8×8, Inc. (NYSE:EGHT) Q2 2024 Earnings Call Transcript

8x8, Inc. (NYSE:EGHT) Q2 2024 Earnings Call Transcript November 1, 2023

8x8, Inc. beats earnings expectations. Reported EPS is $0.14, expectations were $0.09.

Operator: Good day and thank you for standing by. Welcome to the Q2 2024 8x8 Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised today's conference is being recorded. I would now like to hand the conference over to your speaker today, Kate Patterson. Please go ahead.

Kate Patterson: Thank you. Good afternoon everyone. Today's agenda will include a review of our second quarter results with Samuel Wilson, our Chief Executive Officer; and Kevin Krause, our Chief Financial Officer. Lisa Martin, our Chief Revenue Officer has also joined our call today. Following our prepared remarks, there will be a question-and-answer session. Before we get started, let me remind you that our discussion today includes forward-looking statements about our future financial performance including investments in innovation and our focus on profitability and cash flow as well as statements regarding our business, product, and growth strategies. We caution you not to put undue reliance on these forward-looking statements as they involve risks and uncertainties that may cause actual results to vary materially from forward-looking statements as described in our risk factors in our reports filed with the SEC.

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Any forward-looking statements made on this call and in the presentation slides reflect our analysis as of today and we have no plans or obligation to update them. Certain financial metrics that will be discussed on this call together with year-over-year comparisons in some cases were not prepared in accordance with US Generally Accepted Accounting Principles or GAAP. A reconciliation of these non-GAAP measures to the closest comparable GAAP measure is provided in our earnings press release and earnings presentation slides which are available on 8x8 Investor Relations website at investors.8x8.com. With that, I'll turn the call over to Sam Wilson.

Samuel Wilson: Much appreciated Kate and thank you to everyone on the call for joining us today. I am pleased to begin my remarks by saying we met or exceeded our guidance ranges for service revenue, total revenue, and non-GAAP operating margin for Q2. When I took over the CEO role, I outlined our innovation-led strategy to drive growth along with improving profitability and cash flow through disciplined capital allocation. We believe this balanced approach is the best way to build a durable business and deliver value to all our stakeholders. That's customers employees partners and shareholders. Our continued progress on this journey was evident in our Q2 results. As a reminder, we are focused on investing in innovation to drive long-term durable growth; leading with contact center and ex-cast for new business and cross-selling our product portfolio into the installed base; focusing on our target customer, small and medium-sized enterprises with the same technology customer experience needs as large enterprises, but without the same internal development resources; and lastly, building and enabling channel and technology partners ecosystem that allows 8x8 platform customer to deliver best-in-class customer experiences, all of this while growing revenues faster than expenses and returning excess cash to investors.

Our goal is to grow cash flow from operations by an average of 20% in fiscal year 2024 through fiscal 2026. We intend to return $250 million to investors over this period. We have already returned $25 million through early repayment of principal on our 2027 term loans. Let's take a look at the highlights for our Q2 performance. Service revenue increased sequentially by $2.5 million and was roughly flat year-over-year. Improvement in our CPaaS business was a significant driver of the quarter-on-quarter growth as existing customers increase their business with us and we added new customers. The CPaaS team has done a great job retooling the business over the past year and I'm excited by the new opportunities we have identified, both in the APAC region and worldwide.

Now more than ever, I believe our CPaaS business will prove to be a competitive advantage for us. Our UCCC core business continues to perform as expected and we see new products as a bright spot. We demonstrated continued discipline in managing our operating costs, which allowed us to deliver non-GAAP operating profit above our guidance range. Cash from operations for the quarter was $17.5 million, and cash and investments increased to approximately $150 million. We have doubled cash from operations in the first six months of the fiscal year compared to last year. Customer satisfaction and retention remained high within the 8x8 customer base, reflecting the investments we made in our customer success organization as well as continued innovation in our solutions.

This is reflected in the feedback we received from the thousands of customers who participate in our first ever 8x8 Day on August 8, as well as the recent recognition from numerous industry organizations. To celebrate the first 8x8 Day, we ask customers what they loved about 8x8 and after we could publish their response. As a thank you, we sent them what's cooking at 8x8, an e-book of employee recipes and case studies from our food and beverage customers. A few lucky winners also received e-bikes from our customer track who we love. The volume and enthusiasm of the responses tell us the investments we are making in innovation and customer success are resonating. Check out the videos on the website. Adoption of our recently introduced CCaaS product portfolio continues to accelerate.

Early adopters of our AI-powered intelligent customer assistant, both digital and voice versions, are seeing increase of case deflection for specific use cases. Customers are rapidly finding new use cases. The volume of conversations is up over 50% quarter-on-quarter and accelerating. Our ICA pipeline is up over triple-digits quarter-on-quarter. We saw significant growth in our North American reseller channel. We are committed to a channel first strategy and been investing in building out our network of value-added resellers. We have built a strong value-added reseller channel in the UK. And while it takes time and investment to build, it pays long-term dividends in sales productivity, customer satisfaction and durable growth. Partially offsetting these early indications of success was continued downsell and to a lesser extent attrition in the Fuze customer base.

This created a headwind in our enterprise ARR metrics and the customer count. As we've said before, we are 100% committed to retaining Fuze customers. The number of lost Fuze customers decreased significantly measured by logos quarter-on-quarter and we are accelerating the pace of customer upgrades on the 8x8 platform. Our progress this quarter gives me confidence that our strategy is working. We deliver value to our customers by enabling agile workplaces, empowering users across an organization to deliver great customer experiences and harnessing the power of AI and machine learning. We have dramatically increased our investment in innovation over the past two years and the products and features resulting from those investments are now coming to market.

Customer interest has been high and we are seeing increasing adoption and use. Let me share a few examples of our innovation and action at our customers. First off, Westminster City Council, who has been an 8x8 voice and contact center customer since 2020. We recently introduced ICA as part of their user-centered operating model. They are regularly achieving 80% resolution rates on inbound inquiries and in some days as high as 100%. I encourage you to watch the view of their experience, there is a link in the slides. Next up is Acer, a top technology company with customers in 160 countries. They are using our intelligent customer assistant to expedite customer assistants with millions of products including warranty information. I have spoken personally to them and they told me ICA was a game changer.

Our superpower is empowering users and administrators in these organizations with best-in-breed capabilities including AI-powered apps, intuitive interfaces and ultra-high reliability in a wrapper of extreme simplicity. Our goal is to make our users superheroes of their own organizations. CPaaS innovations further extend our UCaaS and CCaaS portfolios. We recently introduced Remote Fix, a prepackaged second-generation video escalation solution targeting field service organizations. We also introduced Omni Shield to our CPaaS customers, safeguarding enterprises from fraudulent SMS activity and a host of other enhancements outlined in our press release last week. Our strategy is to be a leading AI-powered customer experience platform for small and medium enterprises.

The quotes from all the customers profiled in our earnings slides demonstrate our progress in this strategy. They love 8x8 solutions for ease of use, simple deployment and deep native like integrations into the contact center. Our customers see tangible business benefits from our products every day. When I look back, I'm amazed at how many innovations we have introduced in a very short time period. The list of significant product introduction enhancements include; conversational IQ for UCaaS, bringing CC level, speech analytics to UCaaS, integration of open AI's Whisper for transcription and translation. We launched this within weeks of ChatGPT's unveiling and are now transcribing more than 3 million hours a month with a 20% to 25% improved accuracy versus previous solutions.

Composable user experiences empowering agents and supervisors with the information they need to be more productive powerful, user-friendly AI-enabled self-service capabilities in both voice and digital. Expansion of our omnichannel capabilities including embedded secure video and enhancements in SMS and chat apps; an updated version of Microsoft Teams phone app as well as deeper native integration with teams that simplify administration and ease of use and so much more. We are pushing out hundreds of micro updates every week using our automated CICD process, adding incremental capabilities and improving performance. Before the end of the fiscal year, we plan to introduce a host of additional products into beta. Just a few big ones are AI-powered interaction summarization and conversation categorization; a next-generation version of our AI-powered agent assist through our ecosystem partnerships and expanded contact center features for employees outside the contact center that will continue to blur the lines between UC and CC.

Our CCaaS and UCaaS solutions have come a long way in the last 18 months. And this is reflected in the recent recognition from both industry analysts and customers. As I have traveled around the world talking with customers and partners, innovation roadshows in the US and Europe, I have come to the conclusion that our biggest challenge is awareness. It is clear that our velocity of our new product introductions has outpaced our customers and partners' awareness of our phenomenal innovation. Solving this issue and overcoming outdated perceptions of our solution is a multifaceted challenge. We must do a better job of keeping our customers informed, educating our channel, increasing our visibility and creating word of mouth references. We have barely scratched the surface of the opportunity that exists within our installed base, let alone the tens of thousands of small- and medium-sized enterprises SLED organizations and public sector entities that are just beginning to migrate their contact centers to the cloud.

Lisa Martin, who joined four months ago as our Chief Revenue Officer, is up to the challenge. She is joined by Bruno Bertini. who recently joined us as CMO. Lisa and Bruno both have extensive experience in the contact center, and have a track record of building high-performance teams in sales and marketing. They've worked together in the past, are fully aligned and are already having an impact within the organization. Transitions don't happen overnight, but I am confident we now have the right team in place, the right strategy for growth, and the financial and technical resources necessary to achieve our goals. I've asked Lisa to join us on the call today, to talk about her vision and priorities as she and Bruno build a world-class go-to-market engine.

Take it away, Lisa.

Lisa Martin: Thank you for that nice introduction, Sam and for inviting me to speak on today's call. I'm thrilled to be at 8x8. In fact, I accepted this role because I see tremendous opportunity for 8x8 as the UCaaS and CCaaS market continue to evolve. I have spent the majority of my career, focused on customer engagement solutions, the past two years at Twilio and prior to that a number of years at both Genesis and Verizon, leading high-performing sales organizations as the customer experience and communications industries have dramatically changed. In well over a decade of sales leadership, I've learned to appreciate how important strong and well-defined go-to-market motions are to successful sales organization, and how critical it is to align those motions with the buyer journey.

I have spent the first few months at 8x8 doing a deep dive into really understanding current sales processes, the channel strategy and marketing motions to figure out what was holding us back from better sales performance. We are transforming our organization as our go-to-market motions, migrate from UC led to contact center led, and from a single product focus to a portfolio of products. I am focused on optimizing sales operations and enablement, building the processes playbooks and packages that make it easier for our customers to do business with us, and for our business development team salespeople and partners to position and sell our solutions. My go-to-market partner, our new Chief Marketing Officer, Bruno Bertini, will focus on lead generation and overall brand visibility and awareness in the CCaaS market.

We are 100% aligned on our priorities. With the recent innovations introduced in last year, we can effectively compete head-to-head in the CCaaS market, with or without the incredibly strong foundation of our market-leading UCaaS solution. And the timing is right. I believe the market is at an inflection point, and the adoption of AI will continue to drive migration to the cloud because of the benefits companies can realize. The fact is 8x8's portfolio offers the flexibility and innovative technologies, for small and medium enterprise companies to optimize, customer and employee experiences. I could not be more excited for our future, from my due diligence during the interview process, and my first few months here, I'm extremely confident that there is tremendous potential for 8x8.

We have great product market fit. We have strong leaders in our regions and we have the cross-functional collaboration and support that is crucial to any successful revenue organization. I will now turn it over to Kevin for his review of our financial performance. Thank you.

Kevin Kraus: Thank you, Lisa, and good afternoon, everyone. Our Q2 performance exceeded expectations in several key areas, as we delivered service revenue and total revenue above our guidance midpoint. We continued the trend of delivering solid bottom line profitability as we achieved 12.8% non-GAAP operating margin, well above the high end of our guidance range. Year-over-year non-GAAP operating profit grew 162% and cash flow from operations increased 26% versus the prior year. We have delivered positive non-GAAP operating income and cash flow from operations for 11 consecutive quarters, and we plan to continue generating positive cash from operations and operating margin as we build momentum. Total revenue for the quarter was $185 million and service revenue was $177.8 million exceeding the midpoint of our guidance range by $2.3 million.

Our service revenue performance reflected better-than-expected usage activity for our CPaaS business in the Asia Pacific region as well as contribution from new products. This quarter, we recorded year-over-year growth in CPaaS revenue for the first time in many quarters. Other revenue for the quarter was $7.2 million slightly below the prior quarter and generally in line with expectations. Total ARR was $707 million at quarter end up 2% year-over-year. Enterprise customers accounted for 58% of total ARR consistent with the prior quarter and prior year. Enterprise ARR was up approximately $3 million sequentially and grew 1% year-over-year. We ended the quarter with approximately 1,250 enterprise customers. The number of enterprise customers was impacted by approximately 50 customers moving from enterprise to mid-market as we saw some effects from the current economic environment.

Turning to gross margin, operating expenses and operating profit. Please remember that, all items discussed are non-GAAP unless otherwise noted. Overall, second quarter gross margin was 71.5% an increase of 140 basis points year-over-year. Q2 '24 gross profit dollars grew approximately 1% year-over-year higher than overall revenue growth as we continue to focus on profitability. Service revenue gross margin came in at 74.6% up 50 basis points year-over-year. We continuously manage our COGS and expect service revenue gross margins to remain healthy. Other revenue gross margin came in at negative 3.5% for the quarter, compared to negative 11.2% in Q2 2023. The timing of hardware shipments and professional services deployments impacted other revenue which in turn impacted the gross margin on other revenue in the quarter.

Turning to operating expenses. R&D was 15.2% of revenue in line with our 15% target and indicative of the continued investment we are making in product innovation. As we mentioned on our previous earnings call, we expect that our investment in R&D will generate a desirable return on investment, but this will take time as we build world-class software generate awareness and close deals. Sales and marketing expense was 33.1% of revenue slightly up from 32.8% in Q1, but well below the 37.4% of revenue in Q2 '23. Sales and marketing expenses were down year-over-year as we have realigned our resources to focus on our target customers. G&A as a percentage of revenue was 10.4% and down 50 basis points sequentially as we incurred lower compensation employer taxes and benefits costs.

Total non-GAAP spending as measured by cost of goods sold plus R&D, plus sales and marketing, plus G&A was down approximately $17 million or nearly 10% year-over-year and reflects our strategic cost realignment actions taken in the prior fiscal year. Keep in mind that fiscal Q2 also included annual pay increases for our global employee population. At this point, we believe our overall cost structure is appropriate to drive our strategy. The combination of improved revenue and carefully managed operating expenses resulted in non-GAAP operating profit of $23.8 million, up approximately 160% year-over-year. Adjusted EBITDA which is reconciled to GAAP results in our Q2 24 press release was $30.5 million, 16.5% of revenue and up 75% year-over-year.

We have generated over $120 million of adjusted EBITDA over the past four quarters. Cash flow from operations was $17.5 million for the quarter driven by strong profitability and solid cash collections, partially offset by cash interest paid of $12.9 million. Given that cash flow can vary quarter-to-quarter due to the timing of interest payments collections and changes in other balance sheet items, I prefer to look at rolling four quarters cash flow when I evaluate our performance. Over the last four quarters, we have generated approximately $73 million in cash flow from operations, an increase of 62% compared to the comparable trailing 12-month period ending September 30, 2022. We are very pleased with our financial performance so far this year.

We ended the quarter with approximately $150 million in cash restricted cash and investments, up approximately $11 million from the prior quarter. As we have said on prior calls, our plan remains to return $250 million to our investors from fiscal 2024 through fiscal 2026. Our next step in that plan will be to repay the remaining $63 million of the 2024 convertible notes using cash generated entirely from our operations. As we move into fiscal 2025, we intend to begin repaying the adjustable rate term loan as quickly as possible, which will have a significant and immediate impact on our operating cash flow by reducing our cash interest payments. You can expect us to begin voluntarily early repayment of principal immediately after the expiration of the prepayment penalty in August 2024.

Remaining performance obligation or RPO was approximately $780 million for the quarter, increasing $65 million year-over-year on healthy multiyear customer commitments. Before turning to guidance, I want to recap what we are doing as a company to build shareholder value over time. First, we are investing in innovation with a goal to drive long-term durable growth. Second, we are focused on leading with our CCAP solutions to our target small and medium enterprise customers. Third, we are reducing the mix of equity-based compensation which will moderate the pace of new share issuances due to employee stock programs over the long term. And fourth, we are focused on growing revenue faster than expenses leading to increased profitability and cash flow.

Increasing cash flow from operations, while reducing shareholder dilution is our financial North Star and we are very focused on driving improvement in those metrics over the long-term as the best way to build shareholder value over time. For operating expenses, let me walk you through how our strategies to build shareholder value over time drive our expense structure. We expect sales and marketing to be in the range of 33% to 34% of revenue for fiscal 2024, down from 36% in fiscal 2023, as we focus our go-to-market motions on our target small to medium enterprise customers and cross-selling into our installed base. I believe this cost envelope can accommodate programs to drive awareness of our innovations as well as incremental investments to develop our value-added reseller channel in North America.

We expect R&D as a percentage of revenue to remain about 15%, as we continue on the path of investment in our customer-focused product strategy. Finally, we expect G&A expense to remain at approximately 11% of revenue for fiscal 2024, and we believe we can achieve leverage from our G&A functions over time as revenue increases and we achieve greater efficiencies through automation. However, in the near term our expectation is for G&A to remain in the range of 10% to 11% of revenue as we absorb the increases in cash payroll expenses and investments in automation. Regarding non-GAAP gross margin, we anticipate the second half of the fiscal year to be similar to the first half year average of 72% and note that this metric can be influenced by product mix.

With this framework in mind, we reiterate our fiscal year revenue and operating margin guidance ranges and establish outlook ranges for the third quarter of fiscal 2024 ending December 31, 2023 as follows. For the third quarter, we anticipate service revenue to be in the range of $173 million to $178 million. We anticipate total revenue to be in the range of $180 million to $186 million. We are targeting an operating margin between 11% and 12%. We expect cash flow from operations to decline sequentially, but remain over $10 million. We anticipate interest expense of approximately $9 million and cash interest payments of approximately $7 million. Note that interest expenses can change as our term loan is subject to monthly interest rate adjustments.

We estimate a fully diluted share count of approximately 125 million shares. We are reiterating guidance for fiscal 2024 ending March 31, 2024. As a reminder, the ranges were service revenue in the range of $701 million to $711 million. We anticipate total revenue to be in the range of $732.5 million to $742.5 million. Please note that other revenue can vary based on customer-specific deployment schedules and hardware shipments, so there could be some movement in the Q4 2024 other revenue as a result of these dynamics. We continue to focus on delivering a solid operating margin and anticipate achieving between 12% and 13% for the year versus the 8.4% achieved in fiscal 2023. We expect cash flow from operations to be directionally aligned with the non-GAAP operating margin trend subject to timing differences in collections debt interest and other payables.

We anticipate debt interest expense and cash paid for debt interest of $35 million to $36 million again noting that our term loan is subject to monthly interest rate adjustments which have been increasing in recent quarters. We estimate an average fully diluted share count of approximately 123 million shares for fiscal 2024. In closing, I believe that our continued focus on profitability and cash flow from operations is the correct financial strategy for us at this time. This approach will enable us to continue making targeted investments in innovation and growth, while we return value to our investors primarily through debt prepayments. Fiscal 2024 is a period of transition and our goal is to show some revenue reacceleration in fiscal 2025.

I would like to thank the entire 8x8 team for working together to deliver this quarter's solid results and I look forward to the continued execution of our strategy as we move forward in our quest to become an innovation-led growth company. Operator, we are ready for questions.

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