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

Michael Funk. I am one of the software analysts at Bank of America, actually the New York-based software analyst. So if you're based out there yourself, give me a call, we can get a drink or dinner some time. Really happy to have 8x8 with us this afternoon. We have Dave Sipes, CEO, I'm sure you know; Samuel Wilson, the CFO. The format is going to be the same as we've been doing all week. It's going to be a fireside chat. I'll leave about 5 in this at the end for any Q&A if you have it. Just raise your hand. They'll bring a mic around. Please wait for the mic, and I can get your questions [ and then ]. So Dave, Samuel, thank you so much for being here. I think you might have had a few slides you wanted to walk through to begin with, and then we can jump right into the Q&A.

That would be great.

Great. Thank you.

Thanks, Mike.

Let's go to the next slide. This is our forward-looking statements. I just want to give you a little background on 8x8 and for anyone that's new to the story. We are an enterprise cloud communications company, pure cloud, and we are about $687 million in ARR. We have about 2.5 million paid business users, and what we're known for is bringing Unified Communications as a Service together with Contact Center as a Service. We're the only Unified Communications as a Service Magic Quadrant leader, which we've been 10x, who's also in the Magic Quadrant for contact center, which we're a 7x challenger in the contact center. And that gives us the ability to do special things, like the ability to promise our customers we're going to have perfect uptime or 5.9 uptime with financially-backed SLAs because we own and operate both systems. There's also feature functionality capabilities that we're able to bring between contact center and unified communications that is unique in the marketplace. The market for cloud communications is very large. We have both UC contact center and CPaaS. That market globally is over a $75 billion market when you look at what the average revenue per user is and how many potential users are on there. UC and contact center make up the bulk of that. And then where we play is that buyer that prefers both of those together, which is typically the IT leader of the organization with contact center line of business buyer as an influencer. That, we estimate, about 25% of the combined UC and CC. Some people think that's very well underestimated, but it's safe to say this is a multibillion -- over $10 billion market where we specialize. And what's that mean to bring contact center and UC together on employee experience communications is on the left side of the chart here, which brings the modern communications, right, but fundamentally a phone, taking the corporate PBX into the cloud as well as messaging and video. And combining that with omni-channel capabilities on the customer experience side of voice, inbound, outbound and digital. We do that on one platform, meaning we bring administrative capabilities across analytics, integrations to all users as well as we provide end points such as our 8x8 Work, our Frontdesk and our 8x8 Agent. But importantly, we also enable third-party end points, which are commonly more and more common. So in the contact center, you have things like Salesforce as an end point. We enable that with the enterprise telephony. In employee experience, you often have Slack or Teams. We provide the ability to light up Teams with enterprise telephony and bring all the employees in an organization onto one enterprise telephony platform in the cloud. And why is that important? A vast majority of IT leaders, they want an integrated communications platform. They're responsible for the uptime reliability, quality and the ability for all their employees to communicate not only between themselves but also with customers. Bringing that together under one vendor is simpler for them. It's how business was done historically. If you look at all the legacy solutions, they all had this combined. When we went to the cloud technology disruption, it split out for a while into single vendor solutions. But as that cloud maturity disruption matures, we see this coming back together, and that's why it's more and more important. And many of these identified this need but have not done it even during the pandemic. During the pandemic, we saw a light-up of messaging and video for at-home workers, but the enterprise telephony is still often on legacy solutions. And now the CIO organization is starting to focus on that because it brings them lower cost of ownership, ability to light up employees around the globe better and integrate with their modern cloud applications. So our core elements of why a customer chooses 8x8, one is fundamentally bringing employee experience and contact center experience together in a single platform. Additionally, we do it globally. So we enable over 50 countries today in cloud communications, both UC and CC. We've taken that from 40 a year ago to over 50 today. We service over 85% of the world's GDP in those 50 countries. And we have the largest global footprint of any cloud communications provider in the market. And we are also seeing a lot in our organizations of being able to light up Microsoft Teams as a client with enterprise telephony. We're certified as both the UC and CC provider to do that, and this is a large opportunity as a lot of employees have been enabled with Team messaging but do not yet have that integrated with enterprise telephony. So if -- with our direct routing solution, which is an open ecosystem that Microsoft enables for Microsoft Teams, we enable those end points, those knowledge workers to share the same enterprise telephony platform with all employees in the organization, including contact center workers and frontline workers, by doing that with 8x8 and do it across the whole globe. So those are the 3 key things. When we see that in a deal, that's why we win. And when you see all 3 of those, we really win. We recently did an acquisition of Fuze, which was a UCaaS player focused in enterprise. It accelerates our ability to innovate on our XCaaS platform. How does it do that? We're able to take that organization and reassign it onto our innovation platform fundamentally, and it also expanded our enterprise installed base. It gives us a lot of customers to cross-sell contact center into and gave us some geographic expansion. In doing that, we were also able to make it accretive in the very first quarter, which we just booked of that acquisition. And then just a few financial elements before we get into questions. Our total revenue is $638 million. And total revenue, $602 million. And service revenue, so over 90%. Recurrent revenue, about 94% and growing at over 20% year-over-year. Additionally, we've been focused on penetrating the enterprise customer segment as they have more critical contact center needs, and that business has been growing even faster for us. Our enterprise ARR is $393 million, growing at over 55% year-over-year, and the number of customers has expanded even faster than that. And we're doing this while maintaining a profitable growth mentality. We've taken our gross profit up significantly the last 3 years, up over 550 basis points just in the last year. And while reducing and containing operating expenses, we'll operate at a 2% to 3% operating margin this year with line of sight to double that in the future year. So the last thing is we're well positioned to capitalize on a large market opportunity. This is something that did not spike during COVID as many things spiked during COVID but is a current key objective of the IT organizations to bring legacy telephony into the cloud. We have the best combined UC and CC product in the market. The Fuze acquisition allows us to enhance that even further at a faster rate. And we're doing this while keeping a profitable growth mentality and non-GAAP profitable as well as cash flow positive, generating $34 million in operating cash flow last year. That's it, Mike. Why don't you...

No, that was great. Thank you, Dave. Yes, I was hoping to segment the conversation into a few key parts. And I wanted to address, I think, some more important things to begin with. Specifically, what I see is a lot of fear in valuations right now, not just in your stock, but across the entire space. And my interpretation of the valuations today is that I keep running about this recently. There's a principal agent issue that the market sees today. At least the market is perceiving that maybe companies aren't allocating capital appropriately, that they're investing into this large addressable market, this large TAM but maybe not doing it in a way that's going to earn an adequate return. I don't necessarily agree with that, but that's what I'm seeing in the valuations. And underneath of that, I think it's this fear that this market is becoming commoditized, right? That everyone is chasing this commodity market. It's all going to boil down to price and value destruction, right? So I mean I was hoping that you can just address that directly by talking about, number one, the competitive environment, right? And what you are seeing and maybe how investors should think about the competitive environment in your place in that. And then second, you talked a lot about this in earnings calls, the balanced approach towards growth and profitability that you have, right, to address that first thing that I pointed out, which is the principal agent, where investors might be saying that, gee, we just don't trust you to invest this dollar at an adequate return. So I was hoping to start there just to kind of confront that what I think is the biggest issue in valuations at this point.

Yes. So I'll start and I'll let Sam add on to that comment. But some valuations ran up during COVID and have come back as activity increased and then activity decreased. This is not a category where that happened. Where it did happen was in video and messaging. But in enterprise telephony, that transition is only about 20% cloud converted, so that large market opportunity is still to come. And those are planned transition activities that are currently occurring. So that valuation issue and spike and pullback doesn't really pertain to the category that we're playing against. As we do that, we've always taken -- we've taken a profitable growth mentality of making sure that our acquisition versus our customer life is high and is profitable. And we do it with a customer by bringing XCaaS, which we branded contact center in UC with high retention, sticky customer as it enables their entire organization and we integrate with a lot of workflows into the company. But I'll let Sam answer more specific.

I mean it's great answers. Look, I mean just to be blunt, the competition hasn't changed over the last 4, 5, 6 quarters. I mean whatever sort of time period, we compete with the same vendors. We hold our own. We do great. So there's been no massive shift in competitive environment over the last 6 months while stocks have declined. And then secondly, I think your second question is great. I mean as a CFO, it's my power alley. But we invest based on return on invested capital, right? So the same way that you want to -- we actually want to allocate capital to us so that we return future cash flows to them. We hold the same standard to sales and marketing or R&D or anyone else, right? We ask for, if you want a new allocation of operating expenses to be dedicated to a project, what's the business case for doing that? And then we follow up. I think the thing that sometimes gets misunderstood by Wall Street is as we make this move to enterprise, those investments generally take 4-plus quarters to pay off, right? So the average deal cycle for an enterprise buying a new communication system is probably 9 to 12 months. Sometimes more, sometimes less. It was a government agency or something like that.

But they're a stickier customer then, too, end of the day, right?

Absolutely.

Lower churn rate in that customer base and the...

Typically signing 3-year deals. 5-year deals are more common than I've ever seen in any other part of software. So those are all certain things that occur. And the LTV to CAC ratios are good. So I would say the only thing that it's incumbent on us and we do it is we follow up with like, hey, we allocated more capital to you. Are you hitting your business case numbers or not? If you're not, then we dive into that and address that.

And the 2 things we focus on is driving enterprise business, now 57% of our ARR and you saw how it was growing quickly. So we've diversified away from small business and really focused on enterprise customers who have like core critical needs. And we've moved focus on to XCaaS, which is the combination of contact center and UC. It's now 35% of our ARR are XCaaS customers, and that's been growing at over 30% year-over-year. And those are our stickiest customers, highest, best customer acquisition economics and large average revenue per account.

Yes, they're all great metrics. Now if you've shared this yet, but you mentioned return on invested capital, obviously, finance guys, how you think about it. How do the returns look though for these multiproduct enterprise customers versus some of the legacy customers that you're moving away from just so us at Wall Street can conceptualize that it's a better return for the higher return enterprise customer that you're targeting today versus some of the legacy customers?

Yes. So I'm not going to give you the internal metrics that we use to run the company, but what I will say is rough and tough off the top of my head, the LTV to CAC ratios are 50% better for an enterprise customer relative to a small business customer. I mean your term rates are lower. Everybody knows that. Your land-and-expand NDR rates or net retention rates are significantly higher, right? So you've got both sides of the equations that drive up better long-term value of winning one of these customers. That's why we're willing to invest to win them.

Okay. And if you want to give me material information, I'm happy to help you file the 8-K later.

Yes. It's in the back saying, no, I'm not interested.

[indiscernible]

[indiscernible] free drinks.

Okay. I'm just willing to offer because I always value that. You mentioned the few deal earlier. How should we think about future M&A and kind of the build versus buy mentality and then maybe where there are holes in the portfolio? And I know there are 4 questions in 1 there, but I want to give you both a chance to walk me through that.

Yes. I would say there isn't a requirement for M&A that we have a broad set product offering today that's being well received. Obviously, 35% of our ARR is XCaaS. We continue to expand the capabilities, especially in our contact center. And we're doing -- we can do that through our own build as well as partnering and some select -- by OEM-ing some select capabilities into our product, which we've done through AI and other things like WFO. So that approach will be extensible for us as we go and attack this market. Having said that, opportunistically, if the right offering is there, we can make additions to the company like we did with Fuze.

Okay.

And you said -- I mean basically, we invest based on return on invested capital. If the spreadsheet works itself out on an acquisition and it makes sense, great. But it's opportunistic, it's not core to the business.

Okay. And what was it about Fuze specifically then when you looked at it when it was brought to you that you just thought this is the right deal at the right time?

It was the ability to enhance our enterprise customer base, which is our core XCaaS customer, and to get a step change acceleration on our XCaaS innovation capability while doing it in a way that was accretive to shareholders from day 1. And we just felt that was a unique opportunity to execute and to move our XCaaS innovation further, faster for our customers.

Okay. That makes a lot of sense. And Dave, you mentioned earlier just the longer enterprise sales cycle. I think it's something that you guys have highlighted in your earnings calls recently, and it makes a lot of sense to me. I've been covering enterprise purchasing for 24 years, so I've seen that sales cycle. Is it something though that you think is part of the learning process as you brought new strategy to the company? Or is that just the nature of the enterprise sales process? So I guess what I'm going to ask is, can you shorten that? Or is that just the way it's going to be going forward?

Yes. I mean it's not that long at the end of the day, but it is like a 6- to 9-month sales cycle. And it is the nature of the beast as you have a large, complex organization with a lot of influencers in that decision as you make that and they have to transition off a complex application onto a complex cloud application. All of that makes it very sticky long term. But I would say it's nothing out of the ordinary. But as we've moved from small business to enterprise, you see that. But it pays dividends just in the longevity of those customers that come in, your ability to upsell and cross-sell those customers over time and they're greater retention value.

Okay. What are the learnings as you've ramped up the sales force and reoriented them towards enterprise, their learnings though that you think are going to either improve productivity or shorten that sales cycle?

Well, it's really how we swarm the prospects in bringing all our resources to bear in mass both from a selling and sales engineering and marketing perspective. Those -- there's some special sauce in what we do in that regard that really enhances our ability to win. So it's really improving win rates as you can go about that.

Okay. And in the very beginning, you showed the one great slide where it showed the TAM, right, the enormous TAM for this market. And so much that's obviously driven by enterprise is moving from on-prem and adopting SaaS solutions, which is the stuff that's going to be a multi, multiyear secular trend, right? That I don't think anything is going to stop that, right? But where do you think we are just in terms of the slope of that curve and momentum? Are you seeing more momentum, more willingness of enterprises to transition to cloud-based or SaaS? Or are you even maybe seeing some pullback there, hesitancy as the macro climate or environment is more uncertain? Are you seeing anything there?

The movement to the cloud is almost -- it feels like the tide rising, right, some inevitable. And I think post-COVID, the ability to like re-up on a legacy solution is harder for a core IT buyer to justify. They don't enable remote workers as well and they don't integrate as well into their other cloud applications and enterprise applications. So I think the propensity to move to cloud has all increased. We are getting deeper into the organizations that are farther from the visionary and moving into the mass of that purchase cycle. And -- but I see that continuing as a long-term trend. Whether there will be any disruption with economic change, I actually feel -- I've been through it before in '08, and the IT buyer actually in those situations becomes more empowered to execute on key projects that do create total cost of ownership savings for a company. And we bring tremendous savings against managing a large IT organizations focused on telephony as well as having multiple vendors, especially across the globe. So we can bring tremendous 60% plus savings to these organizations by moving to the cloud, and that can become a more compelling event during times of financial austerity.

Yes. I don't know if you called the [ spear ]. Bank of America CTO spoke this morning first thing, and his comments echoed that actually he was noting all the investment the bank made during the pandemic. And he was actually asked a question about moving more towards subscription-based models, right, kind of away from like the CapEx-based model. And I think he said even with the economic uncertainty, he would continue to push forward hard or maybe even harder towards adopting subscription-based, right? Because I think it gives more flexibility. So says one CTO and a CTO of a very large company, right? So that definitely is in line with what you were just saying there. Just quickly on the new logo wins because I talked recently about the new logo wins during quarters. Competitively, what is it either in your product set and your pricing, in the bundling quality of service, what attributes are enabling you to win those new logos when they're competitive bids?

Yes. Like I said, if you go back to our core pillars of what people buy, it's people that want to bring their whole employee force onto one application that they can guarantee quality, have lower cost of ownership through better integration into their organization. So bringing it into one vendor, UC and CC, having a global footprint and being able to bring every employee onto the platform and also bringing not just one set of workers, but we've had a customer offer that does like 3,000 teams licenses but they're a 10,000-seat organization, they have like 6,000 frontline workers in stores that aren't knowledge workers, don't necessarily own something like Teams and they're using our end points, and then they have like 500 contact center agents that are using Salesforce as an end point. But having us as the underlying platform across all that gives the administrator ability to get analytics adoption, usage, quality across everyone and manage everything through one throat to choke.

Great. And I have a few standard questions actually asking everyone this week. I want to make sure I get them in before the end. Some may be applicable, some may not be. But any kind of impact on the business from the war in Ukraine or kind of broader geopolitical?

Look, we have no employees in Ukraine. We don't do any development work in Ukraine and Russia. We have a -- closest is we have an office in Romania. Includes Romania, which is a NATO country. No. We have customers who use our service in Russia, but it plugs into any Ethernet port in the world, but we don't sell in Russia or Ukraine.

Okay. So no material impact. The other conversation we're having a lot with investors recently is around stock-based compensation broadly, not just the absolute level, but how companies are going to address that, whether it's restriking that or shifting the mix between cash compensation and stock-based compensation. I know some companies have already thought about it and addressed it. Others are still in process. Where are you in that process? Have you had those discussions?

Look, so 3 years ago, when we were an unprofitable cash burning company, we were more reliant on stock-based comp. We are in a journey of becoming less reliant on stock-based comp. It was prebaked before the market downturn. It's still that case today. We'd like to become less reliant on equity compensation and more reliant on just regular, good old all-American cash compensation over time and do it right back with holders. I think we do obviously compete in a global talent marketplace, and so we're always cognizant of what is the marketplace in general is doing, and we're not going to do anything drastic or crazy. But as a general rule, we'd like to reduce the amount of equity compensation and stabilize a little bit more in cash over time.

Okay. That's great. And I think you mentioned attracting employees. How has the success rate been in hiring? Have you been having difficulties? Is it challenging? Is it getting easier in attracting employees?

We're a global organization and so we hire globally. We've had a very good success at bringing in really quality people, both here but more so globally. And so that spend, the bright star, [ enter ] from the great resignation.

And just to make sort of a plug for what we do for a company, right? If you think about the world 30 years ago, you had to hire in the 20 square miles around where your offices are located. With products like ours running the cloud, we can offer contact center capabilities to a 300-person company that's broadly dispersed. Their workers can work from home, [indiscernible]. Technology like ours used by us allows us to hire globally, by our customers allows us to hire globally because the workers don't have to be in the office to be fully productive.

Got it. Now it's great to hear because I've heard from a few companies, they're still having difficulty in hiring engineers, for example, or salespeople. So that's great.

You should definitely tell them not to try to hire in any of the regions we have offices and locations.

I'll make sure we delete the webcast so they can't...

Try to hire everybody in Silicon Valley. Good luck with that.

I wanted to touch on margins. I know Sam [indiscernible] a lot of questions here. I think last quarter, you talked about kind of a lot of sight for margin expansion. Can you just remind us what the levers are that you have to pull there to hit the margin targets?

So we're on a multiyear path to continue to improve our gross margins, right? So the areas of the company, I think, was a little bit behind on over the last couple of years, and we've really worked over the last 2, 3 years to improve. So you've seen steady gross margin improvement. We think we have more room to run there. We're becoming much more sophisticated as a company that as we grow in size, we're able to use that size to generate economies of scale. For a publicly traded company, G&A is a relative fixed cost, right? So we can get some natural leverage based on that. I do want to increase R&D spending. So if you look at our long-term model, we've taken it from 9% to 13%. That's the step-up with Fuze. But long term, we'd like to be in that 13% to 15% range. And then over time, we just need to generate some leverage on sales and marketing. And given the changes that we're making up, moving up in enterprise, et cetera, that should be achievable over time. So we'd like to see ourselves continuing to generate more operating income and operating margin over time.

Okay. That's a great answer. Maybe one more for me, and then we can open up to the audience. If you have any questions, just raise your hand in a few minutes here. But one for you, Dave. I mean you joined 8x8. And clearly, you must have known the company relatively well from the outside and something attracted you, believing you can have a positive impact on the company. So what is it maybe that you saw or that you still see today, I'm sure, that investors just don't really fully appreciate? What is it that we don't understand about 8x8 that you see better from the inside?

Yes. We always want to skate to where the puck is going, right? And I saw that the buyer that cares about integrating contact center and UC really does care but didn't have solutions. So it wasn't during the cloud disruption. But they had done it previously. Legacy 8x8 has the -- had the best starting blocks for that and the combined platform and the one platform. There was a ways to go, and that's why we've done so much in investment in contact center and continue to make that investment, to make this world class across both UC and CC and really bring up that XCaaS percentage from 35% into a majority of the business. So it's a multiyear road, but it's a category that's still huge, mostly all legacy still that we're taking to the cloud. And by building that phenomenal product, we have an opportunity to capture the #1 in a segment within [indiscernible].

It's a great answer. If there are any questions in the audience, go ahead and raise your hand. Otherwise, I have a few more that I wanted to get through. So I mean there are 2 different lines I thought, I think, in enterprise communications or enterprise solutions. The one is that you need strong partnerships to penetrate some of these larger enterprises because the purchasing managers are most comfortable going with trusted partners, right? They're relatively risk-averse, right, group. The other is that they're going to choose the best-of-breed solution, and they're going to make that decision -- that's the best decision for the enterprise. So I guess what I'm asking you is to kind of shoot down that first theory that you have to have all these deep partnerships, right, that give you instant access to 200 million enterprise seats and that's not the best strategy.

You're asking about the on-prem installed base is really the question.

Correct. Okay.

Sounds like -- $800 million company.

Not mentioning competitors.

$800 million company. I don't get that you're really small conversation.

No, no. Yes.

Right? So...

Well, there are partnerships that are critical, and they're the more important partnerships. There is a reseller network that we could tap into that generates over half of our business. That's very critical to this and is the core partnership that we think the customer listens to and that we focus on. So I believe that's the key lever here. That's where we focus. We -- and -- so that's one. And then the other -- second part of your question?

No, I think you hit it. But I wanted to quickly, we have a few minutes left, touch on these reseller relationships and the best way to incentivize as resellers because obviously, they have choices, right? So what's the best way to incentivize them? And how frequently do you change those incentives to either turn up or turn down?

So can I ask you a verification? We're not talking about master [indiscernible]? We're talking specifically about resellers? Or are we just talking about channel in general?

Well, I'm talking about the resellers, but...

Okay, so VARs.

Yes.

Look, VARs, I think, have been caught an interesting conundrum. I mean particularly a very large VAR business, retail business in the U.K., right? So they were very quick to embrace the cloud movement. In the U.S., I think it was more difficult because of the IT systems and the taxing systems and some of the other systems. And so I think really it was interesting this conversation came up recently with a number of investors and clients, our partners of ours is like how they migrate their business to this cloud world. Historically, the VAR stack the boxes, had the plastic phones, delivered them, et cetera. And now they're moving to a world where we do all that in a core infrastructure for them. And they're really about stepping up and asking a customer, hey, where are you going in terms of digital transformation? How -- let us put chat technologies in place, et cetera. And so it's -- to me, it's very much about us enabling these resellers in the U.S., in particular, to migrate their business to the next generation of services. You said it earlier, right? The world is moving from a CapEx environment to an OpEx environment. This environment is kind of where the VARs came from. And so they're on this migration to the OpEx environment, and we're there to help them.

It was an educational process, is the value -- is really the value add that you can help them through that process to becoming more of a consultant rather than just a hardware.

Yes, because there's no boxes to stack. There's no move ads and drops to do kind of the tradition of about stocking line cards and there's other things they used to do. They're much more about, hey, how do we implement these technologies, how do we deploy them, how do we support you on your journey to get that better total cost of ownership.

Great. It was a great conversation, guys. I really appreciate it. Thank you all for coming out, and thank you all for attending, and hope to see you all tomorrow.

Can I just say one last thing?

Oh, please.

Mike, thank you for hosting us. Thank you to BofA. I'm on a alumnus of BoA. So thank you very much.

I forgot to mention that.

It's a long time ago, in a galaxy far, far away. But I have many special fond memories of conferences at the Ritz-Carlton, so just thank you.

I was going to name drop at the beginning [indiscernible] question if you wanted me to.

Absolutely. Thank you.

Thank you, guys. Thank you, both.