Eght Initiation Of Coverage

Initiation of Coverage ______________________________________________________________________________ January 15, 2008 ___________________________________________

Event: Initiating Coverage with a “Buy” Rating and $3.00 Price Target ____________________________________ Michael Coady, CFA 310-966-1443 [email protected]

8x8, Inc. Nasdaq: EGHT Rating: Buy Sector: Comm. Service Provider Price Target:

$3.00

Price:

$0.99

Float:

50.07

Shares Out:

61.93

While EGHT is largely viewed as a standalone, residential VoIP service provider, approximately half of its revenues are derived from its Packet8 Virtual Office, a hosted iPBX offering for the small/medium business (SMB) market. Focusing on this market has driven substantial gross margin improvement and enabled the company to generate positive cash flows for the past two quarters, which we believe is sustainable. As Virtual Office increases as a percentage of revenues, we anticipate accelerating top-line growth and improving profits and cash flows. Despite what are improving fundamentals, as Virtual Office increases as a percentage of total revenues, EGHT shares trade at just 0.8x EV/Sales (TTM) compared with its peer group average of 3.2x. We suggest EGHT trades at a low valuation because it is thought of as a residential VoIP services provider—and a comparable company to Vonage—and because of weak Q2 results.

Market Cap:

$61.3

52 Wk High:

$1.84

52 Wk Low:

$0.84

Average Volume:

333,000

Enterprise Value:

$48.3

Dividend:

Nil

After posting solid Q1 results including GAAP EPS of $0.01, 20% Y-o-Y revenue growth and significant Y-o-Y and sequential gross margin expansion, Q2 results suffered from a one-time event. EGHT picked up 25k residential subscribers from the second-largest alternative VoIP services provider (SunRocket), which abruptly went out of business. The subscriber pick-up resulted in an immediate cash influx (from pre-paid subscribers) and we estimate added to revenues in Q3 (December); however, cash and non-cash expenses were incurred in Q2 with little corresponding revenues. The result

___________________________________________ _________ Investment Rationale

*In millions except per-share data and volume. EPS exclude FAS 123R and benefit/loss from non-cash warrant pricing.

Estimates

Revs

EPS

Jun.

Q1’08(A)

$14.7

$(0.00)

Sep.

Q2’08(A)

14.8

(0.05)

Dec.

Q3’08(E)

15.7

(0.01)

Mar.

Q4’08(E)

16.0

0.00

FY’08(E)

$61.2

$(0.05)

Jun.

Q1’09(E)

$16.7

$0.01

Sep.

Q2’09(E)

17.4

0.01

Dec.

Q3’09(E)

18.1

0.02

Mar.

Q4’09(E)

18.9

0.03

FY’09(E)

$71.1

$0.07

Analyst Certification & Additional Disclosures are Included in Appendix A Any recommendation contained in this report may not be suitable for all investors. Moreover, although the information contained herein has been obtained from sources believed to be reliable, its accuracy and completeness cannot be guaranteed. B. Riley & Co., LLC may make markets and effect transactions, including transactions contrary to any recommendations herein, or have positions in the securities mentioned herein (or options with respect thereto) and may also have performed investment banking services for the issuers of such securities. In addition, employees of B. Riley & Co., LLC may have positions and effect transactions in the securities or options of the issuers mentioned herein and may serve as directors of such issuers. Contact B. Riley & Co. for additional information on the securities mentioned herein. Copyright 2008. All right reserved by B. Riley & Co., LLC. Member FINRA & SIPC.

11100 Santa Monica Blvd. Suite 800, Los Angeles, CA, 90025 Phone: 310-966-1444 Fax: 310-966-1448

was a sequential contraction in the gross margin of more than 10 percentage points, an increase in operating expenses and a greater loss for the quarter. The shares declined 14% following the release of Q2 results and are now off more than 30% since then. We believe that its Q2 results created the impression that EGHT would seek to continue to pick up residential subscribers and that doing so would lead to deteriorating financial results. While we expect EGHT to occasionally take on additional residential subs from failing competitors, we expect any negative impact to be negligible (with the exception of Vonage, no alternative VoIP service providers have near the subscribers that SunRocket had). Furthermore, we anticipate that improving results will show that EGHT remains committed to driving profitable growth by focusing its sales and marketing and R&D resources on Virtual Office. As Virtual Office increases as a percentage of revenues, we expect EGHT to enjoy an expanding multiple similar to other companies that service the SMB space with VoIP solutions. Our $3.00 price target is based on an EV/Sales multiple of 2.5x based on our CY ’08 estimates. This multiple is consistent with the average of its peers (see table on page 9). In the near-term, we anticipate that a substantial sequential improvement in Q3 results will be a catalyst for the stock. We are initiating coverage of EGHT with a “Buy” rating.

Investment Highlights •

EGHT has developed an attractive recurring revenue model, providing hosted iPBX services to the SMB market: Introduced in 2004, Packet8 Virtual Office provides feature-rich PBX service at an affordable flat monthly fee, and has experienced steady subscriber growth. The financial metrics of Virtual Office (ARPU, gross margin, contribution margin, churn) are far superior to Packet8 residential service. Virtual Office now accounts for just under 50% of revenues. With residential attrition and continued growth in Virtual Office, we expect accelerating overall growth and expanding margins in FY ’09 and beyond.

•

EGHT was pro forma breakeven and cash flow positive in Q1 ‘08: Thanks to Virtual Office sales, which increased 23% sequentially and accounted for 44% of revenues, the Q1 gross margin improved nearly 10 percentage points from Q4, to 63.6%, and the pro forma operating loss was cut to $0.4MM from $5.3MM and $2.2MM in the year-ago and previous quarters, respectively. The company reported GAAP EPS of $0.01, thanks to a modest gain from warrant pricing.

•

EGHT’s valuation is depressed following weak Q2 results that were impacted by a one-time event—picking up 25k subscribers from SunRocket—that should be a long-term positive for the company: EGHT was named the preferred company to provide VoIP services to subscribers of SunRocket, which shut its doors overnight. Picking up 25k subscribers required shipping $750k worth of hardware at no charge and incurring $1.5MM in shipping, customer service, e911 provisioning and other charges that hurt the gross margin and substantially increased the loss in the quarter. Many SunRocket subscribers accepted a one-month-free offer, which exacerbated the impact on EGHT’s results. Importantly, the equipment shipped was sitting in inventory and need not be fully replenished, and roughly half of the subscribers opted to pay up front for the annual plan, resulting in an influx of cash. With the recognition of revenues from these customers and absence of one-time charges, we expect meaningful improvement in Q3 results that will demonstrate that EGHT remains on a profitable growth path.

•

Leverage in the model should result in expanding profitability and cash flows: Packet8 Virtual Office generates contribution margin of nearly 60%. As Virtual Office increases as a percentage of total revenues, we expect the company will achieve double-digit operating margins likely as soon as FY ’10, with continued improvements in profitability and cash flows as the business scales.

•

Strong patent portfolio: We believe the valuations of VoIP services providers as a group have been penalized based on fears of patent lawsuits by the major telcos. Vonage has settled patent lawsuits with Verizon, Sprint-Nextel, AT&T and Nortel. Owing to its history as a technology company and chip developer, EGHT has 70 issued U.S. IP- , VoIP- and video-related patents.

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While EGHT could pursue monetization of its patents from licensing or royalties, we believe their real worth is in deterring others from filing suit against the company.

Company Background EGHT can attribute its strong patent portfolio to its history as a technology company and a semiconductor, software and equipment developer.

The company was incorporated in California in 1987 under the name Integrated Information Technology, Inc., and changed its name to 8x8, Inc. prior to its IPO in 1997. The company originally developed and marketed video compression semiconductors and associated software to OEMs of corporate videoconferencing systems. EGHT also leveraged its expertise in semiconductor design and software to develop videoconferencing systems for the consumer market. In the late 1990s, EGHT shifted its emphasis from video to voice-over-IP, as it appeared this would be the larger market. The company marketed VoIP chipsets to such telephone OEMs as Cisco, and in 1999, it acquired France-based Odisei in order to further its VoIP offerings. In 2000, 8x8, still thought of as a video company, changed its name to Netergy Networks (and changed its ticker to NTRG). NTRG created Centile, a wholly-owned subsidiary that utilized technology from Odisei to market software to carriers (CLECs) that would enable them to offer hosted IP PBX solutions to enterprises. In 2001, in the midst of the telecom meltdown, it became apparent that the company would need to again shift its focus if it were to survive. The company changed its name back to 8x8 (and ticker back to EGHT) and moved away from an OEM focus to one targeting end users. EGHT developed a service offering in an effort to create a market for its equipment. This strategy quickly changed to one of subsidizing equipment in order to sell a service, and in November 2002 EGHT launched Packet8 Broadband Telephone Service. The company completed its metamorphosis away from selling to OEMs and service providers in March 2004 when it launched Packet8 Virtual Office, which utilizes the same technology that its Centile subsidiary had marketed to service providers. EGHT can attribute its strong patent portfolio to its history as a technology company and a semiconductor, software and equipment developer.

Industry Background and Outlook

Market research firm IDC predicts that residential U.S. VoIP subscribers will total 44MM in 2010, up from 10MM in 2006.

Voice-over Internet Protocol (VoIP) generally refers to the transmission of voice over the Internet. The traditional telephone network (PSTN, public switched telephone network) utilizes a circuit-switched architecture; voice and data is transmitted in a continuous stream over dedicated circuits between endpoints. In an IP environment (packetswitched), voice is digitized and broken into packets that are sent to a desired endpoint using multiple shared network paths. The packets are re-assembled prior to reaching the endpoint. Voice was first transmitted over the early Internet more than 30 years ago; however, the technology is only now becoming mainstream. Enterprises began adopting VoIP technologies in the 1990s—and that adoption is accelerating today—and the residential market took off with the introduction of Vonage’s (NYSE: VG; NR) service in 2002. VoIP service providers include cable MSOs (Comcast has the most VoIP subscribers with nearly 4MM), incumbent telephone companies and alternative providers, such as EGHT and VG. While such VoIP quality issues as echo and latency remain, a majority of VoIP subscribers report satisfaction with the service. VoIP is seen as the future of telecommunications. Market research firm IDC predicts that residential U.S. VoIP subscribers will total 44MM in 2010, up from 10MM in 2006. Subscriber growth is being driven by demand for a lower-cost alternative to traditional phone service. VoIP also enables enhanced features, such as the ability to choose from available phone numbers, voicemail alerts provided by email and on-line account management. Cable MSOs are expected to capture the lion’s share of VoIP subscribers to the detriment of traditional telephone companies. Although service offerings from alternative providers are typically less expensive, the triple-play (phone, TV and highspeed Internet) offered by MSOs and telcos appeals to subscribers. The outlook for pure-

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play residential VoIP service providers has been called into question, as many have exited the market (such as the aforementioned SunRocket) and Vonage, the largest and most well-known alternative VoIP provider, has dealt with highly publicized patent lawsuits with Verizon, Sprint-Nextel, AT&T and Nortel. The triple-play also provides cable MSOs and traditional telcos with a competitive advantage.

AMI-Partners projects the North American SMB hosted VoIP market will grow to $1.57 billion in 2010 from an estimated $416MM in 2007, or a three-year CAGR of 55%.

AMI-Partners projects the North American SMB hosted VoIP market will grow to $1.57 billion in 2010 from an estimated $416MM in 2007, or at a three-year CAGR of 55%. Thanks to technological advances and greater broadband penetration, hosted IP PBX (private branch exchange) solutions are gaining traction, particularly with SMBs. Unlike premised-based PBXs and key-telephone systems that cost tens of thousands of dollars, hosted solutions require limited or no up-front capital costs. Rather, SMBs pay a monthly fee on a per-seat or per-service basis, and the equipment and management of the service is hosted and performed by the service provider. Paying little or nothing up front and having low, fixed monthly communication expenses are especially attractive features to very small businesses with limited capital. Despite the low cost, hosted solutions typically provide a rich set of features that improve productivity and help small businesses appear larger and more professional. Hosted solutions may also be the best option for firms with remote workers and without IT resources. AMI-Partners projects strong growth in the North American SMB hosted VoIP market, driven by a forecasted increase in seats from less than 400k in 2005 to about 3MM in 2010; however, penetration is expected to be less than 10% of the SMB market. In other words, we believe there is substantial further growth potential and room for multiple players.

Growth Strategy – Virtual Office Packet8 Virtual Office was introduced in March, 2004, and toward the end of FY ’06, EGHT began to shift the focus of its sales, marketing and R&D efforts toward growing its Virtual Office subscriber base and expanding its functionality. The reasons for emphasizing Virtual Office are many. Relative to Packet8 Residential, Virtual Office has: • • • • •

Virtual Office, which now accounts for nearly half of revenues, has higher margins, lower churn and faster payback than traditional Packet8 Residential services.

Higher ARPU (average revenue per user) Better gross margins Higher contribution margin Lower churn Faster payback

EGHT’s success in growing the service is evidenced by Virtual Office’s ranking by AMIPartners as the most popular SMB hosted VoIP service. According to AMI’s April 2007 report, Virtual Office’s 6,000 customers (businesses, not seats) were more than those of competitive offerings from XO Communications, Cbeyond and Covad. Covad and XO had 71k and 66k seats, respectively, compared with Packet8’s 48k according to AMI. However, we suggest continued growth in the number of Virtual Office customers has narrowed the gap versus the April report; EGHT reported more than 10,000 U.S.-based SMB customers as of December 31, 2007 (EGHT does not break out seats per customer; but the average customer has five seats and utilizes more than seven services). In an effort to drive subscriber growth, EGHT has improved the functionality of Virtual Office, added direct sales personnel and is expanding distribution channels. In late 2006, the company introduced a high-performance fax-over-IP service and launched Packet8 Softalk Office, a PC-based softphone for use with Virtual Office. Intended for telecommuters and road warriors, Softalk Office gives subscribers access to a fullfeatured Virtual Office extension on a laptop (or PC) without the need for a Virtual

4

Recently launched MobileTalk enables subscribers to place international mobile calls at EGHT’s low international rates by seamlessly connecting cellular calls to the Packet8 digital VoIP network.

Office telephone. The softphone also enables videoconferencing between as many as six participants. In mid-2007, EGHT added Outlook integration, overhead paging, toll-free fax numbers and the Packet8 Complete Contact Center. The call center solution was developed in partnership with Contactual, Inc., a global leader in on-demand contact center technology solutions. Without the need to buy expensive specialized equipment, the solution offers such features as skill-based routing, multimedia management (telephony, email, chat), real-time monitoring and reporting, voice recording and logging, IVR (interactive voice response) support and CRM (customer relationship management) integration. In November 2007, EGHT launched Packet8 MobileTalk International Calling Service, which lets subscribers make international calls using their mobile phones at EGHT’s low international rates of as little as $0.02-$0.05 per minute. The downloadable software enables most Windows-, Palm- or Symbian-based mobile phones to seamlessly connect international calls from the mobile phone to the Packet8 digital VoIP network. This service is available to non-Packet8 subscribers (Virtual Office or Residential), but we believe it will appeal to business users.

Sales and Distribution

Currently, 70% of the company’s sales are direct; expanding distribution channels is part of EGHT’s growth strategy

Approximately 70% of the company’s sales are direct, which entails receiving inbound calls and placing outbound calls to follow up on lead. Inbound calls are generated from such sources as banner advertising on certain websites, print ads in select magazines, direct mailings and the company’s presence in retailers such as Office Depot and CompUSA. Last year at approximately this time, the company more than doubled its sales force to 20 and has steadily increased the number to the current 35. In 2005, EGHT entered into a co-marketing relationship with Pitney Bowes, the world’s leading provider of integrated mail and document management systems and services. The Pitney BowesPacket8 marketing program is a small business outreach campaign consisting of Packet8 service discounts, website promotions and advertising, direct mail and email offers, payment stuffers and packaging inserts. Pitney Bowes receives a flat monthly fee and has been a successful lead generator. The company’s retail presence is limited, as customer acquisition costs are typically higher. EGHT has been in CompUSA (which is experiencing substantial difficulties and store closures) since early 2006 and in late 2006, the company struck a relationship with Office Depot. Sales made directly at Office Depot are considered retail and account for roughly 5%-10% of revenues depending on the time of year—the retailer is more aggressive during the summer and fall promoting back-to-school items. EGHT is also pursuing a channel/reseller approach with marketers such as Hello Direct and, more recently, SYNNEX Corp., a leading business process services company that will offer Virtual Office as part of its Technology-as-a-Service (TaaS) offering. Expanding distribution channels is part of management’s growth strategy. The company would like to replicate the success it has had at Office Depot with such big-box retailers as Staples and OfficeMax. EGHT intends to establish new relationships with distributors, value added resellers and system integrators, other service providers, equipment manufacturers and retailers. We believe the company will be more successful in attracting partners as it becomes a greater force in the SMB communications space. Although Virtual Office is the focus, EGHT has opportunistically picked up residential subscribers and we believe it will continue to do so. In addition to increased revenues, more residential subscribers add scale and enable the negotiation of lower wholesale prices from carriers such as Level 3, Global Crossing and Qwest that own the infrastructure. In July, EGHT announced that Packet8 had been selected as the preferred replacement VoIP service by SunRocket, which had more than 200k VoIP subscribers. SunRocket abruptly shut off its service after running out of funds. During Q2 (September), approximately 25k ex-SunRocket subs signed up for Packet8 Residential,

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Packet8 residential is $24.99 a month for unlimited calling in the U.S. and Canada with a $29.99 activation fee.

Virtual Office provides a host of PBX features including direct inward dial (DID) phone numbers with any desired area code for each extension, conference bridge, music-on-hold, call park/pick-up, business-class voicemail including voicemail to email alerts, extensionto-extension dialing anywhere in the world.

increasing EGHT’s residential subscriber base by more than 25%. As discussed below (Recent Results and Our Model section), taking on the subscribers had a one-time negative impact on Q2 ’08 results. However, we expect increased revenues in Q3 to show the merit of the decision. In September, EGHT announced that it had signed an agreement with a service provider that was soon exiting the market. The service was NetZero Voice, provided by NetZero, a subsidiary of United Online (UNTD; Buy). We anticipate the addition of slightly over 1k subscribers from NetZero Voice, which should have a nominal impact to results in Q3.

Packet8 Services Residential – All that is required for Packet8 Residential phone service is a high-speed internet connection (DSL, cable or fiber) and a service plan. EGHT provides free of charge one of three Uniden Packet8 service-ready phones (corded/cordeless) with built-in adapter; or subscribers can opt for a separate adapter and keep their existing standard telephone. Substantially all of the underlying technologies of the Packet8 service were developed internally. The most popular plan is Freedom Unlimited, which, for $24.99 a month, allows Packet8 subscribers to make unlimited calls to any telephone number in the U.S. and Canada and to any other Packet8 subscriber anywhere in the world. International calls to non-Packet8 numbers are charged at low per-minute rates. Other plans include Freedom Unlimited Global ($29.99/month), Freedom Annual ($199/year), Freedom Choice 500 (which offers unlimited inbound and 500 outbound minutes for $14.99/month) and Freedom Fax (300 minutes for $9.99/month). The company charges a $29.99 activation fee with each plan. Videoconferencing is included in each plan with the purchase of a Packet8 videophone; the Tango ($99 after a $100 mail-in rebate) has a built-in adapter and is all that is required for voice and video calls. All Packet8 accounts come with voice mail, caller ID, call waiting, call waiting caller ID, call forwarding, hold, line-alternate, 3-way conferencing, and web- and phone-based access to account controls, directory assistance and real-time online billing. We estimate that there are approximately 120k Packet8 Residential subscribers. Virtual Office – Unlike residential, Virtual Office equipment is not subsidized. Subscribers must purchase the Packet8 telephone and adapter for $99. The basic Virtual Office service plan is $49.99/month (plus a $39 activation fee per extension) for unlimited calling in the U.S. and Canada and to other Packet8 subscribers worldwide. Virtual Office provides a host of PBX features including direct inward dial (DID) phone numbers with any desired area code for each extension, conference bridge, music-onhold, call park/pick-up, business-class voicemail including voicemail to email alerts, extension-to-extension dialing anywhere in the world, and one-touch controls for regularly used features such as three-way calling, forwarding, do not disturb, voicemail, distinctive ringing and others. Allowing each extension to choose any area code can be useful for one-man shops or disparate organizations. The feature can be used to create the impression that a one-person-shop is a larger, geographically dispersed organization; or that people around the country or world are located in one location. Also, a business can place ads in different spots around a state, for example, using local area codes to make the business appear local in each advertisement. For monthly fees ranging from $9.99 to $89.99, other plans and value-added features are available, such as virtual attendant, metered extensions (limited number of outbound minutes), global extensions and unlimited fax. The average business customer has five extensions, subscribes to slightly over seven services, and generates approximately $700 in revenue per quarter. Virtual Office customers generate gross margins of 81% and contribution margins of 59% (after customer service and billing), or approximately $420 per quarter. With a customer acquisition cost of approximately $1,031, the payback on a Virtual Office customer occurs during the third quarter, and the average life of a customer is 10 quarters. For every $1,000 invested, Packet8Virtual Office service will generate $7,140 in revenue and $4,200 in contribution margin. EGHT does not break out Virtual Office

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churn separately; however, monthly churn for all services was 3.9% in Q2 ’08, and we estimate Virtual Office churn is roughly 3% per month. One of the greatest sources of churn is small offices going out of business.

Competition and Competitive Advantages

EGHT is the secondlargest standalone VoIP services provider to the residential market, and has numerous competitive advantages in the SMB space, such as plug ‘n’ play functionality from any high-speed Internet connection.

In the residential space, EGHT competes with incumbent telephone companies, cable companies and alternative voice and video communications providers. The ability to provide a triple-play is a strong competitive advantage for telcos and cable companies. Alternative providers have used low prices and heavy marketing to attract subscribers, and have suffered losses for doing so. Vonage, the largest and most well known alternative service provider has attracted more than 2.5MM subscribers but has suffered substantial losses in the process. SunRocket and NetZero Voice are just two of literally hundreds of VoIP service providers that have exited the market, indicating just how challenging a space it is. From an investment standpoint, herein lies EGHT’s differentiator: focus on the business market. However, although EGHT spends little or nothing on marketing its residential service, the company benefits from these subscribers as noted above—increased revenue and greater leverage with its wholesale carriers. The departure of many low-cost providers could reduce residential churn. Some of the same players compete in the hosted VoIP, iPBX space, including traditional telcos and cable MSOs. However, this is typically not a focus area, particularly not SMBs. Equipment vendors, too, such as Avaya, Cisco, Mitel (which recently acquired Inter-Tel) and Nortel offer hosted solutions as part of managed services offerings; but they generally are more interested in on-premise solutions and often do not serve the very small office. The most direct competitors to EGHT, in terms of service offerings, are communication service providers, such as Cbeyond, M5, Aptela, Speakeasy, and Covad; although Covad is exiting the VoIP business. A key competitive advantage is that it is not an ISP and its service is available wherever there is a broadband connection. Subscribers are not limited to a particular region in which an ISP provides service. This feature makes the Virtual Office solution highly scalable and ideal for remote offices. EGHT’s patents are a competitive advantage. At some point, we expect EGHT could attempt to monetize them via licensing arrangements or seeking one-time payments from infringers. More importantly, however, we believe its patents are a deterrent to others suing the company, as the plaintiff would likely face a countersuit from a company with a strong patent portfolio.

Recent Results and Our Model EGHT’s Q2 results suffered from several one-time factors related to SunRocket that did not recur in Q3.

In Q2 ’08, EGHT reported a GAAP per-share loss of $0.04, compared with EPS of $0.01 in the previous quarter and a loss of $0.04 in Q2 ’07. On a pro forma basis, excluding FAS 123R and a non-cash gain related to accounting for warrants, the loss was $0.05, versus breakeven in Q1 and a loss of $0.04 in the year-ago quarter. (The non-cash warrant gain relates to EGHT’s classification of warrants granted in previous financings as liabilities, which means changes in the warrants’ fair value, based on changes in the share price, are reported in the P&L.) As noted on page one of this report, the 25k SunRocket subscribers had a negative one-time impact on EGHT’s results, lowering the gross margin and boosting opex. In total, the subscriber pick-up accounted for $2.2MM of EGHT’s $2.8MM pro forma loss, or $0.04 out of the $0.05 loss. The expenses are broken out below. Revenues in Q2 were $14.8MM, up 12% Y-o-Y and flat sequentially. Excluding a onetime benefit to Q1 revenues (from a court settlement related to the Universal Service Fund), revenues increased 4% sequentially. Total service revenues grew 18% Y-o-Y, to $13.3MM, while equipment revenues declined 22%, to $1.5MM. Equipment revenues include activation fees, videophones and Virtual Office equipment. Equipment is not a

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revenue or margin driver, but rather a necessary component of providing a service. Service revenues are therefore the more important metric.

Virtual Office revenues more than doubled in Q2 versus the year-ago period, and accounted for 47% of total revenues.

Virtual Office revenues more than doubled Y-o-Y, to $6.9MM (47% of revenues), offsetting a 20% decline in residential/video and other revenues, to $7.8MM. (In Q2 ’07 the company recognized $0.5MM in wholesale revenue under an agreement with BellSouth that was discontinued. Excluding this, residential/video revenue declined 15%.) Excluding the aforementioned USF benefit, Virtual Office revenues increased 12% sequentially on a 1,000-customer increase, to just over 9,000. Residential/video revenues were $7.8MM, flat versus the previous quarter excluding the USF benefit. The consolidated gross margin was 52.1%, up 30 basis points Y-o-Y but down from 63.6% in Q1. The contraction broke a six-quarter string of sequential gross margin expansion and resulted from shipping equipment to the SunRocket subscribers. EGHT incurred $1.2MM in one-time COGS ($750k in hardware; $50k for number-porting and e911 provisioning; and $350k in freight and packaging), that lowered the equipment gross margin to -77%. Excluding these costs, the equipment gross margin was -4%, flat with the previous quarter. Services gross margin was 66.7%, up from 55.6% in Q2 ’07 but down sequentially from 68.5% (excluding a 150 basis-point benefit from the 100%margin USF payment). The sequential decline related to providing services to the SunRocket subscribers with little corresponding revenues. Excluding one-time COGS related to SunRocket, the blended gross margin was 59.9%. Excluding FAS 123R expense of $430k, opex totaled $10.7MM, versus $9.3MM and $9.8MM in the year-ago and previous quarters, respectively. SG&A included expenses totaling $1MM for sales and customer service call centers to handles the high call volume from SunRocket customers, as well as expenses for credit card processing and bounties paid to the SunRocket liquidator. Excluding the one-time costs associated with the SunRocket subscribers (which generated little revenue in the quarter), the pro forma operating loss was $0.8MM, up from $0.4MM in Q1 and well below the $2.5MM in the year-ago quarter.

We project continued positive cash flows and breakeven EPS in the March quarter.

For Q3, we estimate a GAAP and pro forma loss of $0.01. Based on the level of the stock price, the company likely recorded a non-cash gain from warrant pricing that could results in positive EP. We estimate revenues grew 18% Y-o-Y and 6% sequentially, to $15.8MM. We anticipate that Virtual Office revenues grew 84% Y-o-Y and 14% sequentially, to $7.9MM, based on the addition of nearly 1,000 business customers, which we estimate totaled just over 10k (EGHT announced a couple weeks ago that it has crossed the 10k customers mark). Mitigating the increase in Virtual Office revenues, we expect residential/video and other revenues were up about 7% sequentially thanks to the SunRocket subscribers, but declined 14% Y-o-Y, to $7.8MM. We estimate the gross margin recovered nicely from the previous quarter, expanding more than 10 percentage points, to 63.2%, which implies nearly 10 percentage-point expansion from Q3 ’07. We estimate opex declined by $0.3MM from Q2, to $10.4MM, compared with $9.5MM in Q3 ’07. For FY ’08, we estimate a GAAP and pro forma loss of $0.05 on a 15% increase in revenues, to $61.2MM. We expect Virtual Office customers will total 11.1k, versus 7k at March 31, 2007, and project Virtual Office revenues will grow 83%, to $29.7MM (half of total revenues). We estimate residential/video and other revenues will drop 18%, to $30.2MM. We estimate a blended gross margin of 61%, up from 49.2%, and estimate that opex will increase less than $3MM, to $41.3MM, but decline as a percentage of revenues by more than five percentage points, to 67.5%.

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We estimate FY ’09 GAAP and pro forma EPS of $0.05 and $0.07, respectively, on 16% revenue growth, to $71.1MM. We project that an approximate 40% increase in the number of business customers, to 15.6k, will drive 40% growth in Virtual Office revenues, to $41.8MM. We estimate a 3% decline in residential/video revenues. We estimate the gross margin will expand to 65.6% and opex will increase by less than $2MM and decline to 60.7% of revenues. We feel that Virtual Office revenues could grow faster, and residential revenues could decline faster, which would improve the company’s gross and operating margins. Net, net, we see top- and bottom-line upside to our FY ’09 projections.

Balance Sheet and Cash Flow As of September 30, EGHT’s balance sheet listed cash and equivalents of $12.9MM (~$0.20 per share) and no debt. The company has increased its cash balance two quarters in a row and we expect it to remain cash flow positive. Due to the company’s recurring revenue model and because some customers pay for a year of service up front, EGHT’s accounts receivable balance and working capital requirements are nominal. Cap-ex was a modest $1.4MM in FY ’07 and $0.3MM in 1H ’08. We believe some investors shy away from EGHT for fear of a cash crunch and because the company has a history of private placements. EGHT completed six PIPEs between 2003 and 2005, with its last in December ’05. The company is committed, however, to not issuing additional shares, and we believe there will be no need to do so. Five of the PIPEs had warrants attached. The company’s fully diluted share count is 81MM, which includes roughly 10MM employee stock options and 8MM warrants, with an average strike price of approximately $2 for the options and $3.10 for the warrants. Regarding the warrants, 2.5MM expire in 2008, 3.7MM in 2009 and 1.8MM in 2010. Because the vast majority of options and warrants are underwater, when EGHT reported profitability in the previous quarter, the share count barely budged. The options and warrants would need to be taken into consideration when valuing the company on a take-out basis; however, they are not included in our EV calculation. We project cash flow of $1.1MM and $5.9MM in FY ’08 and FY ’09, respectively.

EGHT had cash of $12.9MM as of September 20, 2007. We project cash at the end of FY ’09 of $20.9MM.

Comparative Valuation Table

CBEY CCOI PAET SHOR TWTC

Price Market 1/11/2008 Cap $ 32.35 917 $ 20.25 976 $ 8.39 863 $ 5.85 249 $ 18.91 2761

Net Cash EV 51 866 (106) 1,081 (686) 1,549 99 150 (1,073) 3,834

Revs EBITDA EPS Revs TTM TTM TTM CY '08E 262 (8) $ 0.47 $ 363 176 32 $ (0.71) $ 228 904 149 $ (0.02) $ 1,405 109 8 $ 0.18 $ 152 1,043 308 $ (0.41) $ 1,209.69

EBITDA CY '08E $ 58 $ 75 $ 268 $ 22 $ 418

EPS EV/Sales EV/Sales EV/EBITDA P/E CY '08E TTM CY '08 CY '08 CY '08 $ 0.65 3.3 2.4 15.0 50 $ (0.22) 6.1 4.7 14.4 N/A $ 0.34 1.7 1.1 5.8 25 $ 0.28 1.4 1.0 6.8 21 $ 0.23 3.7 3.2 9.2 82

57.21

$

$

Average EGHT

$

0.98

61

13

48

N/A

$ (0.13) $

68.26

1.50

0.04

3.2

2.5

10.2

44

0.8

0.7

31.8

25

Source: CapIQ; First Call; B. Riley & Co., LLC estimates

Valuation While cash flow has only been positive for two quarters, given the increasing contribution from the more profitable Virtual Office, we project expanding positive cash flows and improving profitability. We expect that sustained profitability and a growing cash balance will alleviate fears that EGHT will require additional capital, and will prove that the company has developed a profitable, sustainable business model. Once EGHT is no longer viewed as just a VoIP services provider to the residential market—which we suggest will be an increasingly difficult market due to competition from cable MSOs and telcos—we anticipate the market will accord the stock a multiple that reflects its prospects for generation of cash and profits. Our $3 price target is based on a CY ‘08 EV/Sales multiple of 2.5x, which is consistent with the average of its peers. With 200% appreciation potential implied by our price target, we initiate coverage of EGHT with a “Buy” rating.

9

Company Description: 8x8, Inc., the second largest standalone VoIP service provider in the U.S., offers internet-based telephony solutions (www.packet8.net) for individual residential and business users as well as small- to medium-sized business organizations. In addition to regular Packet8 VoIP service plans priced as low as $24.99 per month for unlimited anytime calling to the U.S., Canada and eight additional countries, 8x8 offers the Packet8 Tango Video Terminal Adapter along with accompanying monthly service plans also priced at $24.99 per month. Packet8 Virtual Office, 8x8's VoIP phone system for small- to medium-sized businesses, is a hosted PBX solution comprised of powerful business class features. Companies subscribing to Virtual Office pay just $49.99 per month per extension for enterprise class PBX functionality along with unlimited local and long distance calling in the U.S. and Canada. The Packet8 Complete Contact Center(TM) is a hosted multimedia call center distribution and management platform that works with any broadband Internet service and provides enterprise class contact center functionality combined with Virtual Office hosted iPBX calling features and business calling plans.

10

8x8 (EGHT) Model ($ in thousands) B. Riley & Co. (310) 966-1444

Product revenues Service revenues Total revenues Cost of product revenues Cost of service revenues Gross profit R&D SG&A Other/FAS 123R Operating income Interest and other income Gain/(loss) from warrant pricing Pretax income Income tax provision Net income before extraordinary item Extraordinary item Net income (loss) Net income (loss) pro forma EPS, GAAP EPS, pro forma

FY '04(A) FY '05(A) FY '06(A) 2,679 2,389 5,779 9,086 26,113 6,629 9,308 11,475 31,892 1,768 4,546 10,732 5,195 12,367 2,594 4,946 1,734 8,793 2,747 3,109 5,916 6,060 18,534 27,863 0 0 0 (3,861) (19,909) (24,986) 822 558 1,733 0 0 886 (3,039) (19,351) (23,253) (203) 0 0 (3,039) (19,148) (23,253) 0 0 0 (3,039) (19,148) (23,253) (3,039) (19,148) (24,139) (0.09) (0.09)

(0.43) (0.43)

(0.42) (0.43)

Q1-Jun 2,394 9,877 12,271 2,922 4,720 4,629 1,185 8,765 624 (5,945) 4,141 3,898 (1,804) 0 (1,804) 0 (1,804) (5,078)

Q2 - Sep 1,916 11,240 13,156 1,349 4,994 6,813 1,156 8,113 512 (2,968) 585 401 (2,383) 0 (2,383) 0 (2,383) (2,272)

FY '07A Q3 - Dec 1,800 11,515 13,315 1,814 4,539 6,962 998 8,547 402 (2,985) 152 40 (2,833) 0 (2,833) 0 (2,833) (2,471)

Q4 - Mar 1,974 12,414 14,388 1,972 4,673 7,743 1,001 8,905 272 (2,435) (475) (603) (2,910) 0 (2,910) 0 (2,910) (2,035)

FY '07A 8,084 45,046 53,130 8,057 18,926 26,147 4,340 34,330 1,810 (14,333) 4,403 3,736 (9,930) 0 (9,930) 0 (9,930) (11,856)

(0.03) (0.08)

(0.04) (0.04)

(0.05) (0.04)

(0.05) (0.03)

(0.16) (0.19)

Q1-JunA Q2 - SepA 1,331 1,496 13,411 13,272 14,742 14,768 1,382 2,646 3,986 4,423 9,374 7,699 1,016 942 8,756 9,717 205 430 (603) (3,390) 1,111 832 979 671 508 (2,558) 0 0 508 (2,558) 0 0 508 (2,558) (266) (2,799) 0.01 (0.00) 62,080

(0.04) (0.05) 61,870

FY '08E Q3 - Dec 1,380 14,290 15,670 1,435 4,338 9,897 1,035 9,389 350 (877) 165 0 (712) 0 (712) 0 (712) (362) (0.01) (0.01) 62,100

Q4 - Mar FY '08(E) 1,440 5,647 14,599 55,572 16,039 61,219 1,498 6,961 4,160 16,907 10,382 37,352 1,040 4,033 9,436 37,298 350 1,335 (444) (5,314) 170 2,278 0 1,650 (274) (3,036) 0 0 (274) (3,036) 0 0 (274) (3,036) 76 (3,351) (0.00) 0.00 62,250

(0.05) (0.05) 62,075

Q2 - Sep 1,440 15,948 17,388 1,498 4,525 11,365 1,035 9,684 350 296 175 0 471 0 471 0 471 821

FY '09E Q3 - Dec 1,470 16,650 18,120 1,529 4,640 11,951 1,035 9,814 350 752 178 0 930 0 930 0 930 1,280

Q4 - Mar 1,500 17,392 18,892 1,560 4,764 12,568 1,035 9,952 350 1,231 185 0 1,416 0 1,416 0 1,416 1,766

FY '09(E) 5,870 65,246 71,116 6,105 18,341 46,670 4,140 39,006 1,400 2,124 710 0 2,834 0 2,834 0 2,834 4,234

0.00 0.01

0.01 0.01

0.01 0.02

0.02 0.03

0.05 0.07

62,350

62,450

62,600

62,750

62,538

Q1-Jun 1,460 15,257 16,717 1,518 4,412 10,786 1,035 9,556 350 (155) 172 0 17 0 17 0 17 367

Diluted shares

32,546

44,373

55,889

61,138

61,329

61,420

61,605

61,365

Common Size Product gross margin Service gross margin Gross margin R&D expense SG&A expense Operating margin*

34.0% 60.9% 53.1% 29.5% 65.1% -41.5%

-90.3% 42.8% 15.1% 27.1% 161.5% -173.5%

-85.7% 52.6% 27.6% 18.6% 87.4% -78.3%

-22.1% 52.2% 37.7% 9.7% 71.4% -43.4%

29.6% 55.6% 51.8% 8.8% 61.7% -18.7%

-0.8% 60.6% 52.3% 7.5% 64.2% -19.4%

0.1% 62.4% 53.8% 7.0% 61.9% -15.0%

0.3% 58.0% 49.2% 8.2% 64.6% -23.6%

-3.8% 70.3% 63.6% 6.9% 59.4% -2.7%

-76.9% 66.7% 52.1% 6.4% 65.8% -20.0%

-4.0% 69.6% 63.2% 6.6% 59.9% -3.4%

-4.0% 71.5% 64.7% 6.5% 58.8% -0.6%

-23.3% 69.6% 61.0% 6.6% 60.9% -6.5%

-4.0% 71.1% 64.5% 6.2% 57.2% 1.2%

-4.0% 71.6% 65.4% 6.0% 55.7% 3.7%

-4.0% 72.1% 66.0% 5.7% 54.2% 6.1%

-4.0% 72.6% 66.5% 5.5% 52.7% 8.4%

-4.0% 71.9% 65.6% 5.8% 54.8% 5.0%

Year-Over-Year Growth Rates Total revenue Operating income* EPS*

-15.4% N/A N/A

23.3% N/A N/A

177.9% N/A N/A

104.3% N/A N/A

86.3% N/A N/A

57.0% N/A N/A

39.1% N/A N/A

66.6% N/A N/A

20.1% N/A N/A

12.3% N/A N/A

17.7% N/A N/A

11.5% N/A N/A

15.2% N/A N/A

13.4% N/A N/A

17.7% N/A N/A

15.6% N/A N/A

17.8% N/A N/A

16.2% N/A N/A

*Pro forma excludes FAS 123R and non-cash gain/(loss) from change in fair value of warrants Selected Balance Sheet Data Cash and investments Cash per share Accounts receivable Accounts payable Debt Stockholders' equity

14,049 0.43 608 854 0 12,786

31,800 0.72 1,144 4,496 0 29,744

22,957 0.41 776 4,907 0 12,970

17,806 0.29 792 4,933 0 11,793

14,488 0.24 1,000 5,627 0 10,100

12,424 0.20 640 4,610 0 10,441

11,932 0.19 736 4,919 0 5,377

11,932 0.19 736 4,919 0 5,377

12,216 0.20 804 5,208 0 6,094

12,907 0.21 554 4,338 0 4,991

13,061 0.21 563 4,414 0 4,779

13,641 0.22 602 4,534 0 5,005

13,641 0.22 602 4,534 0 5,005

14,511 0.23 622 4,651 0 5,522

15,904 0.25 648 4,809 0 6,492

17,757 0.28 675 4,971 0 7,923

20,109 0.32 703 5,145 0 9,839

20,109 0.32 703 5,145 0 9,839

Selected Financial Data Price Market cap Enterprise value EV/Sales (TTM) EV/EBITDA (TTM) P/E (TTM)

0.99 32,221 18,172 2.0 NM NM

0.99 43,929 12,129 1.1 NM NM

0.99 60,493 37,536 1.2 NM NM

0.99 60,527 42,721 1.1 NM NM

0.99 60,716 46,228 1.0 NM NM

0.99 60,806 48,382 1.0 NM NM

0.99 60,989 49,057 0.9 NM NM

0.99 60,989 49,057 0.9 NM NM

0.99 61,459 49,243 0.9 NM NM

0.99 61,251 48,344 0.8 NM NM

0.99 61,479 48,418 0.8 NM NM

0.99 61,628 47,986 0.8 NM NM

0.99 61,628 47,986 0.8 NM NM

0.99 61,727 47,215 0.7 NM NM

0.99 61,826 45,921 0.7 25.2 68.7

0.99 61,974 44,217 0.6 12.8 24.3

0.99 62,123 42,014 0.6 8.2 14.6

0.99 62,123 42,014 0.6 8.2 14.6

_________________________________________________________________________________ APPENDIX A

Analyst Certification I, Michael Coady, CFA, certify that this report reflects my personal beliefs about this company and that no portion of my compensation was, is or will be directly or indirectly related to the specific recommendations or views discussed in this report.

Disclosure Requirement • • •

B. Riley & Co., LLC makes a market in the securities of the company covered in this report. B. Riley & Co., LLC does and seeks to do business with companies covered in its research reports. A portion of this analyst’s compensation is based on the investment banking activities of B. Riley & Co., LLC.

Initiated on 1/15/08 with a “Buy” Rating and a Price Target of $3.00

Ratings Distribution as of Dec 31, 2007

Rating Buy Neutral Sell TOTAL

Number of Companies

% with Investment Banking Relationships*

52 24 1

Percent of Total 67.5% 31.2% 1.3%

Buy Neutral Sell

77

100.0%

TOTAL

Number of Such Companies for Each Percent of Total for Rating Each Rating 0 0.0% 0 0.0% 0 0.0% 0

0.0%

_________________________________________________________________________________ APPENDIX A

Explanation of B. Riley & Co., LLC’s Rating System • • •

Buy: We generally expect “Buy” rated stocks to materially outperform both the S&P 500 and Russell 2000 as well as other stocks in their sector. Further, we believe that the potential reward relative to the potential risk is particularly attractive. Neutral: We generally believe “Neutral” rated stocks will perform roughly in line with the S&P 500 and Russell 2000 over the intermediate and long term. Sell: We generally expect “Sell” rated stocks to materially underperform both the S&P 500 and Russell 2000 as well as other stocks in their sector. Further, we believe that the potential reward relative to the potential risk is particularly unattractive.

Risks and Considerations • • • • • •

The company is in a highly competitive business. The company's business is subject to pricing pressure. Certain of the company's competitors are much larger with greater financial resources. The company is at risk of patent lawsuits; although we believe its patent portfolio provides adequate protection. EGHT has raised money via public offerings several times in the past and may need to do so again if it can not sustain positive cash flow. See the company’s financial statements for a further discussion of risks and considerations.