8×8, Inc. (NYSE:EGHT) Q3 2024 Earnings Call Transcript

8x8, Inc. (NYSE:EGHT) Q3 2024 Earnings Call Transcript January 31, 2024

8x8, Inc. misses on earnings expectations. Reported EPS is $-0.17316 EPS, expectations were $0.1. 8x8, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello and thank you for standing by. Welcome to the 8x8 Third Quarter 2024 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 Kate Patterson. You may begin.

Kate Patterson: Thank you. Good afternoon everyone. Today's agenda will include a review of our third quarter results with Samuel Wilson, our Chief Executive Officer; and Kevin Kraus, our Chief Financial Officer. 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.

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 measures that will be discussed on this call together with year-over-year comparisons in some cases, were not prepared in accordance with U.S. 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: Thank you, Kate and thank you to all of our investors, analysts, employees, customers and partners for joining us on our Q3 call. We delivered solid operating results again in the third quarter. Our financial North Star is cash flow from operations per share, and our cash flow from operations performance for the quarter was the second highest ever. Cash flow from operations on a trailing 12-month basis is up 55% year-over-year, and we continue to be very mindful of share count. Cash flow was driven by non-GAAP operating margins significantly above our guidance range. Q3, '24 marks the anniversary of the official launch of our innovation-led strategy to build durable, long-term growth. Our path to complete transformation is underway, from operating losses and negative cash flow, to sustained non-GAAP profitability, and increasing cash generation.

From a UCaaS led to a CCaaS led sales motion across our customer base. From three individual products to an increasingly integrated portfolio of eight products, with more to come. From selling products, to delivering solutions that address urgent business challenges. From transactional, arms-length customer relationships to being a strategic partner in our customer success. From over-levered to delevered. Comprehensive transformations take time, and the progress is not always perfectly linear. But I'm impressed by the strides our teams have made over the past year across all three fronts, financial, product innovation, and go-to-market. We have been profitable on a non-GAAP basis and positive cash flow for 12 consecutive quarters. For perspective in fiscal 2020, we reported non-GAAP operating losses of nearly $61 million, and negative cash flow from operations of almost $94 million.

Three years later, we're on track to deliver non-GAAP operating profits of about $92 million, and operating cash flow of more than $70 million for fiscal 2024. We said in the first quarter that, we would return $250 million to investors by delevering our balance sheet over the three years from fiscal '24 through fiscal '26. Tomorrow, we will officially redeem the remaining $63 million of our 2024 notes using cash on hand. We have already sent the funds to our transfer agent. Since, we announced the plan at the beginning of the fiscal year, we have returned to debt holders over $88 million, or about 35% of the $250 million plan. We are aggressively delevering on our way to creating a fortress balance sheet. All things being equal, this should drive increased shareholder value as a greater proportion of our enterprise value accrues to our equity holders.

Increasing shareholder value is one cornerstone of our strategy, and it is at the heart of our decisions around compensation, operating expenses, and M&A. For example, we took steps to increase the ratio of cash compensation versus equity compensation, for many of our employees. While employees see less volatility in their income, we will reduce dilution, due to share count issuance over the intermediate term. This is a sharp contrast, to some of our peers, who have increased their stock-based compensation expense, as their stock prices have declined. We are harnessing the power of AI to empower our customers, to deliver better experiences, to their customers. Our unified platform allows us to capture, analyze, and correlate data, from customer interactions across the organization.

But the platform is not the end game. We are closing the loop, breaking down silos in customer engagement, and extending specific contact center tools to everyone in the organization who engages with a customer. Today, we announced a new product line to deliver cross-organization customer engagement, empowering end-to-end CX orchestration for all customer touch points across the entire organization. The beta program is in progress for qualified 8x8 customers. This is perhaps the most significant new innovation, we have introduced in several years, and it is a direct result of the increase in our innovation investment. Through a combination of cutting-edge AI solutions, platform-level contact center components, and both native and third-party data, we will be able to offer built-for-purpose experiences for CX professionals outside the contact center.

This initiative further bridges the gap between UC and CC. And transforms the availability, utilization, and contextualization of customer interaction data, through the entire organization. The resulting customer intelligence, provides powerful and predictive insights to enable smarter decisions and positive customer outcomes, across many different touch points in an organization. We believe we have a clear lead in delivering built-for-purpose experiences for CX professionals, outside the contact center. In addition to expanding our product portfolio with newly targeted experiences for an expanded set of users, we are changing the entire dialogue with prospects and existing customers. It's no longer only about migrating phone service to the cloud, or replacing on-prem PBX.

It's about making easier for all employees, to deliver great customer experiences both inside and outside the formal contact center. As important as this initiative is, it is by no means, the only area we are driving innovation. Let me call your attention to a press release, we issued last week with details on new features and enhancements delivered over the last few months. On the CCaaS side, we have included improved AI-based call summaries for improved speech analytics, expanded omni-channel capabilities, and enhancements to our agent and supervisor workspaces, and more. We continue to enhance our UCaaS solutions with value-added features like smart summaries and analytics that, improve usability, productivity, and efficiency. We also continue to expand our outbound customer engagement capabilities available through our CPaaS solutions, enabling customers to build more effective, customized outbound campaigns.

With just a few new products at general availability, we are already seeing 60% year-over-year growth in revenue from our new products, with quarter-on-quarter acceleration driven by workforce optimization, our intelligent customer assistant, digital and voice, payments compliance solutions, all wrapped in add-on subscription-based services. This is before any benefit from new products spoken about here today, along with several other products in beta. We are delivering intentional innovation that addresses the needs of a well-defined target customer. New customers like Yakima Valley Farm Workers Clinic and the Museum of Science in Boston, have chosen 8x8 for capabilities like a broad feature set, configuration simplicity, ease of use for reporting and analytics, and integration with other workflows.

8x8 customers are also continuing, to embrace our leading communications and contact center solutions for Microsoft Teams, with over 400,000 seats sold to-date. Customers like Walsall Housing Group in the U.K. and Teradata are implementing 8x8 solutions to take advantage of our seamless integration with teams, our global presence, and our unified UCaaS and CCaaS capabilities, including AI-driven digital self-service. To keep our products future-friendly, we are continuing to innovate on teams and expect to have some very exciting news, in the near future. A third area of innovation that I'm really excited about is our CPaaS solutions. Until recently, this part of our business has focused almost exclusively on SMS customers in the Asia-Pacific region, where we remain a leader.

But we believe there is a large and growing opportunity, to attract new customers and expand CPaaS adoption with our installed base of UC and CC, as we add additional services. With an extensive roadmap of new solutions like outbound customer engagement and automated employee notification, we are intentional about engineering solutions for specific use cases and wrapping them in a highly automated, easy-to-transact set of technologies. Like our solution for cross-organization engagement, these new CPaaS solutions allow us to partner strategically with our customers, shifting the narrative from price to value. Okay, I would be remiss if I didn't talk about AI. AI permeates our solutions. It is embedded in our platform, provides transcriptions, analytics, and summaries as shared services, across UC and CC.

It powers our digital interactions, where we achieve deflection rates as high as 80%. It is at the heart of our new cross-organizational engagement initiative, and of course, it is a large part of our highly integrated ecosystem. Our approach to AI integration is two-pronged and is intentionally designed to give customers the flexibility to adapt as the market evolves. First, we allow customers to reap the benefits of AI for common use cases, with native AI-powered features built into the platform. Second, we enable a deep native-like integrations with third-party AI tools built for specific needs, including our curated technology partner ecosystem. Some of the advantages to our approach are, we have the data and the platform. We can focus our engineering teams on analytics, integrations, and universal use cases, such as interaction summarization, which we announced last week.

Our customers can adopt AI in their own timeline, with the flexibility to choose the best and brief solutions for their needs. And we can leverage, the massive investments made by the venture capital community in start-ups focused on AI-based products through our technology ecosystem. Our ecosystem extends across UC, CC, and now the cross-organizational engagement products to allow for highly differentiated solutions, to solve specific customer needs. Similar to our own innovation initiatives, our technology ecosystem aims to transform customer experiences engagement for organizations, of all sizes without requiring complex custom development, or exorbitant overhead costs that have traditionally only been feasible for the largest of enterprises.

We have focused on depth rather than breadth, offering our customers a carefully curated portfolio of integrations with leading technology providers. We recently expanded our technology partner program with a new exclusive tier, SellWith8. SellWith8 allows a select group of strategic technology partners to sell directly with 8x8 to solve customer pain points jointly. For example, Awaken Intelligence, an inaugural SellWith8 partner, offers an integration with the 8x8 contact center that leverages our persistent cross-platform data, to provide real-time agent guidance, and AI-supported assistance. Our foundational partner ecosystem initiative, including SellWith8, is one of the foundational building blocks in our go-to-market transformation. When we began the transformation process, I knew that go-to-market would take the longest and would be the most difficult part of our strategy.

A close-up view of a computer screen filled with data and a single figure pointing to a graph.

Transforming GTM is not about throwing more money into Google AdWords or increasing sales capacity. We are shifting market perception, developing and empowering channeled partners, building pipelines, and increasing accountability with experienced leaders and a relentless focus on customer success. It has taken us the better part of a year, but I believe we now have the right people in the right roles to re-accelerate revenue. In closing, I want to summarize our journey so far and the early signs of our success. Last quarter, I discussed becoming a portfolio of product-company. We are still in the early stages of a lengthy, but exciting transformation. Our innovation-led momentum is also evident in our XCaaS ARR, which is up with double-digit year-over-year gains in Q3.

The average ARR of our enterprise customers, has been steadily increasing as we expanded from three individual products, to an increasingly integrated portfolio of eight. We also see a steady increase in larger deployments with ARR, from customers with more than 250 contact center seats, up more than 50% year-over-year. We have been working towards this vision for a long time. We believe we have the ingredients for success. Our product portfolio is compelling. We have a solid financial foundation. We have a seasoned leadership team committed to achieving our objectives. And we have amazing talent at every level of the organization. I believe the best is yet to come. I want to thank our customers, our partners, our investors, and our employees for their hard work and continued support.

With that, I will turn the call over to Kevin.

Kevin Kraus: Thanks, Sam, and good afternoon, everyone. We remain financially disciplined and delivered strong operating income and cash flow in the fiscal 2024 third quarter, exceeding our guidance range, for non-GAAP operating margin, and exceeding our expectations for cash flow from operations. We have delivered positive non-GAAP operating income and cash flow from operations for 12 consecutive quarters. Total revenue for the quarter was $181 million and service revenue was $175.1 million. Service revenue was approximately flat year-over-year and roughly equal to our guidance midpoint. Other revenue for the quarter was $5.9 million, which was below expectations due to lower one-time professional services and product revenue.

Total ARR was $707 million at quarter end, up 1% year-over-year and flat sequentially. Enterprise ARR increased 2% year-over-year and $2 million sequentially. A significant amount of the total churn occurred within smaller customers, which shows up in the sequential decline in small and mid-market business ARR. We have been devoting additional resources, to retention of the Fuze enterprise customers and expect to see an acceleration in upgrades to 8x8, but we probably have at least one more quarter, before this headwind to ARR growth begins to dissipate. Turning to gross margin, operating expenses and operating profit, please remember that all items discussed are non-GAAP unless otherwise noted. Overall, third quarter gross margin was 71.6%, a decrease of 0.5% year-over-year primarily, due to an increased mix of lower margin SMS usage revenue, compared to Q3, '23, which shows up in our service revenue margin.

Service revenue gross margin was 74.5%, roughly flat sequentially, but down approximately 1.2 percentage points, year-over-year driven by pressure on SMS text gross margin. We continuously manage our cost of service revenue and expect service revenue gross margins to remain healthy in the 74% to 75% range given our mix of subscription and usage revenue. Other revenue gross margin came in at negative 11.9% for the quarter, compared to negative 1.4% in Q3, '23 on lower professional services deployment revenue, which mainly has a fixed cost base. Turning to operating expenses, R&D was 14.9% of revenue, in line with our 15% target and indicative of the continued investment, we are making in product innovation. Sales and marketing expense was 33% of revenue, slightly down from 33.1% in Q2, '24, but well below the 36.3% of revenue in Q3, '23.

On a dollar basis, sales and marketing expense was down more than $7 million year-over-year. The decline reflected, the resource realignment we did in Q4, '23 as the first step in our go-to market transformation. G&A as a percentage of revenue was 10.3%, down slightly sequentially, as we incurred seasonally lower employer taxes, and benefits costs, as more employees hit the maximum contribution levels, for FICA and other benefits. I would like to point out that, we took a nine cash charge, of approximately $11 million on our GAAP financial statements, for ceasing the use of office space, primarily in the U.S. and to a much lesser extent internationally, as we continue to support hybrid workforce. Total non-GAAP spending, as measured by non-GAAP cost of goods sold, R&D, sales and marketing and G&A was down approximately $9.3 million, or nearly 6% year-over-year and reflects our strategic cost realignment actions, since the prior fiscal year.

The combination of a healthy gross margin, carefully managed operating expenses and one-time favorable expense items that increased operating margin approximately one percentage point resulted in non-GAAP operating margin of 13.4%, above the high end of our guidance range of 11% to 12%. Operating profit was $24.3 million up approximately 32% year-over-year. Adjusted EBITDA, which is reconciled to our GAAP results in our press release, was $30.7 million, 16.9% of revenue and up 19% year-over-year. We have generated over $126 million of adjusted EBITDA, over the past four quarters. Cash flow from operations was $22.4 million for the quarter, a new record, driven by strong profitability and solid cash collections. 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 cash flow from operations on a trailing 12-month basis, when evaluating our performance.

Over the last four quarters, we have generated approximately $80 million in cash from operations, an increase of 55%, compared to the trailing 12-month period ending December 31, 2022. We ended the quarter with approximately $170 million of cash, restricted cash, and investment, up over $20 million, from the prior quarter. As we have said earlier, our plan is to return $250 million, to our investors from fiscal 2024, through fiscal 2026, by delevering our balance sheet. Our most recent step in that direction is the $63 million, we paid to the loan administrator earlier this week, who will be paying the 2024 debt holders tomorrow, to redeem the remaining 2024 notes. As you heard from Sam earlier on this call, this latest payment brings us to 35% completion of our $250 million repayment goal from fiscal 2024, through fiscal 2026.

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 voluntary early repayment of principal immediately after the expiration of the prepayment penalty in August, 2024. Before turning to guidance, I want to restate what we are doing 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 contact center solution, to our target small and medium enterprise customers. Third, we are reducing the mix of equity-based employee compensation, which will moderate the pace of new share issuances due to employee stock programs over the long-term.

And fourth, we are retooling our go-to-market organization under new leadership to focus on revenue growth, while maintaining solid non-GAAP profitability and cash flow. Increasing cash flow from operations, while reducing shareholder dilution over time remains our financial North Star. And our goal remains to generate cash from operations at a compound growth rate of approximately 20% for fiscal years 2024 through 2026. I would like to point out that the significant growth in cash from operations, we expect in fiscal 2024, implies more muted growth rates through fiscal 2026 to arrive at the 20% compounded growth rate goal. We are very focused on delivering cash flow, with reduced dilution over the long-term, as the best way to build shareholder value over time.

Let me walk you through, how our strategies to build shareholder value over time drive our operating 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 SME customers and cross-selling into our installed base. I believe this cost envelope, can accommodate the aforementioned go-to-market retooling, as well as programs that drive product awareness, and investments required, to develop our value-added reseller channel in North America. We expect R&D as a percent 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 expenses to remain in the range of 10.5% to 11% of revenue for fiscal 2024.

We believe, we can achieve leverage from our G&A functions over time as revenue increases and we achieve greater efficiencies through automation. Regarding non-GAAP gross margin, we anticipate Q4, '24 to be in the same range as Q2 and Q3, with the full year in the 72% range. Please note that this metric can be influenced by product mix. Over the past quarter, we have seen longer sales cycles on large deals, greater scrutiny by the customer regarding contract approval, and a generally tougher economic environment. With this context in mind and the operating expense framework described above, we establish outlook ranges for the fourth quarter and the full year of fiscal 2024 ending March 31, 2024 as follows. For the fiscal fourth quarter, we anticipate service revenue, to be in the range of $171 million to $175 million.

We anticipate total revenue, to be in the range of $176 million to $181 million, implying other revenue of $5.5 million at the guidance midpoint. Note that other revenue can vary, based upon customer-specific deployment schedules, and hardware shipments. So there could be some movement in the Q4, '24, other revenue as a result of these dynamics. We are targeting an operating margin of approximately 10%. As a reminder, our spending increases in calendar Q1, which is our fiscal fourth quarter, as social security taxes and other employee benefits, such as the 401(k) match, restart in January. We expect cash flow from operations to decline sequentially as our cash expenses increase seasonally, in fiscal Q4, as I just mentioned. Plus we expect to make other planned operating cash payments, such as higher debt interest and indirect taxes.

We anticipate interest expense of approximately $9 million and cash interest payments of approximately $11 million. Cash interest payments in Q4, will include the semi-annual payments on our 2024 and 2028 convertible notes, as well as quarterly interest payments on the variable rate term loan. We are currently anticipating that the rate on the term loan, remains approximately 12%, or so for plus 6.6%. We estimate a fully diluted share count of approximately 126 million shares for fiscal fourth quarter. Given the fourth quarter guidance ranges above, fiscal 2024 ending March 31, 2024 is expected to be as follows. We anticipate service revenue to be in the range of $699 million to $703 million. We anticipate total revenue to be in the range of $725.3 million to $730.3 million.

We continue to focus on delivering a solid operating margin and anticipate achieving, between 12.5% and 13% for the year, versus the 8.4% achieved in fiscal 2023. We expect cash flow from operations to exceed $70 million as Sam stated in his remarks. Again, note that cash flow from operations is impacted by 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. 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, while maintaining our targeted investments and innovation, plus our go-to market retooling is the correct strategy for us at this time.

This strategy will enable a return to revenue growth while we also return value to our investors, initially by reducing our debt. Our goal is to show improving revenue trends in fiscal 2025. I would like to thank the entire 8x8 team for working together to deliver this quarter's solid results. Operator, we are ready for questions.

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