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

Thank you all for coming. We're kicked off here in 1 second. Like it will a minute or 2 to walk in, but first, introductions. Really happy to have 8x8, Sam Wilson, CEO. Sam, congratulations again on the role [indiscernible] I've seen you since you took that over and then Kevin Kraus, CFO. Warm congratulations. Thank you as well, and thank you both for being here.

And Michael, thank you for having us. Thank you for Bank of America for inviting us, obviously, a world-class conference. Thanks for it. Thank you.

Absolutely. Thank you, guys, both. So Sam since you have been -- I mean, obviously, you were CFO prior to CEO, but relatively new to the CEO role, so maybe just give us an overview of priorities for the next 12 months and maybe some of the strategic shifts that you're implementing?

So what we are is we're a company in transition. And look, I'll also sometimes I'll use the word I, but we should -- you should always think that it's we, right? This is the management team came together in a room 6 months ago and really decided where we thought the markets were changing, where the inflections points were and what we should do to capture the new things that are happening. And it's interesting because the news has been rolling out over the last 6 months, I think we get a higher and higher level of conviction that what we thought was going to happen is actually happening. So we think the contact center market and customer engagement in general is at an inflection point. And sometimes we use the word contact center as a synonym for customer engagement, but it's not. Remember, only about half the interactions with customers for any given company occur at the contact center and the other half occur in noncontact center type of people. And so we thought that, that market was an inflection point. So what we wanted to do is try to capture. And what really becomes important here is that we had been an on-prem to cloud company. That's been our thing, right? Avaya never made the move to cloud. They've got 89 million seats. Those have to go to the cloud vendors. We're going to fight for those seats. And we thought there was an opportunity here to start to wrap up this new emergence of customer engagement that was occurring. And I can talk more about that if it's interesting to.

Of course.

And so what we decided to do was reduce spending in small business, realign our sales capacity and those kinds of things. Now that has an immediate effect on revenue. Then what we did was -- and we did an action in January, everybody knows that it was an 8-K filing, what we did actually in January, realign the sales capacity, et cetera. And then I've taken a bunch of money that moved into an R&D. So like the amount of digital spending we do today, digital advertising spending today is radically less than a year ago. The amount of R&D spending is up 82% over the last 2 years, right? So put in that, that will pay off over the next 1 to 2 years as we launch products at this market inflection point. And you see some of the spending we did with Fuze transaction in Intelligent Customer Assistant, which is now in beta, that's a digital version of an MLA a bot system, our ecosystem strategy, our APIs, those kinds of things. And we brought the revenue growth down. And then with the launch of the products, with the launch -- with the fruition of all that R&D spending we'll reaccelerate revenue. And in the meantime, we're growing cash from operations 20-plus percent. I predict that we'll go cash from operations of over 20% for the next 3 years. And that is actually my North Star metric as a CEO. My North Star metrics as a CEO is cash from operations per share. Because I think it captures my net income, it captures how I'm running my business. It's not something to a bunch of accountings, 606 rules, et cetera. And it captures also whether we're diluting our shareholders and those kinds of things. And so I think also the decision we made this year was we've moved most employees to a cash-based compensation system. They will no longer receive equity grants on a regular basis. It will take several years to flush through the previous equity grants done under our previous administrations. But the team came together and said, this is going to be our North Star metric. Cash from operations per share. And so we've done a whole series of actions to reduce our dilution over time and increase our cash flow.

It's a great review. Thank you for that. So a lot of moving pieces. You already mentioned the 8-K filing, so they ref more onto your-- your refocus or greater focus on cash flow generation, some of the reallocation of expenses, but the last 12 months, we also had Russia, Ukraine, I think when you caused some pause or pull back enterprise IT spending with the Fed tightening cycle that a lot would agree, maybe it's put some pressure on businesses like 8x8. So where are we today though with the business versus where you were 12 months ago? Are you more confident that we get reacceleration on the top line in the next 6 to 12 months? Or are you about the same? What are your feeing for us?

Trying to give me that 6 to 12 month window versus what about 7 to 13 can I negotiate with you.

I'm trying to give you an a, b, c, multiple choice question here.

So let me actually cover the first part first, and then maybe I'll slightly dodge the second part or at least dance around it a little bit -- we -- so all the stuff we've talked about, about the emergence of MLA technologies and customer engagement and having a platform with an ecosystem on top, this is not a dream of ours. We do it today internally. And what it's led to is we have the highest retention rates right now, we've had in years. So yes, do I think the economy is in recession? I read the same newspapers you read even though newspaper don't exist anymore. I read the same news sources you do. We know there's economic pressure out there. But at the same time, we're having the highest retention rates we've ever had in like recorded recent history. And the reason, I think, is because we've deployed these technologies, we've improved customer satisfaction, and we're driving a higher level of customer engagement. That is the fruition of the technology shift that we're talking about. And so the thing that we're trying to sort of advocate to companies is, yes, economic cycles happen, yes, you may be under pressure, but we have -- I have tremendous confidence that we're going to hold on to our base. I have huge confidence in my engineering organization. It's just not fast, right? You're talking my average sales cycles are 9 to 12 months, right? So let's say it takes 4 to 6 quarters to launch a product, soup to nuts, get it through beta and then another 2 to 3 quarters to get it to actually show up in the income statement, right? It's a 1- to 2-year. When you transition from a sugar high of Google ad words, which is not durable growth to a product-led strategy, it takes a bit of time to go through that transition. Do I believe revenues will reaccelerate? 100%, I believe it. Now excuse me, being delusional. Absolutely, I'm a CEO, it's my job title.

I was going to say, it's b to my second question. All the way. I'm going to say you said the same.

Then like what we're seeing now in terms of like deal velocity, I think some of your questions touched upon that, right? Like we're not seeing any big negative. There could be a little elongation in the decision-making. But in terms of the bookings that we're seeing now and the deal velocity, it's not anything.

Are you seeing an increase in downsell though because I heard it few times this week, and I haven't heard that word for a while. I heard it a few times.

So let me put this up. When we talk about retention rates, we talk about logo churn plus downsell. That's our retention rate. So we -- like I don't -- to me, it makes no difference, right? $1 less of recurring revenue, whether it can be a downsell and lost logos effectively the same thing...

It's all the same to you.

It's all the same to me. And so we are seeing the highest level of retention we've had worked on. The other thing we monitor really closely, Kevin and I watch like a hawk is our credit card default rates, right? We still a large small business base. It's our legacy. It's well in excess of $100 million a year. And so we still see -- we still monitor those credit card default rates. During COVID, when I was CFO, I could see when there was a problem in the small business base because you see credit card default rates spike, we're not seeing any of that. Yes. Very consistent -- very good is a very low level. We're fine.

Okay. That's great to hear. So the reallocation of R&D and you increased focus on contact center. A couple of months ago, you announced I thought it was a pretty unique strategy, the kind of the partner of ecosystem strategy, right, while you're leveraging outside partners and their expertise. Can you give us some more color on that now?

Sure. Okay. So just quick, I'm going to give you the 30-second version of what it is for the audience, and then I'll give you the update on it, right? So what we believe is much like other forms of previous generations, marketing operations, CRM systems, et cetera. The native strategy isn't going to work in end. You have to have a host of players. There are 2,000-plus start-ups out there around these contact center space now and in excess of $100 billion of venture capital allocated to this space. That means they are going to build amazing products. Those amazing products are not trying to compete with us. They need to ride on top of a contact center. And so we have rearchitected our platform from the ground up to be a perfect meet a match to those next-generation technologies, much like Marketo and then you had marketing operations companies that could plug into Marketo. You'll have a core 8x8 contact center can do everything basic, and then you can plug in next-generation technologies. So far, we have had an overwhelming response from the community.

Are you now to 15 partners, I think, a month or 2 ago, was that...

I think -- we're today -- we're at 18. We've already onboarded 6. We've got another 4 or 5 that have demoable products. I mean we've already launched 6. It's super fast, can we built an entire API layer with security, governance, et cetera. And actually, we have a waiting list. I cannot -- one of the things I'm obsessed about is customer satisfaction. And I don't want to sign up 50 ecosystem partners and then have crappy onboarding and everything else. And I'm actually limited by how fast I can onboard these partners. So we're sort of capturing direct categories right now. We started with conversational AI. We've added health scoring, agent assist, payments, workforce management, along with our traditional CRM and some of those kinds of things. We've got new ecosystem partners in all those areas.

And you touched on AI. So your sales test did a survey like 2 months ago and they surveyed 200 clients and asking, who is at the risk of AI? Who is going to benefit? And I think every contact center company ranked at the top of the list as at risk, right? Because knee-jerk reaction was that you're not going to need seeds anymore AI, it's going to take over context. That was knee-jerk.

Sure.

I think the view is more nuanced today than it was a month or 2 ago, but some people still view contacts an area as out of risk. So I guess, in your view, why or why not does AI eliminate the need for human contact center agent and potentially cause TAM compression?

Okay. It does, right? So I know you expect me to stand up here and say, MLAI will not reduce the number of contact center agents. It should. That's what technology does brilliantly. It reduces the amount of human capital that's needed on rote items and replaces it with technology machines. This has been -- since the cotton, gin and even before then, right, we reduced it. The difference is, I think what people miss is the human being market for contact centers is a $220 billion a year market. That's Mackenzie's numbers. The entire cloud contact center software market is $4 billion, $5 billion. So what should happen is that $220 billion number becomes $180 billion, and that $4 billion to $5 billion number becomes $15 billion. What you're replacing with is you're replacing human beings. If your entire world was the number of seats in a contact center, first off, 80% of it is still on-prem or more, right? So it's still got to come to the cloud. But we're not selling just seats, right? We sell the bots, we sell workforce management. You sell a bunch of other things. You're selling the technology that eliminates the seat. And the best example I can give you about this is ourselves. We have less Tier 1 agents today than we had 3 years ago. Why? Because we deployed all these technologies in-house. This is not -- as I said earlier, it's not a dream, we do it ourselves. Let's say, we have more Tier 2 agents. We have more Tier 2 agents, which I think should be called specialists. Why? Because it wasn't about cost savings. It was about increasing retention. For every percentage point increase in retention, I can hire a ton of agents. It's not what I'm looking for. What I needed to do was increase customer satisfaction, so I could increase retention. I'd put more Tier 2 agents in. We have increased customer satisfaction over the last 2 years, thereby driving higher retention rates and driving a more stable base of business. So now I get a more efficient LTV to CAC. I can do this back to the finance world because I'm driving a higher LTV. The more I increase retention, the more I drive our higher LTV. Now we cut our CAC costs because we're going through this transition. But as we come out of this transition, we're going to have a situation of new products, new technologies, a higher ARPU, if you will, or whatever it is for a customer, a higher amount of money we get out of a customer driven with a great customer satisfaction engine. And that's why I think we emerge in the meantime, generate a lot of cash.

Okay. That makes a ton of sense. You touched on ARPU, too. So does the pricing model change though with AI? Do we see base pricing the usage-based. And then I guess, if don't remind me again, what are the economics of your partnership relationships?

Okay. So let me cover the first part and then the second part. Yes. So when you can't sell a bot on a seat basis, right? It runs 7x24 whatever. So you sell it on a consumption-based model. Same way we sell minutes in the contact center or SMS messages or any of the host of other things we sell in telecom, right? So complete usage-based model is a small platform fee keeps out the riff-raff. So the platform fee and then a pure usage-based model. very confident MLAI. So the more the bot does, the more money we receive and our partners receive. We've got multiple tiers of partnerships. We've got a resell model, where we resell the product on our paper, and we do that in certain situations. And then we've got an ecosystem. Today, that ecosystem is free. And in the future, we'll monetize it the same way Force.com or others monetize through various ways, either gateway usage or API usage or those kinds of things, percent of revenue. But I don't know if everybody knows this, but if you're integrated with Salesforce, you send them a check every month. You have to. It's -- and we do others do, right? So Salesforce figure out to monetize. And by the way, the ecosystem partners all understand at some point we'll monetize. Now why do we do this? To drive ecosystem adoption on day 1, we're like, look, if you're one of the first X number of ecosystem partners that signs up on boards, integrates secures and start selling, we'll give you a longer runway before we monetize.

Yes. And none of that is baked into our forward-looking guidance at this point.

It's too early stage to make that. But that's the road map we should think about to thinking about the model, how you drive the top line of the model and then incremental margin that should be the thought process.

Right. And this is super scary for Kevin, me, Wall Street community, but it's where the customer is at. Is you're going to start to see us go from a -- and we were the telecom industry, so we were always a recurring revenue, 90% sort of variable revenue 10%. That number is going to trend -- the 10% is going to trend up and the pure recurring revenue is going to trend down a little bit over time.

That makes sense. And that scares some people, right, the shift in the model away from the recurring...

By the way, it's how the whole rest of the world work. McDonald's revenue is based on the number of hamburgers eaten last quarter, right? So at some level, there's been consumption. I mean how many shorts the GAP sold directly drove how much revenue the gap produced, right? I mean it's -- we sort of became addicted to subscriptions. And -- but the world -- I mean, look, we buy $100 million of software a year, right? The world does have some consumption component part of it.

Yes. But to your point, communications and general enterprise communications broadly has just been more recurring, right? That's been the model going back for 25 or 30 years, right? So everyone has a custom to them?

Yes. So it's going to be a little bit of -- everybody take a deep breath and cross the chasm, but it's great. It's great for our customers and it's great for us. Because the thing that people miss is, you look, we might get a little less revenue from a large customer because it will be a little less shelf ware. But I think we get a lot more revenue from a small customer, who's willing and able to try a new technology, when before they were too scared because you're like, I going to buy how many seats? And how much is that costing?

You want [ voting ] cost was so much higher and [ hardly ] getting over?

With ICA for a $2,000, we can set up a simple use case and have the customer up and running deflecting cases -- and if it works great, pay us, if it doesn't work don't pay us.

Yes, excuse me. The other thing I just want to point out is, as we attach these ecosystem partners to our platform, that enhances the stickiness of our platform, of our recurring revenue. So that should help with customer satisfaction on the customer's end and just general retention improvement over time.

Because a bit of a ball of twine, making me a great example. Why wouldn't ecosystem partner come to us? The ecosystem partner comes to us because we deliver a case to a chatbot and say, "Hey, the person came off the website, came to the chatbot. The person goes through steps authenticates, goes through steps 1, 2 and 3 and says, "Look, I really need to speak to an agent. We immediately grab that case, all the metadata association and the authentication and pass it to a live agent. So as the agent will call you in and just a second what phone number do you want to call you by, bang your phone rings. Person says, "Hey, Michael, I see you've authenticated. I see you've done 1, 2 and 3 great, how can you help you today?" You don't have to re-authenticate, they know it's you. You don't like faster, better, better customer experience, nothing drives me nuts more. I called a very large, they run our 401(k) -- based in Boston starts with an F. And I have to re-authenticate, three times going through their call center agents, and I'm like, you don't like sell software that's stops this from happening, right? I mean, hey can I talk to your contact center guy.

It's a great opportunity for a sale. So what are the shift gears, I mean, everyone talks about Microsoft your relationship with Microsoft -- how should I think about the opportunity to grow through Microsoft and Microsoft teams?

Okay. So everything we've talked about here, everything we talk about MLAI technology as a platform, et cetera, et cetera. We don't care what collaboration tool you pick. That's what makes us partnership different. We're not trying to fight in the world of collaboration because we can put the telephony in place, and we have the world's best integration with Microsoft teams, I believe, because we can do presence, because we can do transcription, because we can do a hand off seamlessly between contact center, because we can -- we're shortly going to be integrated with their chat systems. We can do all this customer engagement, all these MLI technologies, a single training platform, a single set of data with teams, without teams, et cetera. I'm not trying to compete with Microsoft teams. If you want to run Microsoft teams, I want to be your customer obsession platform of choice. If you want to run Google, I want to be your customer obsession platform of choice. Second thing is, we can mix and match. So there are lots of businesses that will not and should not deploy teams to every single use case. Lobby phones, retail storefronts, warehouses, manufacturing plants, line employees, et cetera, great, deploy our technology to them. You can save a ton of money. If you work -- as a blue collar labor on a manufacturing light at Ford, are you going to a Microsoft Teams license? How many video calls you're going to do? How much chat you're going to do? Zero. But you can take our 8x8 work app, put it on the person's phone, his boss can communicate with him, he can do everything else. And it's just incorporated in the regular price of everything else. So there's a whole bunch of mix and match. And remember, we are the world's best solution for telephony behind that. So it's not just selling customer obsession. It's also just selling, if you want to put voice on teams, we're the best at it.

Our largest Teams environment customer operates are telephony 35, 36 countries around the world.

And normally, an operator connect, that'd be like 6 carrier contracts, 6 different vendor engagements, 6 different deployments, et cetera. Call us plugged in, done.

One-stop shops.

One-stop shop.

Incredibly complex across regions to get that put together your to put together yourself? Sam, you touched on it earlier, kind of your North Star is profitability, cash flow from operations. How should investors think about capital allocation? So I presume you do continue to drive increases in cash flow. How do you allocate that?

All right. So if everybody wants to understand what we're going to do at 8x8, by William Thorndike's book called The Outsiders. It summarizes it greatly what I saw in my time on Wall Street, et cetera, et cetera, and say you can do 5 things with capital, and let me screws up here. You can invest it, you can buy back stock, you can buy back debt, you can do M&A or you can pay a dividend, right? Our #1 priority right now is delever the balance sheet, because my brain looks first to the statement of cash flows, then it wants to build a fortress balance sheet and then it looks at the income statement. So we're generating cash flow step one, and Kevin's done a phenomenal job at this. It's why he's the CFO. Phenomenal job at generating cash flow, he is going to generate more over the next few years. # 2, build a fortress balance sheet. That means we fund our own growth. We can go through economic cycles, we can deal with all the headaches and trials stipulations and number three. So we will first pay down debt. And then as the cost effective -- actually, to be fair, first, we're going to invest in R&D. [indiscernible] that's probably buyback stock would be next. And then opportunistically, we'll do some M&A, probably over the next few years'. We've done opportunistic M&A, over the last decade. You know, Fuze was a home run transaction for us. And if I can get, if another Fuze falls into our lap, we'll do it.

And can you remind me, what is your target leverage?

Zero. I'm an old school person, right? I dream of 0 debt on the balance sheet. That's a fortress balance sheet.

Net debt to EBITDA of 0.

What I'm solving in my model, when we return capital to shareholders when we...

Debt of 0. Forget net debt, debt of 0. Like, why? I mean like if your debt is 0, you can survive everything. No one can put you, like all this noise that?

On American.

But when I came -- look when I came to Silicon Valley in the mid-'90s, tech companies didn't carry debt. They didn't carry debt because there were economic cycles. And you never wanted to cut your R&D spending in the economic cycle because your competitors or your -- especially your foreign competitors didn't deal with those issues. I worked at Applied Materials for a number of years. And we gained massive market share in every down cycle, because we continue to invest in R&D. And when the upcycle came and it always comes, we gain tons of share. And so I -- like my dream would be zero debt. My second dream is 0 net debt. And then after that, we can argue about some financial ratios, but like really 0 debt would be my dream -- that's my target.

Okay. Now I can feel my model.

Yes, we -- I mean, we made a statement on our last earnings call about over 3 years of time, returning $250 million to shareholders, primarily through debt repayment or 10% of the way there. We repaid $25 million of our term loan in early May. So we're on that path.

And assuming the multiple stage where it is, hopefully goes higher, it stays where it is, it is still a return of capital to shareholders greater percentage of the equity value and the EV...

Exactly...

Very, very simple and less math.

And then as I mentioned earlier, we do opportunistic M&A, right? So the way I would see us using debt is we opportunistically do M&A. We probably use cash more than stock, right? So we'd opportunistically raise cash. And then based on the M&A transaction, generate more cash flow on the pay back the debt and in some repeat and some repeat. How about 100% of post debt. When I post debt is some general level of debt you're supposed to carry it all time. I have NOLs for days or long, right? So there's no tax shield Bs or anything else. Like I generate cash flow. I want to pass my debt, and then I want to buy back stock. Henry Stapleton. I have a picture of him in my office.

Ought to buy the book, the book you mentioned as well. So M&A, there's been a lot of talk that consolidation showed in [ Wilco ] in the UCaaS space, still relatively fragmented. You are seeing some pockets of price competition that could potentially be solved through consolidation. What's your view on that? Does it have to be consolidation to get to a more stable marketplace or not?

No. Look, the one company that starts with a Z and ends with an M that did most of the price competition isn't consolidatable. And I don't think anybody would want to consolidate them. I'm sure they dream about being consolidated. Look, you remember, we're still what -- your guess is going to mine, 75% on-prem, 80% on prem.

Probably 75% or 80%.

Yes, whatever on-prem. So you can consolidate the UCaaS side of the house, but really in the end, there's still 89 million seats of UC on-prem at Avaya, 78 million seats at NEC, 53 million seats at Cisco and 37 million seats at Mitel. Purely my guess numbers, I know they look pretty accurate, purely my guess numbers, like there's 200 million seats of 4 vendors there, none of which have a decent cloud product. Actually, 3 of the 4, which have no cloud product. And so I think there's still tremendous opportunity in just that on-prem to cloud piece. And now on-prem to cloud with ex-cast, so you can do customer obsession, becomes a very powerful driver. I think some of the price competition at the low end has actually been a good thing. And we're not seeing a lot of it just a slight bit is a good thing because we need to unlock that base. I think one of the things is probably not all 200 million seats are sitting at a $20-something price point. And so I don't care, like I don't mind selling $8, $12 seats because I can sell $150 contact center seats.

So your base case is that in the P times in the equation that the potential compression in P doesn't more than offset the growth in the volume side. So you can still see good industry growth even with pricing pressure?

Yes, a little bit because I think what you're going to see is -- and this is, where 8x8 is uniquely position, right, where we're seeing a little bit of pricing pressure is at very low end. The Z company product isn't that good.

You mean contacts?

No. I mean UC. In UC it's not that good, right? And it's tackling that low end at relatively low price, right? So we can compete there, we've got that midrange, the informal contact center, the receptionist, the billing department, et cetera. And we've got the high-end contact center seats. And I think what you have to look at is blended price. And our blended price has actually been going up, because we've been selling more contact center. So our blended price at a given customer is actually over the last couple of years has been going up. If you nitpick and go at the low end of UC is there some pressure. And by the way, a lot of that's also driven by Microsoft Operator Connect, right? If you just want dumb voice, I don't look at Microsoft Operator Connect as a competitive threat. I look at it as like, "Wow, what Microsoft did was they've opened up companies to move because they needed cheap seats to move." And there's been companies that basically said, "Oh, if you want to move every seat as to get $20 seats." And we now mix and match across all of our seats, so you can have your $10 seats or $12 seats or $15 seat or $40 seats, you end up with all your seats.

Now it's a good -- it's a great perspective to have. And we have about a bit of a minute left here. Just wanted to talk about the move up market.

Yes.

I think historically, investors saw that 8x8 is being more SMB focused.

Because we were.

You were. Put a lot more resources into moving upmarket to enterprise have done relatively well there. So if you can just give me a sense of where you are today with that transition and why you're succeeding in the enterprise base relative to history?

You may handle this one, or?

Well, I mean, I think -- look, it's the R&D investment that is really helping us drive through there. Our ARR and enterprise is accelerating. If you back out the usage piece of our ARR. So for us, I think it's making the investment and paying off the adding ecosystem partners on top of that is, I think, attracting a lot more of the enterprise customers that we have...

Yes. And look, [indiscernible] one of these spot on. Our R&D is focused on an ideal customer that ideal customer is an upper small business to low-end mid-market. If Bank of America walked through that door today and said, you can have my contact center business, I'd say no thank you.

Their CTO was here, earlier today.

I don't need to talk to him, Michael, because I don't want his business, too complex, too difficult, too customized. That's Genesys' world. What I want is a mid-market enterprise customer, who wants to buy off-the-shelf technology that doesn't have CA developers, who needs to rely on me as a strategic partner to bring him a complete solution to his specific customer needs. And if you look, the reason we've been in up market is because we have a contact center, we've been in the business, since 2011. We've small businesses with 20 people, don't have contact centers. They just have a collaboration solution.

Just an untapped market really.

Yes. And that's what's going towards Microsoft and those things, is that low end market or the next [indiscernible] Jive or Dial pad or one of those guys.

It makes a ton of sense. Great conversation, guys. Thank you again.

Thank you.

Thanks Michael.

Sam, Kevin.

Appreciate it.