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

[Audio Gap] everybody. This is Will Power. I cover cloud software for Baird. Thanks for joining us here. I'm pleased to introduce our next company, 8x8, a leader in gigabyte communications and collaboration. From the company today, we have Steven Gatoff, who is the Chief Financial Officer. A role he's had, I guess, since 2018. So an old hand now there, Steven.

I guess, I'm going to jump into Q&A. But I guess, Steven, maybe just to kick it off, can you maybe just provide kind of a high-level overview of kind of what 8x8 is, maybe a little bit about the journey you've been on from a UCaaS sensor provider to the full bundled solution? Kind of what that means for you moving forward?

Sure. Thanks, Will, and thanks, everyone, for making the time. Yes. So in essence, as communications evolve both as a value prop at companies and organizations and as technology improves, you see 2 things happening. You see cloud disrupting communications similar to how cloud disrupted IT and HRIS and ERP and CRM. And so that's one macro bet that cloud is now disrupting a huge on-prem 250 million endpoint population of servers and PBXs that are sitting in the basement of many companies and offices as they move to cloud offerings for all the reasons that they do. And two, what we see is companies becoming more mature about how they engage with their customers. And so the whole telecommunications ecosystem has changed from companies buying phones for a new office to companies buying communication systems so that they can have a better customer experience, so they could use their telecom system as a customer satisfaction tool, a customer service enhancement. More -- even more sophisticated companies use our communications platform as a revenue-driving tool in order to drive customers who call into contact centers to identify who they are, know who the high-value customers are, know what products they have and direct them to the right agents so that they can be upsell and cross-sell better. And so there's that efficiency and CRM-like feel that's going on in communications, really over the last year or so, that is driving what 8x8 does. And then the third element of what we see and are doing in the space is our bet, our hypothesis that's starting to play out now is that the integration of all of these technologies on one data stack, voice, video, messaging, chat, contact center, open API framework and one set of data, one set of analytics is highly valuable to organizations so that they can mine their customer data and they can mine their customer transactions across any mode that happens. And that's what we have been pursuing and driving and investing in to get there. And it feels like it's starting to come together.

Yes. Okay. That's a helpful background. And maybe just to kind of help level set, coming out of your fiscal Q4, you had some puts and takes with respect to COVID, some pressures in SMB. Look like mid-market enterprise continued at a pretty healthy pace. So now that we're into June, maybe just kind of provide us an update as to kind of what you're seeing in the marketplace. A, do you remain comfortable with the mid-market enterprise traction you've seen. And b, what's happening with SMB in terms of churn, payment pressure, et cetera?

Sure. So there are 2 transformations specifically that 8x8 is going through: the transformation from what has historically, well, as you well know, in a small business centered company and morphing and growing into mid-market and enterprise space, particularly as the value prop of single data analytics really appeals to larger companies; and two, we're morphing from an old technology product to a new single-instance SaaS technology platform. So the 2 transformations are SP to MM, Ent and from legacy offering to new platform. And so in driving that, as you well noted, you've seen our growth rates in mid-market and enterprise. You look at ARR, for example, our growth rates have far outstripped the small business. Small business is growing nicely last quarter, grew pretty nicely. Essentially, ARR is growing at market. Bookings are growing a little bit faster. And the mid-market enterprise business are growing together, if you combine those into one large segment, it's in the 60-plus percent ZIP code of growth. Enterprise is growing a little faster, and mid-market is growing in the 50s. And so that's been a continuing trend in the last 2, 3 quarters as we've invested meaningfully in our go-to-market dimension and our technology platform. Of late, to your question, for all the wrong reasons in our economy and all the wrong reasons and the health of everyone around us, the whole move to work from home and remote access where the pandemic has really increased activity and increased demand and increased transaction flow for us pretty much across the board. And so the net impact for us, 8x8, of the pandemic of COVID-driven activity is it seems to be a net positive. There is some dislocation. It is impacting. COVID is impacting small business customers for 8x8, just like it is for any other company. And so you see -- and we expect to see a bit of churn from that, like other companies do because SB, small businesses, are impacted by that. But net-net, we're seeing it as a demand generator.

Yes. Well, I guess in the other twin element that you alluded to this is transition to X Series because it feels like that may have been a surprise to some in the quarter, just thinking about the magnitude of that. Any updated thoughts as to kind of how that's playing out now and how it progresses through the year?

Sure. So the driver of the migration is really an expansion of customer economics. When you look at the whole land and expand economic dynamic with customers, you see that for sure in mid-market enterprise customers. MM and Ent larger customers are the traditional land they buy and then they expand, and they have 20%, 30% expansion rates over time. Whereas small business customers tend to buy what they buy when they like. And so what we're focused on, though, is moving all of our customers over from the old legacy platform to the new X Series platform to remove friction, to introduce an e-commerce capability so customers can buy on their own, provision on their own and scale more effectively and drive down our CAC. And so that effort has accelerated really in the last 60 days. And the reason it's accelerated is that our engineering team has architected and driven ways to move cohorts of customers over in batches. And so we have sprints that drive customers with like feature sets over from old to new, almost entirely behind the scenes. In other words, their UX may not change right now, but the infrastructure behind is moving over. And so the sprint of a few weeks, we'll move 2,000 to 3,000 customers at a shot. And that's been working really well in the last 2 months. And so that's given us the confidence to say that we expect to have north of 80% of our customer base, of our users specifically on the new X Series platform by the end of this calendar year.

Well, yes. No, that sounds great. I think once you get to a more common platform, that will clearly benefit the organization. But I guess behind that, it appears to be creating some churn, too. So on the one hand, it sounds like you think it's going pretty seamlessly. But what's creating kind of the higher churn there? Is it just as simple as customers view this as a new platform and thus they're going to look at other options while that's underway? Or what's actually driving?

Got you. It's not that the migration itself has caused churn historically. It could create some incremental churn going forward. We suspect it will. But we also suspect that the economics, the expansion should outweigh the churn due to migration. As you noted, churn, though, historically, for the past year plus has been at a level that it's just higher than it should be. The good news is that we exited the year with Q4 being the lowest churn quarter of the year. So there are signs that what we're doing to address that is working. And we've been doing a bunch of things on multiple fronts to address churn, and I'll tell you what they are in second. Let me just clarify also when you say, okay, well, where is the churn and why? The churn that we've seen is 65% to 70% in small business. So when you look at our total dollar churn, 2/3 of it is in small business customers. And you're like, okay, well, why is that? When you look at that churn, 70% of that is legacy, it's from legacy customers. Customers who have been around for 5, 6, 7, 9 years who have mostly VoiP-only, very basic functionality, plastic phone on a desk, phone at a cash register, phone even on a wall of a storage room. And so in small business world, those customers are more susceptible to price competition. And they have very basic feature functionality. They're not availing themselves of platform, analytics and all of the more advanced soft phone offerings. And so what we found is when we move those customers to the new platform, churn is meaningfully lower than in the legacy platform.

Got you. Okay. All right. Maybe we just shift back to mid-market enterprise, which has been a source of strength. I mean, I know you all have been focused on the bookings number, which I think has been helpful. I mean, as you sit here today, what's kind of the confidence level that you can maintain some kind of bookings growth rate that's close to where it's been over the last few quarters? I know you've aspired to be in the 30% range. I mean, is that still the target? I mean, it feels like you've got the digital transformation in your favor. [ Both ] side, I don't know, are you seeing any delays in enterprise sales cycles that impact that? And where is that going to net out?

Sure. So that is still our target, to grow bookings in the 25%, 30% ZIP code over time. Some quarters will be a little bit higher, some quarters will be a little lower, but that's still the target, right? That's our target to grow revenue. And so if you're not growing bookings, that's not going to happen. And so a big part of that does come from our presence in the mid-market and enterprise. And the reason we have confidence in that is, one, our channel program has done really well in the last year. It's changed fairly meaningfully. We've been able to make some very productive investments in our channel program. And so that's helpful. And two, the notion of the platform of combined offerings of contact center with CPaaS capabilities, with video and voice all on one database resonates mostly with larger companies, with large mid-market enterprise customers, and that's where the activity is. And so that has given us confidence too in the conversations about the value prop. To your very good question of like, okay, well, what about in a COVID world? Are you seeing any impact? We see kind of a little bit of everything, if you will. The net-net is that we see more activity, but we are seeing some larger deals that get slowed down because the reality is if they were going to go deploy phones in 400 stores, and those stores are still closed, then they are restructuring the deal with us. And they're saying maybe we'll go with our employees with soft phones first, and we'll do the stores physically later and a video in the office later, but maybe we'll do video capabilities now. And so certain larger deals that were very significant across an enterprise are being worked and restructured just for the realities of the environment. So that's true. Small business customers, we see a lot of activity. One dynamic that's really interesting to me is that we've seen a lot of customers that come back to us for some type of relief some, hey, I could use 60 days extra payment terms. Or, Hey, I can't pay this last bill for 30 days at all. Can I get relief and just forgiveness of that 30 days? And what we're seeing with the vast majority of those, well over 50% of those, where they are adding on months to the end of their contract for, hey, give me 30 days, I'm happy to add that on my contract. And so customers are committing, they just need a little bit of relief. So we haven't seen a tremendous amount of churn yet if it happens due to COVID. I think anyone's opinion is what happens to the small business community, mostly in The States, also obviously overseas and so far, as the impact on small business customers over the next 2, 3, 4 months, 5 months is relevant.

Okay. One of the other recent initiatives has been on the distribution front, the bar strategy. ScanSource being kind of the lead horse there, I guess, initially. What are you seeing there? Is it kind of meeting, exceeding expectations? I mean, I know it kind of launched right in front of the pandemic, I don't know what degree that's impacted that or not. What kind of accelerant could that be?

Sure. The VAR channel of that for us was a really important one. And just for everyone else's benefit, the cloud communications market, right, as really you obviously know well, the cloud communications market has a channel route to market that is a master agent where it's all of the channel, when I say, channel and cloud is a referral model, is channel partners referring to us and they get Spiff. The issue is that the majority of the on-prem legacy PBX switches that are out there, the users, those are not owned by Cisco's customers, are not owned by Cisco or [ Vire ] or MYtel or ShoreTel. They're owned by VARs, value-add resellers, that sell not just phone equipment, but also Office 365 and professional services and consulting and support and help desk. And this is part of a bundle. And they have not had a cloud offering to sell their customer base. And so our bet was to give them a cloud offering, and that should play out. And so we launched that January, February, went to market with ScanSource, which is Avaya's largest distributor, and they are in turn with us now going to all of their underlying VARs and engage with them, and we're getting those folks signed on to the platform, on to our portal. The nice development in the last 30 days is that we signed other customers across Liberty and folks in the U.K., Liberty Media, that -- sorry, Virgin Media -- Virgin Media in the U.K., and that to me, personally, that was a really solid VAR validation. The ScanSource transaction came up, right? Avaya was doing their transaction with Ring, and that is very nice. But ScanSource was not interested in changing their business model to get Spiffs. They wanted to maintain their customer relationship. And so we were pleased to see that. I personally was even more pleased to see the Virgin deal come together: a, because their presence is huge in the U.K. that Virgin has across the business community with something over 20,000 businesses. And that, to me, was a really good validation that VARs want a cloud offering around communications to sell into their customer base. And so that's a recent development that I look at as a strong validation point.

Yes. It sounds like, I guess, more of a revenue production standpoint. It's really next year and the year after where we start to see a meaningful contribution.

Yes. Good question for sure. Yes. The VAR channel transactions will start to impact bookings growth in the second half of the fiscal year and then that will trickle into revenue then and going forward. But on a $500 million-plus base of revenue, for that to become a meaningful number in revenue, you're not talking about a few quarters to go for sure.

Yes. Okay. Steve, I guess one other question I get. I'm sure you're getting it, too, is confidence level in getting to net income breakeven. You talked about trying to achieve that, I guess, exiting the year. So how are you still thinking about that? You still feel good about that? And then what's the free cash flow breakeven kind [ of that ]?

Sure. So the short answer is we're laser-focused on that, and we feel very confident in attaining that because we can control our cost structure, and so we are focused on delivering that. We are focused on delivering essentially getting close to breakeven exiting -- breakeven exiting this year so that we're profitable in Q1 of next year. That's the goal, right? We may exit the Q4, might be $2 million, $1.9 million negative, but the next quarter is profitable. That's the point. And we can control our costs around that. We have the right trajectory from here to get to there. And so that is something that everyone on the executive team and the management is focused on doing. And we get there through 2 ways. It's really the divergence of 2 curves. And Will, you and I have talked about this before. It's, one, the continuation of revenue growth, right, and so you'll have growth that comes up. So if you're adding more revenue, and we expect to grow expenses at a decreasing rate. So it's the divergence of revenue growth curve and expense growth curve that will drive the leverage to deliver how we get to breakeven on the P&L from a non-GAAP standpoint. And then your next question was like, okay, what does that mean for cash? Cash breakeven or the cash trough follows probably 2 quarters later. It could be 3, but right around 2 quarters materially. And the reason for that is due to the accounting treatment, ASC 606 amortization of both revenue and expense. The fact that, right, for a SaaS model, you start taking revenue in the first month that you sign a long-term customer, but they ramp and will pay you cash over that first implementation period. And then the opposite is true actually mostly on sales, commissions, Spiffs expenses, channel expenses where you pay that generally within the first 90 days, but it gets amortized over the life of the customer 5 years. And so when you put those 2 dynamics together, there's roughly a 6- to 8-month lag between P&L and cash.

Yes. Okay. I wonder if you could kind of update us what you're seeing more competitively as you look across the product portfolio. I mean, really principally UCaaS and contact center, any changes on that front? And I know you probably get a lot of questions on this as well with ACO launching, has that upped the ante? Is that -- is there any kind of share shifts? Yes. What are you kind of seeing out there?

Yes. So there's 2 dynamics, like what are we seeing and competitively. What we're seeing is we're seeing more bundle offerings more than we anticipated. And so that is helpful. We've seen their quality and the dynamic with our video offering be helpful to securing deals, where enterprise-grade customers are kind of like, okay, good. Your video offering is so much better than it was a year ago. That's good. And so that gets us in more deals now than we were. And so that was just super helpful and fortuitous transaction. And so what we're seeing competitively though is nothing materially different on the win/loss ratio. We continue to win a lion's share of the deals that we're in. And I know we've talked a bit about this with you, and certainly with folks as well, is our deliverable is to have more deals, not to have a higher win rate. We win well for deals we're in. And we needed more at bats. We needed more deal flow, and that's why channel was an important part of our strategy. And we're seeing that as we continue to grow our presence, as the bundled offering has taken hold, as the dynamics for the value of video has really started to resonate, as more people are using that, you've seen the usage numbers are pretty appealing. That seems to be suggesting that it's a big enough pie, and there's so much demand that we don't need Zoom to lose. We don't need Ring to lose for us to win, and it sounds a little corny, as I listen to myself say that. But it is the reality where we're making hay and doing fine without others having to lose specifically in so far as the incumbent. There's so much legacy incumbent on-prem just moving to cloud that will -- if we win our fair share, we'll be fine.

Yes. What are you seeing on the medians growth? You had early on, tremendous growth of large numbers, and you were providing pretty regular updates. Have you seen that continue to tick out? Or as we kind of move back to more of a regular work dynamic, that growth rate probably adds a little bit. But that's question one. And I guess, two, how impactful has that been for the rest of the business, a, having that capability? And is there an expectation at some point that could actually open up the works for you cats, right? If you have means to customer -- probably too early on that front but...

Yes. Good questions. So yes, the fundamental dynamic that happened was that we integrated this higher quality video offering into our platform. We launched that offering in the fall in November for free, right? The view was, go get it in market, build the usage base, go do that for 18 to 24 months, and then we'll monetize that later, like a Google Maps approach, almost, if you will. And then with the COVID pandemic, what we saw was that usage of 2 things increased. Usage of the 8x8 free meetings product started growing more and more. And the Jitsi.org video meetings platform skyrocket to like 20-plus million users. The vast majority, not all, but most, were on the Jitsi.org platform. And so to your point, as things return, that holy cow crisis management, we would not be surprised to see those levels start coming down a bit. It's held pretty much too recently. But what that did for us was it accelerated a -- we need a paying SKU, right, because it was free. So if you're going to monetize the space, you need a charged SKU. So we built and rolled out, and you saw us deploy a few weeks ago, a higher functioning, more value, feature-rich paid meetings offering. And so the view is go migrate, go transition, go monetize the free meeting users onto a paid platform. So the good news is that you have a tremendous base of free users that are now getting served with 8x8 banners. And when they finish even a Jitsi call that pops on screen, click here for more information, add, integrate your calendar and contacts, that did not exist 6 months ago. Now it does. So that's the good news. The reality is that it will take time. That is nothing that's going to drive revenue in Q2, going over the next quarter, but it should reduce CAC, and it should drive more users and usage over the next 12 months.

That seems that it should be a nice additional opportunity for you. I guess -- unfortunately for time purposes, I need to wrap it up here. But I really appreciate your time, Steve, and thanks for all the insights. And for investors, next up is Varonis Deckers. Again, Steve. Appreciate it. And [indiscernible] week.

Thanks a lot. Thanks, Will. Thanks, everybody.