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

Perfect. I just have a quick disclosure to read, and then we'll quickly go into questions. For important research disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. I'm Meta Marshall. I think you've seen me a lot today. I cover communications software here at Morgan Stanley. We're delighted to have 8x8, Sam Wilson, CEO; Kevin Kraus, CFO. Perfect. All right.

Thank you for having us.

Thank you to the Morgan Stanley team. Always a Rock star conference.

Well, hopefully, you've had a good set of meetings and...

Absolute fact.

So Sam, since you've joined 8x8, there's just been a lot of transitions at the company from major management changes, strategic shifts, product developments, just how is 8x8's approach to the market driven these transitions? And do you think we're kind of at a place where this strategy is kind of something where we can work with it and refine it over time?

Can I just start with, I love that you started with a softball. It was very nice on the middle.

Keeping people awake in the afternoon.

Thanks for that. All right. So look, I can answer that at one level, and I sort of answered that at another level, right? Over the last -- I've been with the company almost 6 years now. We've had 3 CEOs, 2 previously and me, and previously I was the CFO, right? So under Vik Verma, we're really focused on sort of integrating the products and making UCCC as a bundled solution we refer to as XCaaS, et cetera. Under Dave, we were really focused on GTM expansion. I'll be blunt with investors. That didn't really work that well because our organic growth last quarter was 0. And you're not going to throw it on -- and so the -- I think the Board felt that change was necessary. And really what we're focused on for the most part, I think the difference that I see the strategy that I'm pursuing with the management team that's different in the past, is in the past, it's been much more of a sales and marketing-driven strategy. And I'm much more -- I mean maybe it's my background as an engineer originally, but I'm much more of a product-led strategy. And so the difference just really quick -- the difference between that is a sales and marketing-driven strategy is things like, okay, you do $100 in revenue with 10 sales reps, so therefore, you're going to have 20 sales reps, so we're going to have $200 in revenue, and it's like this sales, sales engineering and then we'll have 12 channel partners, we're going to have 14 channel partners, whatever. A product-led strategy is like let's build products that customers really want and then that will pull into the market and then as it's pulled, we'll add sales reps and add sales capacity. And that's really -- to me, that's the big change is sales and marketing-led company to a product innovation of the company that started with Fuze a year ago. That's why we did some innovation roadshows last week in the U.K., and we're doing an event at Nasdaq on Friday to really talk about -- because our R&D spending has gone up fourfold since 2018, and it's up 82% over the last 2 years, right? It's time for that spending to show up something in the marketplace, and that's kind of what we're talking about.

Okay. I mean, is that -- I guess, just in stepping into this role, is your kind of focus on getting this kind of product strategy correct? Or how has kind of an investor focused on profitability, kind of focus and change some of those objectives?

So I think as CFO, the thing I was focused on is capital allocation. And let's say, towards the end, there might have been some difference of opinion around capital allocation, but let's just say, capital allocation. So first and foremost, let's be a profitable cash flow positive company. Let's pay off our debt, let's do smart things on a capital allocation thing. I think the thing that has changed in the last 4 months when I became CEO is we really articulated and we're going to talk more about this, but coalesced around a solid product strategy. And that innovation, innovation is a great word, it's sort of, but it means nothing, but like what does that mean? Where are we spending, 80% of our R&D dollars, are going into the contact center space and how we see that going on a go-forward basis and where we go. And then just aligning those two things and then really focusing on efficiency, right? We've done two layoffs. We did one in October and another one in January. And those are really focused on improving the operating efficiency of the company.

Got it. But do you think we're at a more stable place of not as many kind of concurrent changes kind of taking place at once?

I do. I mean we have two more changes coming up. The big one being we're in the midst of changing our employee compensation. It may not -- I'm not sure it's going to really show up to you, but it is a headwind from a non-GAAP because like all companies, we give non-GAAP guidance, right? And we are fundamentally changing our employee competition to be more cash-centric. And so that's a headwind for our operating growth -- operating margin growth. It'd actually be better, if it wasn't, but we're trying to be really cognizant of shareholder dilution. That's the notion of capital allocation. So share dilution and those kinds of things. So there's a few more minor moving pieces, but the big stuff, I think, is done. It's really just about executing. And I see it in the company, right? The drama levels now, things are really kind of moving forward. And it's yes, most of it is behind us.

What Sam just said about the internal change on the comp, I mean it was really well executed by our HR group and a lot of outreach during the course of that, a lot of personal meetings internationally. And it went over fairly well. I would say the reaction is neutral to positive largely. So it didn't...

So and what it -- I mean to Kevin's point, what investors see over time is our stock-based comp was wrong, right? It's not immediate because stock-based comp works, it takes time to work through the system. But our stock-based comp will drop and our dilution will drop.

Okay. Got it. There's been kind of communication software has been on a little bit of a roller coaster over the past couple of years...

More ski slope than roller coaster -- up part of the coaster but...

Well, it's like a ski lift and then, yes, ski hill. So the benefits of cloud communication are clear, but that was very clear when we were kind of going towards hybrid work or work from home. Just how do you -- what do you think is like the new normal in terms of adoption rates for cloud communications? And where are you seeing kind of macro impacts there?

So I'm going to take this in reverse order. On macro impacts, I think I'm a terrible indicator on macro impact to your point earlier question, right? We've had some changes. There's some things happening, right? We're seeing increased contact center sales. We've reduced our investment in small business demand generation, and that's slowing down some of the UC stuff, so I'm not sure. I will tell you that from a credit card default rates and those kinds of things, our retention is the highest level it's been in years. We're not seeing an increase in credit card default rates. So the base is healthy to me. From a DG side, we've exited some really inefficient routes to market that we were doing. So I think I'm a terrible indicator on that stuff. On the -- your question is, I think, a little bit more UC-centric and CC-centric. So on the UC side, look, I think the collaboration portion of the market is really the conversation is very dominated by RingCentral, Microsoft and Zoom. And really, to be fair, it's Microsoft, Microsoft and Microsoft, right? I mean it's 280 million seats of MAU. And the thing I really see there is that Microsoft has disintegrated the UC suite. So up until 2019, 2020, we sold this voice video chat for employee collaboration, who -- and that's like we were one of the first companies to invest heavily in Microsoft Teams. Our Teams seats are growing triple digits on a year-over-year basis. It has some dynamics and so we benefit from that wave. But I think that's the biggest dynamic. I think Zoom and Ring are my rivals, are trying to fight Microsoft, more power to them. I embraced Microsoft early, and we'll continue to do that.

I mean you've kind of highlighted that. Just how large do you think that opportunity is? And how can you kind of continue to differentiate in that Teams' opportunity?

I mean, look, when I look at the road map around what we're doing with Teams, it's amazing. Now to be fair, look, for just for the investors' benefit, there's 3 doors to Microsoft Teams, and Microsoft when they built Teams, built an ecosystem strategy. So there's -- their dialing plans, probably the least popular for all those reasons. There's operator Connect, which is a SIP trunk kind of simple dial tone, and then there's direct routing, which I would argue we have a sort of market-leading or a great solution in. And that's sort of rich APIs, more feature functionality, those kinds of things at lower margin, maybe as long as we attach contact center. But if it's just a straight low-margin, high-volume seat deal, we generally pass on it. Verizon or AT&T is going to win that business.

Okay. Got it. I mean -- and so when we think about that and just kind of concerns that investors have had around ARPU around the space, is that context in our hook basically, what kind of continues to keep ARPU healthy for you guys?

I think so. I mean, the ARPUs are relatively robust. And depending on what you sell and how you sell it, there's a lot of opportunity for add-ons there. We see that. Obviously, we're moving more to enterprise. So ARPU is generally slightly lower in enterprise than a small business because the volumes are much bigger, but then the margins are better, the net dollar retention is way better. So there's a lot of offsetting factors, but I think so. I think if you're -- in our industry right now, if you're a straight UC provider, and that's all you really do, I'd be nervous.

Right, you're not helping -- you're helping all of the [ bear ] cases of various investors, but...

Look, I'd be nervous, right? I mean -- and it's -- Microsoft wants to dominate employee collaboration. And they're not doing it directly. They're doing it through proxies, but they want to dominate that and Zooms fighting them tooth and nail because they want to survive. And I'm not going to get the middle of that. I've got a contact center. Our contact center was started in 2000. We bought it in 2010. I've been in the contact center business for 12 years. It's a great market. It's at another inflection point. Last year, contact center spending for agents actually increased for the first time in a long time. Why? Like that's a gorgeous market. I'm going after that market. Have good time over in that market. See you over there. And that's what you're going to see. You're going to see it, that the stuff we talked about last week in the U.K. and the [indiscernible] all about innovation in the contact center. 80% of our R&D dollars is going in that. I'm racing in that direction. And I'll attach UC for enhanced benefits for your customer experience.

I mean you've talked about kind of embracing the Teams' opportunity. But certainly, Microsoft has talked about building out better UC opportunities, they've talked about contact center, like what kind of gives you confidence that you can continue to differentiate in that market both -- or to take advantage of the Teams' opportunity and be able to differentiate in that market?

I still think of it as two problems. So Microsoft doesn't think about 8x8. I mean I'd love to think they think about 8x8, but I'm a little more realistic than that. But Microsoft would have to say they want to compete with AT&T, Verizon, BTTT, et cetera, in a portion of the business, they really don't care that much about, right? And they care about employee collaboration. They don't really care about employee experience. And then in terms of their contact center ambitions, look, we were the first Microsoft Teams-certified contact center. And we've got incredible feature functionality. If you buy our Teams' integration seats with our contact center, there's lots of cool stuff we can do, and there's a very sophisticated road map for more cool stuff we can do. Microsoft so far has a digital-only version attached to dynamics. So let's just parse that for a second. Dynamics has what market share, 4%, 3%. Maybe on a good day. And then you're only going to do digital. Has anybody looked at what happen at Frontier Airlines when they tried a digital-only model, that didn't go so well. So yes, but not -- I mean we talk to them about our contact center stuff all the time, and they're always super interested.

Okay. Got it. So I guess just in terms of -- you've talked a lot about the contact center market and kind of UC has been something else that you pull in. Like is that sales conversation at this point, starting with contact center and then pulling in other things. Are there still UC seats and then you say, hey, we have this many seats that would be better suited for kind of the XCaaS?

That's our heritage. That's our heritage, right? 8x8's heritage is we're the -- we've got more patents in VoIP, in UC than anyone else. Really, VoIP, we developed, global telephony. We have PSTN replacement in more countries than any other UC provider, multinationals, enterprises, that's our heritage. That's what we're moving away from, and it's really started last quarter and this quarter, and it really started internally the acquisition of Fuze is to become exactly what you said, a CC-led company that pulls through UC, not a UC-led company that at the very end, remembers to solve some CC.

Now certainly, you guys have -- but Zoom and Ring are also kind of rolling out contact center solutions as well. And so what just kind of helps continue to differentiate you guys? Is it just being puckered down that road?

Well, we could start with the basics since Ring's contact center actually belongs to NICE and Contact. So we're a reseller of someone else's contact center. I don't -- I wouldn't call it their contact center or I'd call it someone else's. And then in Zoom's case, look, I don't talk a lot about the competition. I'm kind of doing it today for some reason. But if you look at the Gartner Magic Quadrant, the most recent entrants as a company in the Gartner Magic Quadrant's Talkdesk, which was founded in 2010. So it's 12 years old, it's probably spent well in excess of $0.5 billion of capital. Anyone in software, in any segment of software, it can eventually be a player, if you spend enough money for enough time. The idea that any one of my rivals is going to put out a couple of press releases and make a product that actually works at a level that's a Gartner Magic Quadrant level product. Any time in a year or 2 is, fill in your blank, lunacy, crack smoking, whatever word you want to use, press releases cost you $150 to put out. A slew of winning customers takes you a lot longer. Giving the product away is easy. Getting customers to pay for a product much harder.

Got it. Part of changes in the go-to-market, maybe you've deemphasized some of the very small business customers instead focusing upmarket. What is that ideal 8x8 customer today? And what are you -- what initiatives are you putting in place to assure that you get to that customer first?

That's a fantastic, right? So our ideal customer is, let's say, [ 20,500-employee ] size company to 20,000, 30,000. Now I use employee count, but really it's a proxy for sophistication. What we want is a mid-market customer that doesn't have developers around the contact center. Is it running a contact center as a core business? So they're not a BPO and they're not Morgan Stanley or Capital One or Bank America or somebody that's doing 10,000 or 20,000 agents. Because at that level, you're going to have developers, you're going to have an incentive to build a highly customized solution because of 1% or even a 0.1% difference will be monetarily worthwhile. What we want to do is we want to take the technology that has been developed over the last 5, 10 years, and bring them down into that mid-market enterprise as a complete packaged solution. And it's a combination of our products and an open ecosystem and a set of APIs and webhooks, et cetera, that allow that complete solution to be brought today.

But how do you get to that customer first, I mean channel partner...

Channel plays a role, SIs play a role because if you -- when you talk about ecosystem, it's going to be about mix and match and technology. But remember, there's been a big inflection point in the contact center market starting in 2020, right? There are 1,400 start-ups now. There's $100 billion of venture capital that has flown into the contact center space. I think we can be the platform of choice for those 1,400 start-ups to develop on top of because I'm not going to compete with them. Every one of the companies that we've talked about today generally want to compete with against Sand Hill Road. I want to embrace a Sand Hill Road. Same way I want to embrace Microsoft because of their R&D spending, I want to brace Sand Hill Road because of their R&D spending. And so I think that's the differentiator to make that sort of flow through. And then if we can get that package together, we'll have the best of breed set of technologies, certified, ready to go, and then we just deliver that through SIs, through channels, through VARs.

Got it. One of the -- when you rolled out the Fuze acquisition, part of the goal was that they had a great set of enterprise customers that you could then kind of go and upsell contact center solutions into, just what have been the hurdles there? And how do you kind of take advantage of what does seem like a very good opportunity eventually?

I'll take the blame. I'm going to throw this one to Kevin just so he get to say something, but this one is not a good answer. Like we...

I'll make him answer the next one.

We've done a terrible job of cross-selling to Fuze space. We've done a great job of holding Fuze space. The retention has been way higher than we expected, the cash flow and profitability and those things from them, we've struggled cross-selling. It's an incentive that I've -- initiative I've taken on. We're doing better. We've got momentum now, but it was one of those integration things that fell through the cracks and if you want to point to somebody, blame me. But we've sort of got our ducks lined up. I've changed some leadership around some of those areas and I think we'll now get some momentum behind it.

It does represent a good opportunity for us.

Yes. got it. Kevin, from the last earnings call, you discussed the trade-off between revenue growth and profitability, and shifting towards profitability in the company in the coming years. You've delivered on incremental operating margins over the past couple of quarters. Just what levers are you pulling to drive most of the profitability over the next year?

Sure. No, I mean, as Sam mentioned, we did do two actions, one in October, one in January, so roughly 14% of the team. But we're also really surgically looking at non-headcount spending as well. We've got -- we purchased a lot of software. We're very good at reducing our telephony costs to maintain our gross margins. There's that we can really scale our support teams that are in COGS. So we've got a -- we've shown over the last several quarters a real uptick in our non-GAAP gross margins. On the spending side, we are looking at sales and marketing efficiency primarily. We're looking at all sorts of -- every way we go to market, we're looking at things selectively in terms of geo and how do we approach that with boots on the ground versus channel only, things of that nature. So we're stacked ranking things. We definitely want to preserve the R&D spend at 15% of revenue. That's our target because we're an innovation-led company. On the G&A side, we've got some work to do there. We're higher than we want to be, but there's some additional costs we've got going on there, particularly around the remnants of the Fuze acquisition and so forth. So I think that we still have levers in terms of greater efficiencies. We're looking at not just headcount, but more of the same, but we're not -- we don't have any plan at this point to do any more people actions. But we're looking at a margin profile ideally in the, hopefully, 15% margin before too long.

Got it. I mean I think reducing commissions has been kind of a common theme kind of across the space. Just I think one of the questions that investors have had is just like, well, isn't that going to have an impact. Or it doesn't matter?

Well, it does. Yes, it will have an impact over time as you look at it. And we're looking at things -- well, you can take a look at say, lowering commissions is outside commissions for lower-margin products. So you can look at it as a SKU base, you can look at it prospectively, get new partners, et cetera. But that takes time because we have such a large installed base that's on these channel residuals that over time, you'll see the effects. But right now, with our growth being low single digits, you're not going to see a lot of impact in the near term on the commission side.

Just one thing I would add to that is, look, HubSpot put out a press release, talking about it. I think the industry is starting to wake up. And the idea that end customers -- like I think the pressure is not only from us, wanting to do -- it's also from the end customers not wanting to pay, like they don't see necessarily the economic benefit from paying large commissions to channel partners. They'd rather see that money spent on innovation or things just lower prices.

Okay. Got it. When we think about your CPaaS products, there's been some volatility in that business since you acquired Wavecell. And like, can you just tell me what your CPaaS strategy is today and...

CPaaS strategy today, fix the business, like it's been a disappointment for the last 4 quarters, right? And I heard of that, fix the business, get it going on the right path, figure out next steps.

Okay. Got it.

We've hired a new leader.

We have a new leader.

A really good guy.

And it's very focused. I mean, I should say -- so it's really focused on a few things, right? It's very focused on building out its market presence. CPaaS is a very scale-oriented business, super scale-oriented business, right? So it's Vietnam, Thailand, Philippines, Indonesia, Singapore, right? We've got size. We've got scale in those markets, and we're just scratching the surface. So as we go deeper, we've got a cost advantage in each of those markets. As we go deeper, I think we can really sort of improve on that and start building more economies of scale and then figure out what the next logical steps are for the business.

And you can get good leverage out of that business, too, because it's pretty operationally efficient below the gross margin line.

Got it. Okay. Maybe just remind investors, I think your balance sheet has been cleaned up a fair amount over the past couple of quarters. Just what some of the steps were there? And are there any other steps that need to be taken?

Yes. great. I'm glad you asked. So in August, we restructured our debt. We did share buyback recently as well in conjunction with some of the activities we did there. We have, right now, purchased -- we prepaid $33 million of our 2024 convert. So that includes $5 million that we did 2 weeks ago. So this will be our third quarter in a row that we've prepaid our 2024 converts. So we have about $520 million-ish left in our debt, $250 million is a term loan there. We have the ability to prepay that. That's due in 2027. We have the ability to prepay that penalty-free starting in August, up to 10% or $25 million. And then after that, a year after August, we'll be able to repay without a penalty. And the fiscal '24 -- the 2024 converts are due in February, that's about $63 million left. We will be able to pay that with cash we have and now we have about $130 million in cash and investments now. We will be generating cash flow and using our cash flow to pay down our debt. And we have $202 million of 2028 convert. So I think with the cash that we expect to generate, we will be able to pay down quite a bit of our debt, return more of our enterprise value to shareholders. And ideally, we could be debt free in 4 or 5 years. The 20 -- the converts of '28 converts do convert at like [ 7 15 ], so conventionally -- could conceivably that's in 5 years or so.

All right. Perfect. And then it wouldn't be 2023 Morgan Stanley TMT conference if we didn't ask an AI question. So I think there's been a lot of questions both on how AI impacts contact center -- was here yesterday, saying how it could affect the UC market. Just where do you see opportunities there? And then just how do you see some of these generative models changing some of the approaches you may have taken to kind of AI?

So two things. Number one is you'll see an announcement on Friday. We've been working with [ OpenAI ] for a while. We'll announce that we were using their Whisper technologies to improve our transcription. It's better transcription at lower prices, faster, those kinds of things. The bigger for me is it gets back into those 1,400 start-ups, right? If you look at almost all those 1,400 start-ups, they all have some sort of ML/AI spin. I think the opportunity is to be the platform of choice for those next-generation ML/AI solutions. I don't want to compete with them. I think it will be a core mistake from incumbent contact center vendors to try to compete with those 1,400 start-ups. I have no desire to compete with ChatGPT. I think they'll do a better job at chat. I have no desire to compete with Cresta or Amelia or Cognigy or any of these other companies, right? I think there's an opportunity to be the workflow management company for all those sort of -- and I think that's the big opportunity. And so I would say that strategy was not feasible 4, 5 years ago. That strategy is feasible today because we're going to leverage the spending that Sand Hill Road is doing. And we started this strategy, we started executing the strategy April 1, and I have been utterly surprised at how overwhelmingly successful the feedback has been so far. We've got more ecosystem partners signed up that we can onboard. We've got a waiting list of ecosystem partners. We've got our first products at beta. We've got demo-able products from our ecosystem partners. So where a competitor in the contact center space may have on chat bot, I've got literally 11 chatbot vendors each with different flavors, shape, size, colors, et cetera, depending on what the end customer use case is. I think in the end, that's going to win as a strategy.

Got it. All right. Sam, Kevin, thank you so much for being here today.

Thank you. Thank you again for having us here.

Thank you. Yes, appreciate it.