8x8, Inc. (EGHT) Earnings Call Transcript & Summary

All right. I am Meta Marshall. I cover the communication software space here at Morgan Stanley. I'm going to start with some disclosures, and then we'll get into 8x8. And pleased to have you guys here. Please note that all important disclosures, including personal holding disclosures and Morgan Stanley disclosures, appear at the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the research desk. Pleased to have Vik and Steve here -- Steven here today, CEO and CFO of 8x8.

Kind of starting up every session with just a general coronavirus check and just how you see that impacting your business or if you have seen any impacts kind of to date.

Yes. So this stuff is -- I have no -- I'm not a doctor, so I have no idea whether this is real or not. I don't know the extent of it, et cetera, et cetera. But very few times in your life do you have an opportunity to do good for your community and do good for your company. And 8x8 was built for this type of issue. So if you think about it, what do we do? We do virtual office, which enables workers to work from home seamlessly and look like they're in the office. We do virtual contact center that enables contact center agents to work from their home and answer customer problems seamlessly. And so every once in a while, you may hear a dog barking in the background, which tells you that the contact center agent is actually safe and at home. Video conferencing, which we just launched 1.5 months ago. Just in between January and February, free meetings increased threefold and new user sign-ups. And then the part that was even more gratifying is virtual office where we made free meetings available integrated with our virtual offering, Virtual Office X Series, we saw adoption double between January and February. We've also seen an impact on our CPaaS business, of all things, with food delivery in Asia Pacific where we're seeing increased text messaging and voice calling for food deliveries. The goal here is, as I said, we've made meetings available for free for everybody, whether they're a customer or not. We've done outreach programs to all of our various customers. Several customers have asked us. A very large customer, which is in the financial services industry, has asked for increasing the pace of our deployments because they want to enable every one of their workers to work from home. We have a very large university that has asked us to see if they can deliver classrooms for students seamlessly, whether they're in the dorm or whether they are global because about 20% of their student population are international students. So it's a scary time, but business must continue on, and I think we can help as a company to enable this to be as seamless as possible.

Are those upticks in uses what you're seeing primarily in Asia? Or are you seeing that kind of elsewhere?

All over, actually. We're seeing an impact everywhere. In the U.S., for example, we're seeing an increased use of both virtual office where employees can work from home in several instances. We have now allowed all our employees, based on whether they want to or not, whatever they prefer, our employees have the ability, every one of them, all over the world, to work from home. We have offices in London, Cluj, Singapore, Philippines as well as in the U.S., and there are a lot of people that are working from home. We're seeing that that's happening with our customers also. We have seen a huge spike in, as I said, meeting adoption. We have seen usage on our virtual office go up because I think people are using this as an opportunity to be safe and not travel, yet make sure they're connected to the business.

Got it. And so maybe kind of diving into core 8x8, thanks for that update. This past couple of years have been one of focus and redirection for 8x8. And can you just lay out what steps you've taken on both product and channel? And what recent proof points you're most excited about kind of in that transformation?

Yes. As you know, this has been a multi, multiyear journey, 9 acquisitions. We started off as a VoIP company for small businesses. And then over the last few years, we have evolved into a communications platform that delivers voice, video, contact center and CPaaS, all integrated together for our customers. And so we're increasingly seeing that the platform adoption is going up. But what that involved is you have to totally change out the sales team. The sales team that sells pure VoIP is very different than the sales team that can sell a communications platform with the contact center product. We have seen that the channel has also evolved because the channel has become much more sophisticated in selling a complete platform. And in a way, it's a very interesting trend that we are seeing where communications is becoming a strategic tool. And this is more evident now than it ever has been before. The CIOs -- one of our customers is Condé Nast. The CIO was a very big believer early on that you always have to be prepared because you have lived through SARS and MERS and several hurricanes. So you wanted the ability for all Condé Nast offices all over the world to be able to work instantly from home without any loss of continuity. So you're seeing how communications has become very strategic. And what we're noticing is that the communication platform is the underlying baseline for making people live, work and play in a way that there is complete continuity of business without any impact of any events like this because business must continue.

And so -- I mean maybe from where you started 3 years ago, where you said, okay, we need to -- or 2 years ago, really, where you said we need to improve our channel. You came out with X Series kind of 1.5 years ago. When you started making these acquisitions to today or when you started making that channel improvement, are there any changes to the space, whether it be upmarket adoption or just more people interested in full platform like I'm going to give you credit for being a visionary, but what maybe didn't you see kind of on the periphery that's happened...

Good. So I'd tell you what is going on. So the good news is, I think, the most recently reported quarter, for customers greater than 50 seats, approximately greater than 50 seats, we saw that 71% of our bookings bought both our contact center as well as our virtual office, the X Series product, which tells you people are increasingly buying both the contact center and the virtual office together because they see this as one integrated solution. Of our top 10 deals, all 10 deals bought are virtual office and a contact center. 4 out of our top 10 deals were Avaya replacements, which also bought contact center and virtual office. 34%, 35% [Audio Gap] the total bookings were [Audio Gap] So contact center is a relatively new evolution for us. So we are finding more and more that customers are saying, in essence, we want to go up to a communications platform, X Series, where you have the ability to get voice and you have the ability to get a contact center. Increasingly, we're finding them that they want to use CPaaS to customize the last interaction they have with a customer. We have an example of a customer where -- it's a vacation rental company where what they want to evolve to is the ability to send a link in real-time to the end-user customer, where, in case you can't find the thermostat, you can go press on the link. Immediately, it takes control of your camera on your phone. You point it over the thermostat, and it's like press the green button not the red button, it may cause the house to blow up as opposed to sending a property manager. So that concept of platform is increasingly where the market is heading. You saw our bookings, I think, grew 35 -- between 30% and 35% the last few quarters, total organic bookings, which is a good health of the business. And so we're starting to see that level of acceleration at the upper end of our market, which is mid-market and enterprise, which is where we are biased and focused.

Got it. I do know UC has been dominated by -- or this kind of cloud transition, at least to date, has been dominated by kind of start-ups like yourself, like RingCentral, like others who have -- Five9 kind of more on the contact center space. But as it moves more upmarket, it's bound to kind of draw the attention from kind of more enterprise software names. And how do you see the competitive landscape changing? And how do you see it by kind of still maintaining a competitive lead as this space becomes more -- if and when it becomes more competitive?

So at our core, we believe that we have the best global voice quality, which is the basis for everything. Second part, this whole integrated platform, particularly with contact center, which we think is extremely complex, I think -- and integrated that with the virtual office and our voice product, I think those 2 things give us a huge competitive edge. We have seen people like Microsoft and others enter the market. We see Microsoft Teams as an adjacent product. So we integrate with Teams for various applications. And so the intent here is to ensure that we can create an ecosystem where we are the core contact center, voice as well as video conferencing product, and that it's 1 suite. And we think that will give us the level of differentiation going forward.

Okay. Got it. And maybe another area that sometimes [ some people ] are just that the international markets are still at even earlier stages than we are seeing in the U.S. You guys, by virtue of some of your acquisitions as well as just some early presence, probably have a little bit more penetration there than others. When should we see some inflection kind of in these international markets?

We're seeing it. So U.K. is probably 4, 5 years behind the U.S., but we're starting to see quite a bit of adoption happen in the U.K. Australia also is starting to show quite a bit of acceleration. So you're starting to see adoption globally. Central Europe has just started to get going, but Singapore and others are starting to see adoption. But U.K., in particular, is accelerating. Australia is right after that. So you're seeing what I think all of us saw in the U.S. Cloud is here to stay. Communications, particularly communications that is in the cloud, ensures a level of capability for employees. It enables the mobile worker. And it -- and more -- again, it's more evident now than ever before. You have to be able to seamlessly operate no matter where you are, no matter what device you're using, whether you're a customer service agent, whether you're a knowledge worker or whether you're a frontline salesperson, you have to have that level of seamlessness, and communications in cloud is critical. And so the rest of the world, which was on the on-premise basis, is now starting to also accelerate towards cloud. So I think over the next 5, 6 years, you will see widespread adoption of cloud communication platforms all over the world. And I think increasingly, you're going to see the on-premise portion of the business kind of become pretty much de minimis and only for certain key industries where they actually want to hug their on-premise equipment, right?

And you see that in our bookings numbers. Roughly 1/4 of our new bookings each quarter has been outside the U.S. Revenues falling behind that at a few points lower than that.¡

Okay. Got it. And then building on that, we've seen this kind of acceleration that you were hoping for over the past year kind of play out over the last couple of quarters as some of these investments in the channel started to really show traction. Moving forward, is there more work to do on channel, whether it be international or others? Or are we at a point where we can kind of start harvesting some of the investments that you've made over the past couple of years?

So there's 2 types of channels. And there's a traditional master subagent channel where we have shown great traction, and they have phenomenal partners. They know the customers very well. And we co-sell with them. And -- but it's done essentially on our paper. And that's a traditional master subchannel. There's another channel, which is the reseller channel, where the resellers essentially do it on their paper. They're -- you basically wholesale your product to them, and they essentially retail the product to the end-user customer. That part of the channel has not been penetrated by cloud. And I think we're the first to meaningfully go after the reseller channel. And the reason we're able to do that is we have created essentially a platform, and then on top of the platform, we have something called PartnerXchange, which enables a reseller to literally order the product, get it quoted, provisioned and then delivered to the end-user customer and do it essentially on their paper. That's the genesis of our CloudFuel partnership with ScanSource. It's also 3 very key VARs that we signed up in the U.K. One of our larger deals was signed by a VAR. And what was quite attractive about that is the level of involvement of our sales team was significantly less than if we were basically working with a master subchannel because the VAR had the relationship that we enabled them how to sell, and they were able to close a very large deal. So that is a blueprint. And as I said, what makes us unique is the fact that we have a comprehensive platform, so a VAR can deliver voice, video, contact center as well as CPaaS to their end-user customer. And by doing that, do it essentially co-branded with us. So it's, obviously, got 8x8's name on it. It's also got their names on it. And I think by owning all of that technology, we are positioned to do that very well. It's early, early days in all of that. We've just had our first few wins on that. So let's see how that plays out. But a very significant part of the channel, the telco channel, in particular, has been the province of VARs because they have essentially owned the relationship with the customer. And our intent is to enable them to continue to own the relationship with the customer but provide them with the tools necessary to essentially resell our product.

Do you have any -- I mean, I had spoken with Steven about this in the past about whether are you biased one way or another of which way you would like to see a customer end up with 8x8, whether it be through a master agent or through a VAR channel? Do you guys care which way you end up selling in the end or which potentially provides better economics to you?

Customers' choice. I mean we have now an e-commerce engine, particularly for small business, so there are customers that basically sign on without talking to a human and literally data. It's fully self-provisioned. And we've seen e-commerce tick up actually quite significantly in February as well. You have the master subchannel where they have relationships with customers and some customers prefer to buy it with them because they want that relationship with the vendor, which would be us. And then there are VARs, which are so used to a relationship where they basically have the relationship with the customer and the customer is comfortable with them, and you're essentially an OEM to them. And so from my perspective, it is all up to the customer, whatever makes them happy.

Steven?

Yes. Same thing. And we've talked about this, as you said. And really, the point of view now for the next, fill in the blank, 2, 3 years is that the VAR channel opens up to us an incremental revenue opportunity and customer opportunity that we would not otherwise have. And so it's really about unlocking the mostly controlled legacy end points that the VARs own and control to bring those on to the platform. And if that works to enable VARs to have a cloud offering to sell into the legacy base, great. That's a customer that we might have seen but most likely not. And so it's incremental to us and glad to have you come in through the VAR channel through a reseller.

Got it. And then we also kind of referred to this maybe a couple of weeks ago. But since you announced your ScanSource announcement, have you had interest from other kind of VAR channels looking to kind of...

Yes. There's a host of folks we've talked about; VAR proper, other folks in the industry as well as other folks who have embedded customer bases who would be interested in selling a cloud communications platform into that customer base. So stay tuned over the next 60 to 90 days, you'll see other folks coming out with us.

Got it. And so maybe getting a little bit into the financials just for a second. There's been a large number of changes in 8x8 over the last couple of years. And the margin profile of the company has changed a fair amount over that past couple of years. What gives you confidence that you're kind of through the hard part of the transformation and you can start working your way towards getting back to breakeven exiting fiscal '21?

Yes. That's a good question. So earlier in 2019 -- calendar 2019, we did a lot to fix the one big engine we needed to go to market, both marketing, direct demand gen as well as channel. We threw a lot of money at that. And so the big bet around technology and platform is something that will continue. We have spent money on, and we'll continue to spend. There's no material change there. And so what we take comfort in, I guess, in confidence is that the money we've invested in go to market, sales, marketing, lead gen, lead qualification and in the delivery of customers, both support as well as deployment, seems to be working, right? And the litmus test of that is our new bookings growth, organic, CCaaS and UCaaS. We've put up a bunch of quarters of good solid 30-plus percent new bookings growth. And so now we're at a point where we're able to say we invested a lot, we fixed what we really needed to fix, we're seeing the growth, and now we're basically pulling back and realigning our cost structure. And so we talked about this a little bit, some of the activities we did in January, where we aligned both the aggregate amount of spend, what we're spending on shifting away from investing tremendously in SB and more towards mid-market and enterprise as well as driving efficiencies on deployment, on support and on our cost structure, overall. So we do feel like from a gross margin standpoint, the low is behind us, and then the various attributes of the core subscription business that's a high 70s kind of gross margin that we feel good about the economics of the business, now go run support incrementally more efficiently, go run deployment incrementally more efficiently. CPaaS that is in the service revenue right now came in at 16% to 18% gross margins. But as we expand to voice, as Vik just noted, as we expand into the U.K., you have higher-margin products, higher-margin geographies that should lift that up to more attractive levels, so that we see gross margin coming up, and then we see leverage in OpEx coming up as well.

Okay. Maybe circling back to contact center for a second. You noted upfront the tax rates have been even higher than you expected. Is that a market you would see moving upmarket in? Do you have what you need to kind of compete for a larger implementations? Or is it really a matter of -- there's a lot of customers who need a little bit of contact center, and that's our prime customer?

So there's a lot of customers that need a little bit of contact center, and that is the prime customer, but we can -- we have several customers that have 1,000-plus seats. And so we can scale to that level. Sweet spot for us. 5 seats to probably 500 seats in contact center is what we go after, and we can deliver that all day long. We don't -- I mean, frankly, after all these acquisitions, I don't have a burning need for an acquisition per se. I think I have all the features necessary. We have spent time integrating it together, but we're just in stage 1 of integration of all of these various platforms, you're starting to see it get tighter and tighter and tighter. We recently bought a call stat company, which basically gives you call quality monitoring for end points for WebRTC. Again, it's all about global call quality, global video quality as well as overall responsiveness, resilience and reliability of the system.

Got it. And then again, you alluded to at the beginning kind of the -- just the acquisition you made and kind of the ability to improve the video platform you guys had. Where are you in determining whether you want to sell that as a stand-alone product versus just like selling that as part of X Series and really exploiting that ability to kind of pull through a lot of additional kind of ARPU?

So we made both. So what we do is we went through a process, and now it is integrated for all our X Series customers. I think as of a few weeks ago, every one of our X Series customers has videoconferencing integrated. We also made it available for free, particularly now, for any person whether they're 8x8 customer or not, where you can have unlimited meetings all over the world. I think all you do is go to 8x8.vc, and you can literally join a meeting. You don't have to even give us your e-mail or anything else like that. We're making it completely seamless, so people can use it. I think that is a way to basically ensure, a, people are able to communicate in these hard times, but it also gives us a level of knowledge and about how we need to continue to evolve our product. So now we will be -- end of March, we will be introducing 8x8 meeting rooms. What that is, is essentially conference rooms where you have a TV, an iPad and a camera, where you partner with people like Polycom and Logitech, and you literally press a button and your conference will start. And we're making that, as a matter of fact, for one of the things we are doing is we're making our video conference rooms available to schools, so that they can conduct some of these courses.

Yes. I mean I was a big advocate protagonist internally as we were developing the product for having it go out for free for the excellent reasons that Vik went and did this as a land and expand. Our ability to offer video at a super low marginal cost is the power of the platform. A little corny as I listen to myself say it but actually true. So that's good. And then it also preserves the ability to then go upsell, sure, but then also charge in 2 years, 3 years, you're going to turn that on, for sure. And that's an attractive part of the ability to go do that flexibility.

Okay. Pricing has been one of the things that's held up remarkably well in the UC space kind of over the last 5 years, a lot from having more and more additional features. We're starting to pick up on some increased competition kind of in the small, mid-end piece of the market. What do you think helps stabilize it up market? And how do you kind of defend more of the small, mid-sized market?

So 2 parts. I mean actually, frankly, CPaaS is key because, one, if people use contact center, contact center, by definition, is stickier because once you train your agents. Now if you use CPaaS, CPaaS is a way for you to customize an experience. So for example, if you have a PBX system, but using our CPaaS technology, if you do a simple ability so that at the end of every call, I send you a little text message on your mobile phone, where you say, did you like talking to me or not? 1 or 2? Good?

You know already.

I know you'll press 2. And then the other things we do, for example, is with contact center, I gave you an example. I mean imagine a recruiting firm. In real time, you could literally go from voice, "Oh, yes, I'm having a good conversation. I want to see you." Press a button, now you're in a full-blown video conference. So that, again, is CPaaS technology because I send the link, I don't even need you to download our app. All I need you to do is click on this and use essentially a chrome browser, and you are now connected. That's the -- because we built our technology on WebRTC. So those are the things that, frankly, will create the stickiness because what you're doing is you're taking a packaged product, voice, video, contact center. And at the edges, you're customizing it that is unique to the business value of your particular customer. That business value is huge in terms of preserving stickiness and also unlocking value for the customer.

Okay. I'm going to open it -- or did you want to add something?

I was just going to say it's also relevant to the customer segment, where the value prop and pricing power is far more pronounced than enterprise, sure; SB, less so, right?

Okay. Got it. I want to open it up to questions if there are any. Otherwise -- okay. One question over here.

You talk a little bit about the impact the Ring-Avaya deal will have to you guys on maybe 2 fronts. I mean certainly, there -- Avaya is a big donor to you guys and had been. So they have the propensity to pick up some more of that. I love to hear kind of what that mix looks like for you. Then on the other hand, they also have this big theme where they need to go and devote a lot of their sales resources to supporting that. So does that maybe give you a little bit more breathing room in the master channel segment?

So I'll take it, and we'll tie it in as necessary. So the part -- from our view, we looked at that deal, and it was our view that the end users would want a choice. And the end users typically had a relationship with the VARs and not necessarily with Avaya, which is why when you think about it, we went and built the relationship with ScanSource, and ScanSource is VARs, so they could provide essentially to the end users. We view this as an opportunity because if you think about it, the Avaya offering with RingCentral is just for the telephony piece. Contact center is not part of it. Avaya intends to provide their own cloud contact center that is being developed in the future. The ability for us to offer 1 platform, which has voice, video and contact center, we think, is differentiated. The second thing is every time Avaya approaches one of their existing installed base customers, most of them want to know what else is out there. The good news is 8x8 is out there. We've been out there for a while. We've built this 1 single platform. And so that opens up the market for us, where now it's obviously clear that Avaya is not going to develop anything on their own. They're basically going to white label RingCentral and to the contact center that was the original partnership of RingCentral is not going to be part of the deal. They're going to provide the Avaya contact center that does not exist yet. So we think that opens up the market for us. And we continue to see traction with Avaya end-user customers.

It's a very different dynamic and bet between what they are doing and what we are doing. The -- our view of the Ring-Avaya bet is that they are going to an embedded customer base that is, for the most part, 60% owned by VARs. And you have customers who buy all of their IT stuff, not just phone, but laptops and servers and gear and Office 365 subscriptions from their IT provider, their VAR. And the benefit they're making is that those customers will, in the mass, change their buying behavior and pull that telecom communications platform purchased out of their bundle with their VAR provider and go direct to Ring. Okay. We don't share that view. The bet that we are making is that it's great that the Ring-Avaya announcement and work is going on because it will get people thinking about moving to cloud, and that is helpful. And we are going to go provide the VAR community with a cloud offering that no one in the VAR community has had to date. They've only been able to resell on-prem equipment. And so our bet -- our view that we're seeing a lot of interest around is that the VAR community will now have a cloud offering to sell in. And so we're betting that people stay with their buying behavior, and that benefits us.

We got -- was there a question up here?

Yes. I had a very similar question, so just a follow up. My understanding was they were going to sell this through the VARs, and they were not asking their installed base to pull it out of the bundle. And that was part of the attractiveness of the white-label opportunity was to give the VARs opportunity to sell a cloud-based solution.

So what they -- our understanding of what they had offered the VARs was the ability to achieve, attain a spiff, so that they would still -- Ring would still take the customer direct. They will take the customer away from the VAR to Ring direct, and the VAR would get a spiff as a payment. So they would not get completely cut out of the loop, but their economic model would change. So where they would receive $100 of revenue, let's say, in a transaction, and they would provide support and deployment and sales cost, and that's their economic model. The model here that Ring and Avaya are betting is that the customer will then pay $100 to Ring, and Ring will play $7 in spiffs to the channel partner, thank you for the business. And so there's an economic participation, but it's a huge change to their business model, and what we have been the recipient of in a positive way is the VAR community saying, no, thank you. We're not interested in changing our economic model. We would have to offload our support. We'd have to offload our deployment costs to have you do that, and that's not what we're about.

It basically converts the VAR channel into a referral channel. The way we are enabling it is the VAR will still own the customer relationship. They're just delivering our product. And they're able to essentially order our product, wholesale, deliver it retail, but they own the relationship. They'll provide deployment, first-line support, and we'll provide second-line support. We enable them. We train them. We do all of those things necessary. So for us, it's attractive because one of our weaknesses as a company over the years has been we're damn good at technology, we've not necessarily been great at marketing and sales. This extends our reach. Nobody knows our brand. They're finally starting to hopefully figure us out. The ability for a VAR to then go to the installed base, co-label with us and then essentially continue to own the original relationship that they have with the customer means we are almost making cloud equivalent sale to the way that we're used to selling for years and years before with on-premise equipment. We think that's a very compelling model. And then the platform becomes unique because, in essence, you're only selling one time. It's not like I have somebody else's video conferencing equipment that I then need to sell to a VAR or sell to Avaya, who then sells to a VAR or whatever. It literally ends up being, everything is owned by us. The VAR is able to provide all of these, but literally turning on, on a configuration manager, they can turn on voice, great, you've got a PBX system. Would you like video conferencing? Hallelujah, we'll give you a video conferencing. Do you want to contact center? Yes, you can get that, too. And oh, by the way, we can do custom -- customization and custom programming for you using CPaaS technology. We think that is hugely compelling, and that's what we built the company to do.

Got it. Well, we're out of time. So Vik, Steven, thank you so much for being here.

Well, thanks.

Great.

Thanks, everyone.