contact center. You literally Not even download, I'm sorry, via web. You log on, and you're now starting to use your contact center, and you can use it to do outbound dialing. You can do take inbound calls, and it's simple to use, and it's completely seamless. No training involved, no professional services. For non-traditional contact center, we think it can be very disruptive. We want to introduce all three of these products together.
I expect contact center, both VCC and ECN over time to be a very appreciable growth driver for us, and we want to make sure that those get the kind of attention and energy and effort that they deserve, because in the past, we've underinvested in those.
Thank you. Our next question comes from the line of Will Power from RW Baird. Your line is now open.
Hey, guys. Thanks for taking my question. This is actually Charlie Ehrlich on for Will. I was wondering if you could tell us who specifically did you guys compete against for those two large customer wins this quarter, and how competitive was that process, and how do you ultimately think that you ended up winning that contract? Thanks.
I don't know specifically, the one was 12 vendors, I know one was a whole bunch of vendors. I'm not sure we can tell you who, but I think we all signed an NDA with the customer in terms of the process. What I can tell you, this tells you what is our strength and what is our weakness, we always get brought into every deal late. I figured that part out, we've just learned to live with the fact that nobody knows our brand as well as they should, our intent is to start to change that. Every deal we have is competed. More often than not, the more complex the deal, global, Virtual Office, Virtual Contact Center. The more complex the deal, more demanding the requirement with uptime, reliability, and stuff like that is very critical, we win.
If it is pure cosmetics or it's a simple application and UI is the key driver, that's not necessarily our strength. It will become our strength. As I said, we're going through a complete refresh. We believe we can kind of compete on all levels, because I think we've captured the high ground, which is our ability to compete for very complex deals where reliability, integration, and the comprehensive on the solution is key. We win on those. Right? I want to make sure our UI is world-class, once our UI is world-class, as I said, you'll start to see that around the March timeframe, I think we'll be tough to beat. The other part we got to do is more and more, we got to start making our brand known.
I think with the wins we have had, with the kind of prominence we've had, with the kind of complete comprehensive of the portfolio that we've assembled, the gaps that we had that we have subsequently filled, collaboration being one of them, I think we have an opportunity to really be a one-stop shop. I think we'll start to really raise our brand starting in the March timeframe.
Makes sense. Thanks.
Thank you. Our next question comes from the line of Mike Latimore from Northland Capital Markets. Your line is now open.
Yeah, great. Thanks a lot. Just on the ARPU, I think it looks like it grew about $5 in the quarter. It had been growing $10 or so. I guess any influence from the discontinued ops or generally, how do you see ARPU trending over time here?
If you look at the mid-market ARPU, it's trending right in the same direction as it has in the past. It is a little lumpy from a percentage perspective. This quarter was 10%, last quarter was 7%, the quarter before that was 10%, the quarter before that was 7%, right? Within that 7%-10% mark seems to be pretty consistent. On the total ARPU, it was a little bit lower. It was 12% this time. It was 14% last quarter, 13% the quarter before that. I think we're in the ballpark. I would say 12% seems to be the low over the last couple of quarters, so maybe 11%-13% moving forward.
Okay. Great. Thanks. Professional services, you sort of mentioned that. I guess, can you give a general sense of what % of revenue professional services is today, what it was maybe a year ago?
Yeah. That's something that we started this year, actually more actively pursuing, especially with our larger accounts, professional services contracts to do the deployment. We get pushback, of course, on the smaller customers. On the larger customers who are used to paying for deployment. This particular quarter was right slightly more than 1% of revenue. It's still small, slightly above 1% of revenue. About a year ago, it was maybe a half a % of revenue.
Okay, got it. Thanks.
Thank you. Our next question comes from the line of Mike Crawford from B. Riley & Co. Your line is now open.
Thanks. To only hit the high end of your guidance for Q4, it looks like OpEx would need to grow about $4 million or $5 million from the pro forma of $43 million in Q3. Would you be able to provide just a little bit more color on how much of that might be from the technology acquisition, or how much of that is Enterprise Connect, and how much of that would carry through into next year? Thank you.
Yeah. A little bit will be from the technology acquisition. Not a significant amount. We did hire a very capable team, but think of it very much like our Quality Software Corporation acquisition that we did a little bit more than a year and a half ago. It started out with a team of maybe seven or eight individuals pre-revenue, but the core of some phenomenal technology that we've been able to bring to market very quickly. That's the same situation here. In addition, we are ramping up our R&D, as Vik had said. We were down year-over-year from 10.4% on a non-GAAP basis to 9.5%. We really want to pull that up from a non-GAAP perspective. We won't be able to do it overnight, of course, but we are building a very solid team in our Romanian operations.
We're able to get some of the best of the best university students, as well as some folks that have 10 to 15 years of experience that can lead the Agile teams, the Scrum teams there. We will be making investments. We will be preparing, again, as I had said, getting ready for our new fiscal year in fiscal 2018. We will be hiring additional direct salespeople in our enterprise team as well as our mid-market team. We'll continue to ramp up on the channel because that's where we're seeing the traction. We're seeing traction on both sides, we're seeing some very, very nice traction on the channel. We continue to search for channel account managers. You're going to see increases across the board.
All right. Thanks, Mary Ellen. The second question is, while we fully expect the mid-market enterprise to continue to comprise a little bit more than half, with 60% this quarter of new MRR book, you also still booking substantial amounts in your small office, home office business. Where would you say the market is relative to small office, home office and where it plays in that market?
It's continuing to grow robustly. It's important for us in the sense that, to me, as long as it's got a great payback, it continues to grow, and we'll continue to do whatever's necessary to make sure we get our fair share. It's not an area we're going to at all neglect. I like the business, and I have an integrated team. We've got fully ramped up reps. I've got good leadership there, and we're bringing in some more help for them. Actually, even in that area, we're going to simplify. We're heading towards much more packaged solutions, which will basically accelerate velocity, because we're starting to see that people are able to buy without the kind of consultative sales process. From that perspective, I actually think there's nontrivial headroom even in our SMB business. The intent is, I want the SMB business to grow.
I just want mid-market and enterprise to grow faster.
Right. One thing to remember, Michael, is we're not necessarily going after the home office, the 1-to-2 line customers.
Yeah
or the very small businesses of less than 10 lines. We're moving that team up as well, because the payback for that size, 10-plus lines. They focus on the 10-plus lines up to 100 lines, and that's much better than the 1-to-10 line business, which for us, it's a low payback.
Low payback.
Okay, great. Thank you.
Thank you. Our next question comes from the line of Jonathan Kees from Summit Redstone Partners. Your line is now open.
Great. Thanks for taking my questions. I just want to ask about the CapEx that ticked up for the quarter. Are you now just expanding on those data centers? I know you had increased the data centers from 9 to 12. Are you expanding on them, or is that the reason why CapEx ticked up from last year?
No, actually this year is pretty consistent where we've been investing in next-generation capabilities and upgrading our technology in each one of our data centers, as well as now we're bringing the ContactNow product that we purchased in the U.K. We're bringing that to the U.S. We're building a new data center with new technology for that product here in the U.S. to support that. We're upgrading our technology for all of our Virtual Contact Centers. We have the 12 media centers that are up and running. Now, remember, that's not huge investments because in that regard, we're renting racks from a partner like an Equinix. Those are relatively inexpensive to do. We might deploy another one or two next year. Right now, it's more or less taken our technology in their contact centers to the next generation.
Okay. Thanks for that clarification, that explanation there. My next question is at a higher level. There's been talk in the news in terms of 8x8 being acquired or the board seeking strategic alternatives. I guess I want to reconfirm that the board is not seeking strategic alternatives. Then two, if you can humor us, who could possibly be interested in 8x8?
That was-
I realize it's hypothetical, just humor us.
Look, here's the thing. I think you've seen our governance score as a company that, I don't remember exactly they calculate it, but we are as shareholder-friendly a company. I have no blocking rights. Nor do I seek them. We don't have multiple classes of shares. We don't have classification. Everything is, I think, as blue ribbon from a governance perspective as possible. We will do what's right for the shareholders. From time to time, people express an interest. That's fine. Everybody's entitled to express an interest. We have a view on what this company is worth. Our view is that when we can get our mid-market enterprise base to be very significant portion of our revenue, the value of the company, because the net present value for mid-market and enterprise customers is about 35 to 40 times that of a SMB customer.
That transition, we think, is well underway. With all of these enterprise customers, we have the land and expand opportunities. I think we believe we can get to a certain place on our own. In order for somebody to make a compelling offer, they have to bake in that value for us to be fair to our shareholders. I have a general philosophy. If anybody ever comes in and gives us an indication of interest or even makes an overture, I always involve my board because I believe that is my responsibility. I'm not trying to run this company like a fiefdom. Who's interested? Look, all kinds. There's an alphabet soup of companies that at one time or the other either expressed an interest or circled around.
To me, it really comes down to when somebody's willing to pay what I think the company is worth, and that's actually at the board's discretion, we'll do the right thing for our shareholders. Ultimately, we serve at the pleasure of shareholders, and the goal is to ensure we maximize value for shareholders.
Thank you. Our next question comes from the line of Catharine Trebnick from Dougherty & Company. Your line is now open.
Hi, good afternoon. Thanks for taking my question. This is Jack on the line for Catharine. I just wanted to briefly hit on the international piece. Can you give us the percentage of revenues that came internationally? Are you seeing any differences in penetration rates or purchasing behaviors international relative to the domestic environment for UCaaS?
For us, our total international revenue is a little bit lower. We've been running about 12%, that'll be around 10% because of the drop in the British pound. When you actually look at our businesses in the U.K., the solutions business that we have has grown well over 30% year-over-year in their currency.
In their currency, yeah.
In their currency. We haven't seen any slowdown in the U.K., which is where most of our international revenue is. Certainly, as we will continue to expand into Europe, that'll be a bigger piece of our revenue come next year. For right now, we're not seeing any slowdown in the U.K. market.
Yeah.
I guess on the second part of that question, are you seeing any difference in penetration rates or purchasing behaviors in the international market relative to the U.S. market for UCaaS? Just any clarity on that.
I think the best way to characterize it, U.K. is about 2-3 years behind us in terms of adoption. I would say Western Europe is probably 2-3 years behind the U.K. Asia is essentially comparable to Western Europe. The inevitability of cloud is starting to become obvious all over. That's quite fascinating to see because it almost has become where, as you said, all mainstream businesses are starting to go down that direction. We see, I think we positioned ourselves in the U.K. at the right time, and I think we're building a core capability there. We've got quite a few people there. We've got 200 people in the U.K. between London and Aylesbury, and now we have 100 people in Romania.
We are as diversified, and then we've got a few people in Australia and a few people in Canada. We are as diversified to take advantage of the trend. I'm increasingly of the view that the vendor that can provide a comprehensive one platform-type solution with Virtual Office, Virtual Contact Center, Virtual Meeting, as well as all of the collaboration capability, do that on a global basis with global support, global sales, as well as global deployment, and do it with the highest uptime and reliability, stands to take over Avaya's crown that they're in the process of ceding. I think that could be massive for us. That's what we're building the company towards. That's what we're trying to be.
Got it. Thank you.
Thank you. I'm not showing any further questions at this time, I would like to turn the call back over to Vik Verma for closing remarks.
Thank you all for listening in to our call today. We look forward to meeting with you over the coming weeks and perhaps seeing you at Morgan Stanley Technology, Media and Telecom Conference in San Francisco, and even more importantly, at the 2017 Enterprise Connect Conference, where we will unveil a broad set of new services and features. Again, thank you very much.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.