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

All right. I think we'll get started. Thanks, everyone, for coming to JPMorgan's 51st Annual TMC Conference. We're really excited today to be hosting 8x8's CEO, Sam Wilson; as well as CFO, Kevin Kraus. We can maybe get kickstart with maybe just introducing yourselves and the 8x8 story.

Thank you. My name is Samuel Wilson. I'm the CEO of the company; Kevin, Chief Financial Officer of the company. Just to level set for everyone in the audience, we deliver communications for the customer obsessed. That's our new tagline. Historically, we've been known as business communications, voice and video chat for employee collaboration and Contact Center. But we sort of broadened out this last quarter to make it around customer access because we really focus on a few key areas: enabling the agile workforce; making sure that we empower employees to offer great customer service to whoever their end customers are; harness the power of AI and machine learning, all the buzzwords. We've been in there for a little while because the Contact Center market, in particular, is at an inflection point around these types of technologies. And we've been early in trying to build a platform around enabling those technologies to be deployed. And I guess I would add a fourth one for this room, which is we try to do this in a very shareholder-friendly way. We are working on reducing our share dilution, paying back debt and doing all kinds of things to drive more cash flow. And cash flow per share is kind of a key metric that we'd like to drive. And really, the key here is that we offer a set of technology software-as-a-service to enable companies to both allow business communications for their employees and for their employees to offer great customer service. And in a real quick summary. That's what I'll say. You may have heard this market a lot about UC and CC, unified communications, traditional voice video and chat; CC, Contact Center; CPaaS, which is communications platform-as-a-service. Yes, we have products in all those areas, and we do sell all those buckets in various forms or fashions. I think the last thing I'll just say real quickly is our claim to fame is that we were early in having both unified communications and contact center, all on one single platform. That allows us to offer a high SLA and offers us to enable a bunch of key feature functionality for end customers to be successful. I think this is really important when you think about things like Microsoft Teams. We have a market-leading Microsoft Teams integration. We allow lots of people to use Microsoft Teams as their front-end interface and add telephony capabilities behind that, so you can make phone calls, receive and send SMS messages and all those kinds of things. So it's just like kind of a holistic solution. It's B2B sales for people to communicate.

Got it. That's a great overview. I mean you spoke a little about your last quarter results. It might be just helpful for the audience. If maybe you can just touch on maybe what were some of the key highlights from your last quarter earnings and what has maybe been a more difficult earnings period for just tech in general?

So over the last 6 months, we've done a lot of work in pivoting really towards more profitable growth. So the last couple of quarters, particularly we've outperformed on our operating margins. So cash flow has been -- free cash flow and cash flow rather has been positive for 9 quarters in a row, but we're targeting the more profitable growth. We beat on our bottom line margins. Our gross margins came in really strong. And so we're really -- we've really hit on all cylinders from an operational efficiency point of view. And we plan to continue driving that through future time periods. We're continuing to invest in R&D to drive innovation, which we believe is going to lead to future revenue growth. And that is something that we'll continue on, but we've definitely hit our stride now in operational efficiency, particularly in the sales and marketing area.

Got it. And then maybe for you, Sam, you've been part of 8x8 for quite a while. There's been a few management changes over the past few years and different product developments as well. I mean, what do you really see as the overall strategy for the company moving forward? And where do you think you can maybe make the most progress?

I think it's a great question. So I mentioned earlier in my -- sort of my quasi prepared remarks that our core competency is that UC and CC together. I think one of the things that the company has not done well the last few years and we're rectifying is really invest in innovation. And so I think the company tried to take sometimes the short-term route of investing in digital ad spending or more sales capacity to try to drive revenue growth instead of investing in innovation. And really, I mentioned this earlier, the Contact Center market, in particular, is at an inflection point with what's going on around it. I mean for 20-some years, we saw year-on-year decreases in total contact center spending. In the last 2 years, we've seen increases. We've seen onshoring of contact centers versus offshoring of contact centers as corporations understand that retaining customers is as important as getting new customers. And so the biggest strategy change at the company is we now spend -- the last quarter, we spent 15.4% of non-GAAP revenue on R&D. We're spending in excess of $120 million, $130 million a year, rough and tough. About $100 million of that is going into the contact center space. And we started this journey a couple of quarters ago. So we've got new innovation hitting the marketplace here. So the company is in a bit of a transition, right? It was a UC small business company just a few years ago. We've been in the contact center business since 2011, but it hadn't been an area of investment. We're now 57% enterprise. I'm looking at Kate because I'll forget. 57% enterprise. And we're driving with more and more investment in innovation on the Contact Center side, and we see tremendous opportunity here on a go-forward basis in that area.

Got it. So maybe pivoting a little bit to what everyone's really talking about now is it -- just generative AI and how that's really impacting pretty much every company at this point. But how do you really envision generative AI in your space? And what are maybe some of the positive tailwinds or headwinds that comes with it? And what are you may be doing on the R&D front with respect to generative AI in general?

Sure. So generative -- so I'm going to take us back and just say, generative AI is somewhat applicable directly to our business, there's parts that are very applicable. So I'm going to take a step back and just talk about AI in general. So there's really 3 areas. So number one, when OpenAI came out, the first week they came out of stealth mode, we were already talking to them. We had known about them. And we've already incorporated Whisper technology for transcription, which is what they use their -- it's the generative model that ChatGPT is based on. We use that in-house for transcription. We're getting more accurate transcriptions for lower cost, and that's a common service that we provide to us and our ecosystem partners is those -- that's bringing AI technologies onto the platform for use by everybody. Number two, and I think this is super important, is we've developed an API layer and a Webhooks layer that allows for next-generation ML/AI companies to drive on top of our platform for the Contact Center. And over the last 5 years, we fundamentally refactored our Contact Center. So this is a company that 5 years ago would do one software release every 90 days maybe -- et cetera. We now do 5 releases a day using CI/CD methodology, continuous innovation, continues deployment methodologies, et cetera. What this means is 5 years ago, we might have had a backlog of 100 or 200 customer-found defects. Today, we have 0 because if a customer finds a defect today, we can fix it tomorrow. We don't have to wait 90 days, whenever those things pile up. This is super important because now we have a platform that works in an innovation speed that matches effectively the venture capital community. So the venture capital community is funded. I don't know. It depends on which numbers you see, maybe 2,000 to 3,000 startups mainly using ML/AI, though not all of them, around the contact center space. And a lot of that started in 2020. And the amount of money that's talked about is about $130 billion in venture capital money has been allocated to the contact center space and next-generation solutions. They're not trying to build a contact center. They're trying to build technologies on top of the contact center. And so what we've done is we've built that integration layer that allows them to plug into us. And we think this allows us to offer a more tailored solution to a mid-market and enterprise customer. We're not focused on those high-end JPMorgan Chase, your firm or Bank of America or Capital One, that's not our customer base. Our customer base would be a regional bank, a retailer, those kinds of things, who don't have a large developer in the house and would benefit from having a large number of sort of fine-tuning customizations to drive that. It's more of a cookie-cutter solution. And then number three, of course, we use ML/AI technologies in-house. I have a bot that scans every contract to make sure that rev rec has done correctly and those types of technology. So we use in different cases. I think the big thing that differentiates us is really that bucket number 2. Most of the competitors in the contact center space are trying to build all the ML/AI technologies in-house themselves natively. So if you look at their sum total of R&D spending in this area, it's probably less than $1 billion. Meanwhile, we're trying to build a platform that leverages the $130 billion put out by the venture capital community. We think in the end, that will be more successful. It will take a little bit of time to show through because we're in that transitionary period. But we think it absolutely gives us a competitive differential in the Contact Center space.

And maybe following up with that, you sort of mentioned how with that you're able to do more software releases and maybe fix different patches as part of the whole CI/CD pipeline. How has that really resonated with your customers? And how has that maybe improved maybe retention levels across your customer base?

Great question. So our retention level is the highest they've ever been. We've got really good data going back I don't know 5, 6, 7 years. You can correct me if I'm wrong. But we've got -- like it's highest it's been for at least the last 4 or 5 years. And a lot of that's driven by the fact that our uptime is higher, our customer-found defects get resolved the next day, those kinds of things -- or within a week. And I think it's super important to understand that we have refactored our underlying Contact Center and overall, our whole platform to a microservice, agile CI/CD environment. And I talk about CI/CD a lot, and I know it's a nuance, but it's really important to understand that, that's like how Facebook or Google or those types of companies -- it's the underlying methodology that they use to rapidly innovate on software and a lot of us who are in the contact center space. So the contact center is a funny beast, right? We got into the business in 2011. Talkdesk, I think, was founded in 2010. I may get a couple of these wrong, but -- and NICE is like -- they were on the on-prem world, so they were like in the 1900s. Five9s is like 2005, right? So you're talking about, it takes 10-plus years of investment to get good in the contact center space. And then you end up with a lot of monolithic code that's hard to innovate on at these market shifts. So we have bitten in the bullet the last 5 years and really fundamentally refactored our original architecture. That's about a quarter away from being done I mean this is a 5-year journey, it's about a quarter away from being done. That's why we're talking more and more about innovation and where we're trying to drive the company on a go-forward basis.

No, got it. That's a great overview. Maybe we pivot a little bit just to the macro environment. I'm sure you've been speaking to your customers and partners at length about it and how it's sort of impacting your business, but what is your sense on the current demand environment? What are you seeing? And how is that sort of being baked into maybe your guidance for next year?

Well, I'll let Kevin talk about the guidance. Look, I would say we're a $750 million a year software company, which puts us in the top 5% of all software companies. But in the world of telecom, where you're talking about Verizon, AT&T and Lumin and [indiscernible] we're a flea, right? I mean we -- I struggle and it's a fair question, trust me I struggle. But I'm going to answer the question in 2 ways: Number one is, in terms of deal cycles, we see a small elongation of deal cycles. And I'm -- like usually, our deal cycles are anywhere from 6 to 12 months, and maybe we see an extra week on average as we double check the TCO numbers or those kinds of things. We're still seeing -- we've had great pipeline numbers, great bookings numbers. We're all above plan recently. So I'm not seeing anything on that side. And then during the pandemic, when I was CFO, I could really see when government subsidies and those things, when the installed base was under distress, because we would see a surge in collections issues and a surge in credit card default rates. And as you can see our DSOs are great. We're having no issues with collections at all. And our credit card default rates are right on par where they're supposed to be. And so we're not seeing -- and our retention rates, as I mentioned earlier, are very high. So we're not seeing really any distress in the installed base in terms -- and when I mean retention rates, those are dollar-based retention rates. So down cells, customer shrinking, all that is factored into that. I think we're doing great on that side. I think there's just a little bit of CFOs and CIOs just wanted to go sure before they stand in front of the Board to do typically -- for an enterprise deal, it could be a $5 million TCV deal. They just want to make sure the Is are dotted and Ts are crossed before placing them.

Got it.

Anything you want to add about guidance?

Yes. On guidance, I mean, really, we -- as Sam mentioned before, we have really good retention rates. We've done some investment in that area, too, over the last 2 years. It's been a really great ROI for us. We've done it in smart ways. So it's a lot cheaper, obviously, to keep a customer than go get a new one. But in terms of guidance, there's no new product releases baked into the guidance or anything like that, a little bit of a rebound in the second half on some of our usage-based business. But generally speaking, it's a steady net new type of guidance for our growth for the year.

And just so everybody understands because it's kind of a group from here, so I can kind of take a step back, right? We made a decision about 18 months ago, a year ago to forgo revenue growth, shift to this innovation model, cut some of our inefficient growth angles, right? So we were -- I was witnessing situations where we were spending money. And the misnomer is for some reason, we as a company can't grow. I can grow next quarter if I wanted to. All I have to do is call up Google and spend money. It's just going to drive down my op income. It's not efficient. It's not great growth. It's not smart growth, but I can do it. And I think that's the part the company has changed philosophically. We want to be a smart, durable grower. And when you invest in R&D, you get durable growth. What durable growth means, if I cut my spending in R&D, I could still keep selling that product into perpetuity. If I go buy a bunch of Google ad words or go spend a bunch of money on channel spifs, the minute I stop doing that my growth rate plummets, my growth rate plummets, and that's the part I'm trying to avoid. I think that's the -- our industry got caught in this land grab mandality. And I think we were the first company to really take a step back and say, this is foolish. I will forgo some revenue growth as I transition. And then we've got a bunch of new products in beta -- a bunch of new products coming in beta next quarter. Those are not factored into the model. They're in beta, we'll know whether they meet market criteria to go to general availability here shortly. It's not a time-based thing. It's a function-based thing. And then hopefully, that re-excites -- sorry, reignites revenue growth, which I think is absolutely doable.

Got it. So I mean you mentioned a pretty interesting point. You're really heavily invested in the R&D area to really drive that durable growth. Just curious, what would you say now -- or are you hoping to maybe in the future as well, be your competitive advantage? And maybe to a point, what are you really seeing from a competitive front? Who are you typically bumping up against both in maybe the small business, but also in the mid-market as well?

Sure. So look, our competitive differential is we offer UC and CC together as a combined platform -- one single platform. That enables Five9's SLA. We're the only ones with the Five9s SLA. And lower total cost of ownership because it's one vendor, throat to choke and some capabilities across 2 platforms. Let me give you a really simple example. Everyone is interested in artificial intelligence and customer experience. But if you have your contact center on one vendor, then the bot gets trained on that and then you have your unified communications on a different vendor, then it's a whole series of different data sets that you need to go train your bots and your artificial intelligence on. But because we're on one platform, we have one single architecture. We have all our transcriptions, all our call recordings, all those things in one unified area, it's very easy to train your bots. Now if 100% of your customer engagement came from your contact center, that -- what does it matter. But the reality is almost all businesses, half of their -- roughly half of their customer engagement comes through the contact center and the other half comes through UC users who are interfacing with customers, inside sales, sales reps in general, billing, cancellations, accounts payable, receivable, all those kinds of areas. They're generally not on a contact center solution because they're not agents, they're not waiting in queues, they're not doing those things. And so one of our differentials on a big picture for the future is that we have that single platform that allows you then to innovate on top of for these next-generation technologies. And that's really -- like I see a time within a year where we walk into a customer, us and a channel partner, walk into a customer -- or a prospect, even better. And say what exactly is your use case? What is your business? How are you trying to differentiate, your customer experience to drive higher retention rates for your business? And then we mix and match off-the-shelf technologies that are secure, efficient, et cetera, for that end user. And the business across the street may need a different set of capabilities. As I said earlier, most of my competitors in the Contact Center space and in the UC space are trying to build all this in-house. They want to do everything. They want to be the Walmart of business communications. And historically, if you look at tech, that strategy does not work, right? Salesforce doesn't do everything. Microsoft doesn't do everything. IBM doesn't do everything. No large company. There's Force.com, there's Marketo. There's Azure, right? You have to integrate with other pieces of the software stack, of the technology stack inside of a business to offer a complete solution to a customer. And that's really what we're focused on, is being that glue layer inside of business communications, which plays such a pivotal role in customer experience.

So with that, I mean, you kind of mentioned about the channel a little bit, but how critical is the channel at this point to really augment growth? And what are you sort of seeing within the channel at this point?

So I think the channel is super important to us. Over half of our new bookings comes from channel -- through channels of some sort. And in particular, we're -- in international markets, we're very channel centric. So in places like Australia, New Zealand, France, those kinds of places, we're a channel-only model. In some of the U.S. U.K. markets we'll run a hybrid model with the majority still being channel. The channel itself -- it's interesting, it's a completely fair question, but I have to break it apart in 2 pieces. The channel outside the United States in the telecom space and the channel inside the United States work radically differently. So outside the United States, they work much more analogous to a traditional IT channel. So we have great partnerships, great business, great relationships, Virgin, Softcat in the U.K., these types of places, okay? Inside the U.S., it's totally different because of the regulatory environment. The business that we're in, business communications, phone numbers, phone calls, all those kinds of things are really governed by a very set of very specific taxing rules, governed by the FCC, universal service fee, 25% of every bill. E-Rate, California telecommunications tax. And then the other one is 911 services and wire tapping. And so those have to be provided by the taxing authorities, not us. And so our channel model looks very high hybridy, very different. It's a little less VAR. There's a master subagent. There's a couple of different components to this. I think one of the areas that we've done well in the channel, we're known as a major player in the channel, but there's a lot more on the operational side we could do to unlock more of the on-prem world. Remember, in the UC side of the house, maybe 20%, 25% of the world is in cloud and 75% is still on-prem. And in the Contact Center side, the number is probably 10% to 15% is in the cloud. The rest is on-prem because this is a late adapter to cloud for a whole host of technology reasons, jitter, latency, time sensitivity, bandwidth, compute, et cetera. And the thing that's changing for all the cloud vendors and contact center is no longer are we going after just the on-prem to cloud. Maybe it's $12 billion, $15 billion, $20 billion on-prem going to cloud. With ML/AI technologies, we're now going after the $220 billion labor market around contact centers. That's Mackenzie's number, it's not mine. I've no idea if it's accurate or not. I just plagiarized it from them. Footnote, asterisk, et cetera. But with ML/AI technologies, that's what technology does the best. That's historically what it's done the best, is replace human labor, particularly high-volume repetitive labor with robots, for lack of a better word, steam engines, whatever you want to call them. And that's, I think, absolutely what will occur again.