8×8, Inc. (NYSE:EGHT) Q3 2023 Earnings Call Transcript

8×8, Inc. (NYSE:EGHT) Q3 2023 Earnings Call Transcript February 1, 2023

Operator: Good afternoon. Thank you for attending the 8×8 Fiscal Third Quarter Earnings Call. My name is Matt, and I’ll be your moderator for today’s call. All lines have been muted during presentation portion of the call and opportunity for question and answer session at the end I would now like to pass the conference over to our host, Kate Patterson, Vice President of Investor Relations. Kate, please go ahead.

Kate Patterson: Thank you, operator. Good afternoon, everyone. Today’s agenda will include a review of our third quarter results with Samuel Wilson, our Interim Chief Executive Officer, and Kevin Kraus, our Interim 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 our increased focus on profitability and cash flow as well as our business, product and growth strategy. 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 the U.S. generally accepted accounting principles or GAAP. A reconciliation of those non-GAAP measures to the closest comparable GAAP measures is provided in our earnings press release and earnings presentation slides, which are available on 8×8 Investor Relations website at investors.8×8.com. With that, I’ll turn the call over to Samuel Wilson.

Samuel Wilson: Thank you, Kate, and thank you to everyone joining us on the call today. I believe our solid third quarter results were a strong indicator of our ability to perform against our objectives. We said we would forgo some near-term revenue growth for profitability as we build a sustainable long-term business and that’s exactly what our teams did in the quarter. Despite the lower-than-expected total revenue, we delivered almost 10% operating income, increased deferred revenue and RPO, and experienced high customer retention, all early indicators of future success for a SaaS business. I’m impressed with the quality of our performance in the third quarter, and I want to thank our employees and everyone in the 8×8 community for their hard work.

Turning to the future. I have been working closely with the leadership team and the Board of Directors on a multiyear strategy to grow our business and create value for our stakeholders. We laid the foundation for our next step several years ago when we re-architectured our core technology. We built a modern microservices-based platform that powers both our current UCaaS and CCaaS solutions. We have fully embraced continuous integration and continuous deployment and are delivering more than 1,000 micro service updates every quarter. This enabled near perfect uptime for the third quarter and reduced the number of customer identified defects to single digits. We are innovating faster than we ever have before. At the same time, we embarked on this journey we could not have predicted the global COVID pandemic or how it would accelerate adoption of cloud-based telephony and internal collaboration tools, especially Microsoft Teams.

While UCaaS migration continues to create revenue and profit opportunities for efficient providers like 8×8, I believe the opportunities to differentiate based on stand-alone UCaaS are becoming increasingly rare. Our XCaaS platform, which delivers the high availability, scalability and security of a unified cloud native solution and a lower TCO is highly differentiated. By focusing on CCaaS innovation within the platform, we can continue to extend our leadership. Specifically, I believe the contact center market is at an inflection. According to PwC’s Future Customer Experience survey, 1 in 3 customers would leave a brand they love after 1 poor experience. No longer can the contact center be viewed solely through a cost lens. It has become the primary way for companies to interact with their customers and build brand loyalty.

At the same time, advances in ML-AI technologies as well as customers’ growing preference for high-quality digital and self-service interactions set the stage for a new wave of contact center migrations and upgrades. Technologies like large language models such as ChatGPT have the potential to transform the customer experience. Our modern platform enables these technologies today and I believe we are well positioned as this opportunity evolves. We have identified 6 areas I believe are critical to our future success. One, further acceleration in CCaaS innovation while maintaining our leadership position in cloud telephony. We began our shift to an innovation-led company with the acquisition of Fuze, which doubled the R&D resources dedicated to innovation.

We have successfully accelerated the pace of project completion and are already seeing the results of our increased investment. We are already in beta on a number of new CCaaS features, including capabilities based on advanced machine learning and large language models. We remain committed to our leadership position in cloud telephony as an important component of the XCaaS platform. Our ability to deliver both voice and CCaaS solutions for Microsoft Teams users is increasingly a deciding factor in new business wins around the world. We saw triple-digit growth in voice for Teams seats in the third quarter and have now sold more than 300,000 licenses. The largest team’s customer has already deployed the technology to more than 30 countries. Global coverage matters.

Recent XCaaS with Teams wins include the Australian Computer Society selected 8×8 XCaaS with voice for Teams to help drive operational efficiencies, productivity gains and enhance their contact center performance. This channel-led win demonstrates the competitive differentiation of our XCaaS solution within the Teams environment. In the U.K., Gateshead Metropolitan Borough selected 8×8 XCaaS with voice for Teams to support hybrid work for their nearly 3,000 employees and enhance their 200-plus agent contact center. Two, increasing our focus on small and midsized enterprise customers. Small and midsized enterprise customers need the same automation and ML-AI contact center capabilities as large enterprises, but don’t have the large enterprise budgets or a team of in-house developers.

Our mix and match pricing model, unified communications and enterprise class APIs, make XCaaS the natural choice for these customers. Just as important, our modern platform enables the adoption of advanced contact center capabilities, future-proofing their investments. The strong product market fit improves customer satisfaction, often leading to follow-on sales and reference sales down the line. A great example of a win directly tied to a happy existing customer is Chubb Group Security Limited, a global fire safety and security solutions provider protecting more than 1 million locations worldwide. After acquiring a division from an existing 8×8 CCaaS customer, Chubb reviewed and selected 8×8 CCaaS for a complete secure cloud contact center solution.

Another example of a customer satisfaction driving new business is Indiana Hemophilia and Thrombosis Center, the only federally recognized comprehensive Hemophilia treatment center in Indiana and 1 of the largest centers in the nation. With a key decision-maker having previous experience with 8×8, the nonprofit entity selected 8×8 XCaaS for its comprehensive CCaaS solution that is certified for Microsoft Teams. Our best-in-class reliability was also a factor in the decision. Three, increasing XCaaS win rates and sales and marketing productivity. As we continue to innovate and expand our XCaaS platform, our win rates should increase. We are attracting more go-to-market and technology partners every day, especially around our market-leading Teams integration.

This expands our market reach, increases our capacity for innovation and creates an ecosystem of application and features that allow our customers to tailor their customer experience to their business needs. A customer that fits squarely in our sweet spot is Panine Care NHS Foundation Trust in the U.K., a provider of mental health, learning disability and autism services to 1.3 million people across Greater Manchester and beyond. They selected 8×8 XCaaS to upgrade to modern reliable cloud communications and deliver enhanced patient engagement capabilities for over 3,000 staff. Another U.K. win, the South Hampton Football Club in the English Premier League is a good example of how unified XCaaS platform delivers contact center features to users across the organization to enhance the customer experience.

The Sanks selected 8×8 XCaaS with 8×8 Front Desk to deliver a premier fan in hospitality experience and introduce new communications channels such as e-mail and web chat because they are customer obsessed. Four, maintaining an outstanding experience for customers so they can focus on theirs. The investments we’ve made in customer success, including more than 8,500 hours of training for our Tier 1 support engineers are evident in our statistics and customer success scores. We’ve seen a 50% reduction in escalated issues, a 20% improvement in First Day resolutions and a 49% reduction in global backlog. As a result, our customer satisfaction scores are up double digits versus a year ago. We still have a lot of work to do, but are passionate about leveraging our platform and the solutions of our technology partners to drive continuous improvement in customer experience and customer satisfaction.

We use our own products and intend to document our progress as an early adopter of each new innovation in an ongoing case study. In this way, we remain accountable to our commitment for improving the experiences of our customers and we provide a road map for our customers to do the same in their organizations. Five, establish CPaaS leadership in the Asia Pacific region. CPaaS was down year-over-year and sequentially again this quarter. It was the single largest factor in our third quarter revenue miss and downward revision to our revenue guidance for the fiscal year. That said, the CPaaS technology is important to the XCaaS platform, and we continue to add new customers on a regular basis. We are going through a transition in the business and there are some signs of stability.

This gives me confidence that CPaaS will make a positive contribution to our operating performance in the future. Several third quarter wins illustrate this point. Plugo, an Indonesian D2C e-commerce platform with a vision to democracize e-commerce, uses a combination of 8×8, SMS, APIs and WhatsApp through 8×8 Chat Apps API to send secure onetime passwords and notifications as well as for customer care. Privy, Indonesia’s first and leading legally binding digital signature with more than 37 million users and 1,800 enterprise customers, uses 8×8 SMS API to keep all users secure with onetime passwords. Plusdane Housing, a U.K. housing association that owns and manages over 13,000 homes across Northwest of England. They selected 8×8 XCaaS with 8×8 CPaaS, voice for Teams and Verint workforce management to support their over 500 employees and drive customer satisfaction with greater omnichannel capabilities.

We love our triple play customers. Sixth, increase our profitability and cash flow to delever our balance sheet and fund investments in innovation that will drive our future growth. We have already shown tremendous progress in fiscal 2023, and we have come very close to our second half ’24 target of double-digit non-GAAP operating margin this quarter, a full year ahead of schedule. As Kevin will discuss, we believe we can drive our margins higher again in fiscal ’24 as we align our investments and cost structure and improve our sales productivity. We intend to leverage improvements in our operating margin to pay down debt, which will reduce our interest payments and allow more enterprise value to accrue to our equity holders. We began this process in Q2 when we repurchased $6 million in aggregate principal value of our ’24 notes, and we continued in the third quarter with the repurchase of approximately $22 million in principal.

What I have outlined here is a long-term strategy based on an efficient, focused innovation engine and a modern cloud dative platform. At the heart of this strategy is delivering superior customer experiences. The experiences of our customers and partners as they engage with us and the experiences they can deliver to their customers and their employees with our XCaaS platform. This is our North Star. Every customer interaction is an opportunity to delight. And our goal is to make every touch matter, whether digital or in person. This commitment to our customers’ experience is already built into our DNA. Our financially backed commitment to Five 9’s availability is just 1 example. We are already well on our way on our multiyear plan to lead with innovation and be the customer success platform of choice for our customers.

The best measurement of our continued progress is the willingness of our customers to recommend our solutions to their peers. Our goal is to achieve 100% referenceability within our targeted customer segment. It is a lofty goal, but 1 I believe will allow us to deliver sustained growth and profitability for many years to come. I will turn the call over to CFO, Kevin Kraus, for a more detailed review of our financial performance.

Kevin Kraus: Thanks, Sam, and good afternoon to everyone. We remained financially disciplined and delivered solid profit and cash results for the third fiscal quarter. In the third quarter, despite service and total revenue being slightly below our guidance ranges, we delivered non-GAAP gross margin, non-GAAP operating profit and cash from operations above our expectations. Total revenue for the quarter was $184.4 million, and we generated $175.8 million in service revenue, both an increase of 18% year-over-year. Our revenue performance reflected strong customer retention and renewals, partially offset by a continued decline in our CPaaS business in the Asia-Pacific region. Other revenue for the quarter was $8.6 million, roughly flat with the prior quarter and in line with expectations.

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Fuze accounted for $26.5 million of service revenue and total revenue and was impacted by a $1 million third quarter reserve adjustment we made as part of our integration of back-office processes. Fuze’ customer retention remains strong and the business continues to outperform our initial expectations. Strong retention across the customer base was reflected in our RPO and ARR metrics. Remaining performance obligation was approximately $750 million for the quarter, up from $715 million in the second quarter on solid bookings performance. Customer renewals were notably strong and our customer retention was the highest it has been in many quarters. Total ARR was $698 million at quarter end, up 22% year-over-year. Enterprise customers accounted for 57% of total ARR, and Enterprise ARR was up 30% year-over-year, but down approximately $1 million sequentially due to the continued decline in CPaaS ARR.

We had hoped this part of the business had stabilized last quarter, but due to continued challenges, we are taking a conservative view of the potential revenue contribution going forward. Turning to gross margin. Operating expenses and operating profit. Please remember that all items discussed are non-GAAP unless otherwise noted. Service revenue gross margin came in at 75.7%, an increase of approximately 600 basis points from Q3 ’22 and 160 basis points sequentially, driven by continued COGS improvement programs, which drove down unit costs and, to a lesser extent, lower CPaaS revenue. Other revenue gross margin came in at negative 1.4% for the quarter compared with negative 32.2% in Q3 ’22. Other revenue gross margin has shown consistent improvement over the past few quarters due to increased professional services operational efficiencies plus better product margins.

Overall, second quarter gross margin was 72.1%, an increase of over 700 basis points year-over-year and up 200 basis points sequentially. Turning to operating expenses. R&D was 14.5% of revenue, which was in range of our 15% target. We improved sales and marketing leverage as we realigned costs early in the quarter with sales and marketing expenses down $3.3 million sequentially, and sales and marketing as a percentage of revenue declining over 100 basis points sequentially. We expect further improvements in sales and marketing efficiency as a result of our most recent cost alignment action in January, which further reduced our investment in sales and marketing initiatives in nonstrategic areas of the business. This will be partially offset by the seasonal increase in employee-related costs in the first calendar quarter.

G&A declined $3 million sequentially, improved 140 basis points as a percentage of revenue to 11.4%. Total non-GAAP spending as measured by cost of goods sold plus R&D, plus sales and marketing plus G&A, was up approximately 8% year-over-year, primarily due to the addition of Fuze’ operations, but it was well below our 18% total revenue growth. Non-GAAP operating profit was $18.3 million, up nearly 6x from fiscal Q3 ’22 and more than double sequentially. As Sam mentioned in his opening remarks, we achieved approximately 10% operating margin in Q3, nearly a full year ahead of previous expectations. As you can see, we are committed to improved operational efficiency and delivering enhanced operating profit. Turning to the balance sheet. Total cash, cash equivalents and restricted cash ended the third quarter at approximately $132 million, substantially equal to last quarter despite consuming $20 million in cash for debt repurchases.

As Sam mentioned in his prepared remarks, during the quarter, we made notable progress delevering our balance sheet by repurchasing approximately $22 million in aggregate principal amount of 2024 convertible senior notes, after repurchasing $6 million in Q2 ’23. These debt repurchases and the exchange transaction from August 3, leave approximately $68 million of aggregate principal value of 2024 convertible senior notes remaining. Given our current cash balance and expected future positive cash flow, we see no issues with repaying the 2024 debt with cash at maturity in February 2024. Going forward, we expect cash flow will increase with operating leverage subject to timing differences in collections and other payables. We intend to use the excess cash generated to opportunistically prepay debt, including our term loan.

This will lower our interest payments and will enable continued investment in product innovation while simultaneously shifting more of our enterprise value to our equity holders. Cash from operations was over $15 million for the quarter, ahead of our expectations and approximately $2 million higher than Q2 despite paying approximately $3 million more in interest expense in the third quarter. We continue to actively manage cash flow and customer collections remained solid in Q3. Free cash flow was over $12 million for the quarter, a greater than $1 million sequential increase. Our CapEx costs have been declining over time as we have focused on capital efficiency. As previously stated, we took action in January to realign our workforce to accelerate innovation as we continue to shift to enterprise and XCaaS.

And this included the difficult decision to further reduce our total headcount. When completed, the action will impact approximately 7% of our employee population. This action will be factored into our non-GAAP guidance, and we expect some onetime severance and restructuring costs will impact our fourth quarter cash flow and GAAP results. Before turning to guidance, let me provide some context based on our commitment to building a sustainable growth business with SaaS-like operating metrics. We have been doing a top-to-bottom strategic review of our business to ensure that all areas are operating efficiently. The strategic cost realignment activities from last October and in January allow us to reallocate limited resources to the areas of focus for the future, while improving our operating metrics in the near term.

We are raising our exit operating margin target for the fiscal year based on improving efficiency and discipline around the business we are pursuing. For operating expenses, we plan to control sales and marketing spend and would like to exit fiscal year 2023 between 33% and 35% of revenue, down from 39% 4 quarters ago. We plan to focus our R&D efforts on our core product offerings and 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 with an emphasis on contact center features and functions. We are focused on extracting more leverage from our G&A functions as we work to improve operating efficiencies in those areas. We are establishing guidance for fourth quarter of fiscal 2023 ending March 31, 2023, as follows.

We anticipate service revenue to be in the range of $175 million to $178 million, up sequentially from Q3 at the midpoint and representing approximately 1% to 3% year-over-year growth as we pass the Fuze 1-year anniversary and remain cautious on the CPaaS revenue outlook. We expect that Fuze’ service revenue contribution will be roughly flat with Q3 at approximately $26 million. Please note that next quarter will be the last time we provide Fuze revenue contribution as we will have passed the 1-year anniversary and the businesses are now integrated. We anticipate total revenue to be in the range of $184 million to $187 million, up sequentially at the midpoint and representing approximately 1% to 3% year-over-year growth. This guidance reflects the 1-year anniversary of Fuze and our cautious approach to the CPaaS revenue outlook.

We expect other revenue to be approximately flat compared to Q3. We are targeting an operating margin of approximately 10%, roughly flat with fiscal Q3 ’23, as we experience our normal expense headwinds related to the restart of employer taxes and other benefits, such as the 401(k) match. These expense headwinds impact all cost lines in the consolidated statement of operations. We expect cash flow from operations to be positive, but down quarter-over-quarter as we make semiannual interest payments on our 2024 and 2028 convertible debt and absorb severance costs from our January headcount reductions. We are updating our guidance for fiscal 2023 ending March 31, 2023, as follows. We anticipate service revenue to be in the range of $708.5 million to $711.5 million, representing approximately 18% year-over-year growth at the midpoint.

We continue to be cautious regarding our CPaaS business and with the Fuze 1-year anniversary past us, we expect to exit fiscal 2023 with service revenue growth in the low single digits on a year-over-year basis. We anticipate total revenue to be in the range of $743.4 million to $746.4 million, representing approximately 17% year-over-year growth at the midpoint. Our total revenue guidance for the fiscal year reflects the combined Q3 and Q4 impact, resulting in a reduction of approximately $5 million at the guidance midpoint. We continue to focus on improving operating margin over time and anticipate landing at approximately 7.5% for fiscal 2023. We also would like to provide some directional color on fiscal 2024, which commences April 1, 2023.

We anticipate total revenue and service revenue growth in the low single digits, as the revenue step-up from the Fuze acquisition will be reflected in every quarter of fiscal 2023. Additionally, we remain cautious regarding the revenue trend for the CPaaS business. We anticipate non-GAAP operating margins steadily growing from the expected Q4 ’23 base of approximately 10%, hitting double digits every quarter in fiscal 2024. For the full year, we expect operating margin to be 4 to 5 percentage points higher than full year fiscal 2023. We anticipate cash flow from operations to be directionally aligned with the non-GAAP operating profit trend. Additionally, I would like to mention that we are reviewing our key metrics to ensure that we are providing the appropriate insight into our revenue growth drivers.

We will follow up in subsequent earnings calls on this matter. In closing, I believe the continued focus on our operating margin and cash flow is the correct strategy for us at this time. This strategy enables us to remain an innovation-led company as we fund investments in key product areas. On a personal note, I also would like to say that I’m happy to be continuing my business partnership with Sam in my new role as interim CFO. With 8×8’s modern, unified XCaaS platform, we are well positioned to deploy our strategy to capture more of the contact center market, to delight our customers and to deliver on our commitment to improve profitability and cash flow generation. Operator, we are ready for questions.

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Q&A Session

Operator: First question is from the line of Matt VanVliet with BTIG. Your line is now open.

Matt VanVliet: I guess as you look at sort of the realigned cost structure here and an outlined kind of focus around servicing smaller customers and also the Teams ecosystem. Just curious on sort of where within the sales and go-to-market organization are we seeing the most cuts? And it sort of feels like some of these investments are in areas that were maybe less focal for the previous leadership team. So just curious on how much of this is a change versus just kind of moving from 1 pocket to another.

Samuel Wilson: I’m going to give you 1 of those great answers that CEOs like to give, which is a little bit of both. I mean — so we are in line with what we’ve said in the past, we continue to moderate our investment in our smaller customer segment, so the small business side of the house, while we continue to invest in mid-market and enterprise. We have made some — reduced some investments in the sales and marketing front, in line with what we have again said in the past, where we’re willing to forgo some revenue growth for increased profitability and the 9.9% operating margins clearly shows that we’re taking that seriously. I think the things, Matt, that we changed a little bit is we’re a little bit more aggressive on not making those changes sooner than later, and we’re continuing to focus on investing in contact center, XCaaS and innovation, those 3 things.

And I think we’re a little bit more aggressive behind those investments also. So a bit of both, if I can give you that answer.

Matt VanVliet: And then, I guess, as you look at the Fuze business that you acquired and we’re understandably we’re lapping that and create some headwinds on growth. But curious, as you look at that customer base, is that — should we think about that growing at any different pace than the legacy 8×8? Is there limitations on sort of how much you can grow in that base and as much of the acquisition is around the technology and the development team, I guess maybe just help us think about what that Fuze base looks like? And eventually, is there still plans to move them to XCaaS?

Samuel Wilson: So in order — the first and most important thing, and we have not done a great job of this yet, is cross-selling our contact center into that UC base. So there’s a tremendous opportunity, and that wouldn’t show up necessarily in the Fuze numbers if we continue to report those. We’re not going to report after next quarter, but if you can imagine the wind the each open the side of the house. And we’ve already started upgrading some of the customers to the 8×8 platform, and we’ll continue to do that. That’s part of the reason Kevin said in his prepared remarks, that as we anniversary it just gets kind of meaningless to report these. And remember, we’re not adding — we’re not investing a new logo acquisition on the Fuze side of the house.

We’re investing on the 8×8 side of the house. So in a notional sense, the Fuze number we report is the Fuze UC base. And with natural sort of things, we’d expect that to slowly degrade a little bit over time. And as the numbers show, it’s been a very slow over the last year. It was well — it’s done much better kudos to the GCC team. It’s done much better than we expected when we originally did the acquisition. And so I would expect that to continue. The number one area of focus besides retaining the revenue is cross-selling our contact center into it.

Operator: The next question is from the line of Meta Marshall with Morgan Stanley. Your line is now open.

Meta Marshall: Maybe as you look to fiscal ’24 and just kind of the low single-digit outlook that you gave. You guys mentioned a lot of conservatism around CPaaS or conservatism just on Fuze term. But just if you could give kind of an update as far as like what you’re seeing as far as deal activity, trajectory, just given kind of the macro environment. And then maybe as a follow-up question on the CPaaS business. I guess, just like what is the ongoing rationale particularly just given it’s in a region that you guys don’t do a tremendous amount of business in, like what is the business rationale continuing to kind of invest in that business when you’re making kind of cost decisions elsewhere?

Kevin Kraus: This is Kevin. So in terms of the 2024 growth of low single digits, we are being conservative with respect to the CPaaS business, as we said. We do see signs of stabilization in that business. But since it’s usage-based, it’s a pretty dynamic market. We’re just going to continue our conservatism into the forward-looking forecast on that, until we see absolute signs of change. In terms of the rationale for the investments in that business, that business can really turn revenue up pretty quickly. So we’re very interested in that business. It could provide a lot of growth on — in pretty short order, more so than our typical recurring revenue business does. So that’s 1 of the areas where we’re looking at potentially ramping up our growth.

Samuel Wilson: Yes. So a couple of small things I’d add is, so you talk about economic sensitivity, probably some things like CPaaS, which isn’t contracted revenue, we’re seeing a little bit more of that economic sensitivity. I think on the core business, where it’s really interesting is our collections were absolutely fantastic. So as Kevin talked about, our cash and cash balance was sort of in excess of what we expected for the quarter. Our collections portfolio is the best it’s been in a long time. And that’s also a clear sign in our retention metrics. So if you look, our retention metrics were highest in many quarters, months, I forget out exactly what Kevin said, but in 1 of those — so the quality of our portfolio from an economic perspective is absolutely fantastic.

And you did see RPO trended up, right? So the contracted revenue had a pretty good quarter relative to some of the other things. So I think from an economic front, I’m not super stressed right now about the economic health of our — both on the recurring side and the ability to add new logos. And then lastly, just on the conservative nature of the model, look, it’s my first quarter. I’m definitely not going to stick my neck far out with a super aggressive model. We’ve got a ton of new innovation that’s going into beta, which we basically have 0 in the model for. We’re trying to be really conservative on the CCaaS side of the — sorry, CPaaS side of the house also. So cut me a bit of slack. I’m conservative on the first quarter out.

Operator: The next question is from the line of Siti Panigrahi with Mizuho. Your line is open now.

Siti Panigrahi: Sam, it’s good to see focus on profitability side. Just wanted to ask on the revenue side. Your service revenue, I say organic services revenue growth was flat, excluding Fuze. So you did talk about CCaaS, but what do you see in terms of macro trend, anything on the enterprise side? Is it definitely disoriented. What are you seeing in the market right now?

Samuel Wilson: I — it’s a fair question, and yes, your math is correct. It’s just — it’s a little hard for me to tell. We took an action in the beginning of October, and we took another action in January. So both of those had consequences. And as we said earlier, we’re walking away from low margin or negative margin revenue for improved profitability. We think the improved profitability allows us to delever our balance sheet, just makes the company better off and allows us to reallocate investments in the better ROIC areas. So I think absolutely, economics played a relatively small role in the revenue performance, it was really self-generated. And the other thing I would say is I think that reallocation of investment is working, deferred revenue’s up quarter-on-quarter, deferred commission’s up quarter-on-quarter, RPO’s up quarter-on-quarter and retention at the highest levels we’ve seen in a long time.

So in terms of the underlying indicators of a healthy SaaS business, they all got better last quarter. And so I sort of believe that the right play right now is to sacrifice a little bit of revenue growth to make all those things substantially better.

Siti Panigrahi: And then in the CPaaS business, I know you talked about weakness in the CPaaS business the last few quarters. So wondering what’s the current run rate of CPaaS right now?

Samuel Wilson: We don’t disclose that. As Kevin mentioned in his script, it’s 1 of the things that we’re looking at disclosing potentially in future quarters, so we kind of put the breadcrumbs out there, but it’s under review.

Operator: The next question is from the line of Catharine Trebnick with Roth Capital Partners. Your line is now open.

Catharine Trebnick: Sam, when you talked about your bullet point #5, Asia Pac and CPaaS revenue has been down. What other assets are you looking to build that up with, so you can really drive that as a key growth driver?

Samuel Wilson: It’s a completely fair question. So I think in the past, we missed a bit of a product cycle in CPaaS in Asia. And you could — like I can get into more details in — at another time, but just we missed the product cycle, and we sort of caught up on that. We’re investing in the platform in the business. Our unit volumes have continued to increase. And we’re continuing to land brand name customers, as I mentioned in the prepared remarks. And so I think the business funnel is there, et cetera. We just need to close the gap on a few product features. And there’s some other news that’s coming in the near future on that front also in the CPaaS business. And so I think that the stars are starting to align for us to turn that business around. It is taking longer than we had expected, and I grant that to everyone, but I think the stars are therefore, to turn around and do better.

Catharine Trebnick: Well, then, you also then layer on your CCaaS business in like the Australian market, it seems like that would be a right market for you.

Samuel Wilson: I know I don’t want to pooh, pooh, the Australian market. It just happens to be that Australia is like the 58th largest population country in the world and the State of California is the sixth. I’m not sure if I wouldn’t rather invest in California than in Australia. Right now, we’re investing pretty aggressively in the U.S., U.K., California — I’m sorry, Canada, Ireland, because those are just great contact center markets right now for us.

Operator: The next question is from the line of George Sutton with Craig-Hallum. Your line is now open.

George Sutton: Sam, you talked about the importance of your customer recommendations to their peers, as being a driver of your business. Can you talk about that in a little more detail? Is that something you’ve actually seen? And is that — is there something you can quantify there?

Samuel Wilson: Kate may know the quantification numbers off the top of her head, but 1 of the things that we’ve been very focused on over the last few quarters has been improving our reference ability. So we really were talking about NPS, so there’s notion of referenceability and we saw a pretty substantial increase in our referenceability. This all goes sort of full circle, right? So in my prepared remarks, I talked about our investment in customer success. Kevin talked about the very high retention rates we’re having. That in turn leads to happy customers, happy customers give good references, which then, in turn, drives RPO improvements and deferred revenue improvements and those kinds of things, right? So we’re trying to get that virtuous cycle, maybe spinning a little faster than it has in the past.

George Sutton: Just as a follow-up. You mentioned customer churn is something you’re comfortable with. I’m curious if you can talk about seat churn. And of course, as we’re starting to see some layoffs around the market. Is that starting to have an impact in the results?

Samuel Wilson: I’ll let Kevin follow up if you want to add anything. Look, so when we talk about retention, we talk about logo plus seats, right? So if a customer down sells from 100 seats to 90 seats, where a customer goes from 10 seats to 0, we count that the same. And last quarter, we had the highest retention in many years. And so I don’t think it’s that much — I think what’s interesting is we’re launching a lot of really important things, Conversational IQ, some of the things we have in beta, et cetera. So even if we’re seeing a little bit of ARPU decrease from the core product, just the number of seats, we are seeing an uptick in the number of add-ons going into our contact center.

Kevin Kraus: Yes. I think — so on the customer retention, we need to go back over more than 3 years to get — I just can’t find any numbers for more than 3 years that are better than the ones that we just put up this quarter. I will also say that we’re making the right investments in global customer care and delighting our customers. So it’s really starting to pay dividends for us, and we’re keeping the right high-value customers. And looking forward, although we don’t give guidance on this, we do look out. We’re very, very proactive about what customers are renewing, what’s coming up, and we address any risks that way. We’re doing a really good job of that right now. So I think that’s reflected in our recent trend.

Operator: The next question is from the line of Will Power with Baird. Your line is now open.

Will Power: Yes, I guess I had a question on the revenue guidance, both for fiscal Q4 and in ’24, thanks for the initial framework there. And I guess I recognize that CPaaS is going to be a headwind. You’ve talked about that. Is there any way to kind of help us parse apart what you’re seeing in kind of XCaaS and CCaaS, which I know is the strategic priority versus UCaaS? I mean are there demonstrably different growth rates there? Any color you could provide on that front?

Samuel Wilson: Yes. I mean, I’ll start, and I’ll let Kevin fill in. So a couple of things, right? So XCaaS is now almost 40% of our ARR and has growth rates well in excess of what we’re seeing across the whole business, right? So the whole business is flat and our growth rate in XCaaS is high 20s. And so definitely a situation where we’ve got a lot of moving pieces under the table. CPaaS, you mentioned small business, UCaaS. It had an okay quarter this quarter. It was kind of flattish on a year-over-year basis, right, up 4%, those kinds of things. But not blowout numbers. And so we are still under the covers. I think all of this is starting to show up in a complete soup though, right? XCaaS, our contact center doing better. That’s driving higher growth rates in enterprise. And small business is starting to become a smaller and smaller component of the overall ARR mix. And so as all that flushes out over time, we should naturally see a lift in growth rates.

Will Power: Let me ask you 2 then maybe this ties into that. I mean you noted RPO was — had a nice sequential increase. And what’s helping drive that? I mean is that XCaaS adoption? What are kind of the key pieces of that?

Samuel Wilson: Yes. no, I mean, I’d love to make it — well, I’d love to make it super sophisticated and cool, but — we had a good quarter for XCaaS sales, right? The combination of UC, CC and a world-class Microsoft Teams integration, I mean we mentioned right? Microsoft Teams triple-digit growth year-over-year. That’s pulling in our contact center. Our contact center then has higher dollar ARPUs attached to it and good margins associated with it. So if we can just keep in princing and repeating that, the numbers will continue to get better.

Kevin Kraus: Yes. We also — I mean, in addition to the strong new logo bookings, we had a great renewal quarter as well, which is indicative of the investments we’re making in delighting the customers.

Samuel Wilson: Thank you for calling that out, Kevin.

Kevin Kraus: So that’s reflected in our RPO. Our deferred revenue is also up quarter-over-quarter as well.

Samuel Wilson: Yes. And XCaaS has a net dollar retention well in excess of 100, right? So like the more that XCaaS becomes a bigger part of the business, the more the math starts to work itself out.

Will Power: And I’m sorry, maybe just a quick clarification. On the — for fiscal ’24 on the operating margin guidance, I think you said 400 to 500 basis points. Was that above the full year fiscal ’23? Or is that above the exit rate of ’23?

Kevin Kraus: Yes, we took about 7.5% we’ll have for the full year and then just add 400 to 500 basis points on top of that for the full year, but we do expect a steady improvement on the strength of the balance sheet.

Operator: The next question is from the line of Peter Levine with Evercore ISI. Your line is now open.

Peter Levine: When we think about foregoing, I think, near-term growth of profitability, managing the business for more cash. I think your comments on having, a, become more of an innovation by company, but it does sound like the offsets that will be sales and marketing. So is the idea to rely more on partners for net new? Or is the strategy to kind of focus back on the base? Just what initiatives are in play, I think, today to deliver, I think, greater sales and marketing efficiencies, if you’re going to be pulling back a little bit on the sales for?

Samuel Wilson: Yes. So we are a partner-led company. And so we’re putting — I think the key is — and there’s a timing aspect to this, and I know that everybody sort of gets that. But if we invest today in innovation, it takes a little while for that before that to show up in pipeline. And so what we have done is we’ve really worked on improving the sales and marketing efficiency at the company, while we incubate a solid innovation road map, particularly around contact center. And so once that innovation road map starts to get into the market and whatever, we should be more of a customer pull model instead of a sales or partner push model, and that’s much more efficient over time. And so there is a timing aspect to this. We’ll deal with some quarters of relatively low growth rates as we make this transition to XCaaS being a larger part, to innovation to new products driving more of the business.

But that’s really what we’re focusing on to improve that efficiency number instead of some of the things we’ve done in the past.

Peter Levine: I apologize if I missed it, but can you quantify, I think, the CPaaS headwind this quarter? If I look at organic growth year-over-year, I’m just trying to understand how much of that was attributable to the CPaaS headwind versus kind of macro just impacting customer purchasing decisions?

Samuel Wilson: We don’t break out CPaaS separately. We don’t want to run a foul of the segment reporting rules of the SEC and some of the other rules that are out there. I would just tell you that it was the — the difference between our guidance and what we actually produce, the vast majority of that was the CPaaS business, if that helps you quantify it.

Operator: The next question is from the line of Ryan Koontz with Needham. Your line is now open.

Ryan Koontz: Sam, I want as you look at the kind of the broader UC space and obviously slowing growth across the board. Are you seeing signs yet of consolidation that could improve the health of the industry?

Samuel Wilson: Well, we consolidated Fuze and the Street didn’t like that deal. So I’m not sure anybody is going to be consolidating anything too soon. Fuze for us has been a big success. I wouldn’t — I would do it all over again. But so far, no. I don’t see a whole lot in the consolidation space.

Ryan Koontz: And in terms of the Fuze installed base, no update there in terms of customer migration or how we should expect any kind of impact on the model going forward at this point?

Samuel Wilson: We’re accelerating my upgrades as I say, migration we selling upgrades. And we’ve got automated tools and the work we’ve done on the engineering front to make that just a really easy seamless transition, is starting to come into market. So we would expect that, that — those upgrades to start to accelerate over the next couple of quarters. And if any Fuze customers are listening, we’re not going to force you to migrate. We’re not going to force it upgrade. We’re going to do it when you’re ready.

Operator: The next question is from the line of Ryan MacWilliams with Barclays. Your line is now open.

Ryan MacWilliams: Sam, also nice to see the improvement quarter-over-quarter in non-GAAP gross profit. It seems like you’re certainly targeting the right revenue. For the 2024 target for low single-digit top line growth and look, I’ll cut you some slack on this one, but on a quarterly basis, should we think about any differences in the year-over-year revenue growth rates for the first half of the year versus the second half? Like at this point, are you thinking stronger year-over-year growth later in the year?

Samuel Wilson: Yes. I mean we haven’t baked really any of the new products in, but because of the comps and some of the other things, the growth rates will naturally lift as the year goes on. Thank you for calling it out, right. Last quarter, 31% year-over-year growth in gross profits. And we would expect that next year gross profit growth is in excess of revenue growth. We continue to get solid gross margin improvements. But yes, more back half of the year. Kevin, anything you want to add?

Kevin Kraus: And provided what happens with CPaaS, we’re going to be taking a look at that and doing what we can to help ramp that above our conservative estimation.

Ryan MacWilliams: Yes. Good to hear that for sure. We also noticed that your disclosure for Microsoft Teams licenses went from a few hundred thousand last quarter to over $300,000 in this quarter. Do you have a sense of what percentage of 8×8’s net new business comes with the Microsoft Teams integration? And then separately, the strength around renewals, but did you notice any additional price headwinds, perhaps from competition around those renewals in the quarter?

Samuel Wilson: So I’ll get back to you on the first 1, because we give away the integration for Microsoft Teams for effectively free. So it has no real consequence on the UCaaS number. Just before everybody freaks out, it’s not I’m giving seats away for free. They stop to buy an X1 or X2 or X3, X4 seat to go with it. The integration is free. So it’s easy for me to get the seat number, but I have to go do some math to say what percentage of new logo dollars that was. Microsoft Teams is an important aspect. And obviously, if we’re talking about organic growth at 0 and Microsoft Teams growing at triple digits, it’s becoming a larger share of our new logo wins. And I think it is pulling through contact center and some of the other things.

Ryan MacWilliams: Sure. And just around the renewals in the quarter. Did you notice any like additional competition around price renewals? Or was it pretty similar?

Samuel Wilson: Yes. If I speak really candidly, it’s the fiscal fourth quarter, December for a number of our competitors, and I swear at the end of the year and at the end of their fiscal year, they have absolutely no pricing discipline at all. So did we see mud thrown in several directions, sure. I suspect that while they’re busy, they’re SKOs now and posting on LinkedIn, they’ll forget to do that this quarter.

Operator: The next question is from the line of Michael Turrin with Wells Fargo. Your line is now open.

Austin Williams: This is Austin Williams on for Michael Turrin. I wanted to go back to margins. I’m wondering if there’s any way to quantify how much of the margin improvement that you’ve seen thus far are from taking costs out of Fuze and how that compares to just the core business efficiencies?

Samuel Wilson: So we have really gotten a lot of great margin out of the core business as well as Fuze. So it’s really on both sides. And the Fuze gross margins comparable with the 8×8 organic gross margins. And we’ve done the same kind of work on, say, COGS that we did with the Fuze base. So it’s kind of been done in tandem. So I would say that there’s a fairly equal distribution of margin improvement from both entities, if you will.

Austin Williams: Just 1 follow-up. RPO was up nicely on a sequential basis. I’m just wondering if there’s anything to call out as it relates to deal duration, if there are any longer-term deals in there?

Samuel Wilson: Yes. We saw a slight change, but the vast majority of it was just more contracts. It’s roughly the same. It’s roughly the same.

Operator: The next question is from the line of Michael Funk with Bank of America. Your line is now open.

Michael Funk: Yes. A couple if I could. So earlier, you mentioned hoping to see attach rate of CCaaS increase over time. So just wondering more details on what’s going to make that happen? Is that just a sales training and processes, better partner training? Is it technical integration? So what’s the gating factor there?

Samuel Wilson: I believe that — okay, so I believe as we — as the innovation we’re investing in, particularly on the contact center of the side of the house, comes into market, our contact center is going to start to pull through more and more. And given the fact that we have things like Conversational IQ, which gives a distinct advantage to moving your base on to UC from the same vendor on the same platform. So as our contact center gets better, it gets us involved in more deals that, in turn, makes the prospects look at the fact that we have Five9 SLA, a single platform, high availability, high reliability, tremendous feature set and all those other things, just makes it a lay up to buy it all together in 1 package. And I think that’s why we’re seeing XCaaS resonate with the market, right, 40% of ARR, higher retention rates, higher net dollar retention numbers, all those things.

And the more we invest on the contact center side the more, I think that flywheel spins faster and faster, because contact center is where there’s a tremendous amount of white space in terms of innovation room today.

Michael Funk: Understood. And then also, I think the comment was made about addressing risk about expirations and that being helpful with the retention rate. Is that related to some of the competitive pricing pressure you were seeing in the market? And then how are you addressing those risks? Is that through discounting, incremental product additions? How are you addressing that with customers?

Kevin Kraus: I think that was my comment about how we’re looking forward. So yes — so what we’re trying to do is we’re trying — first of all, we have a pretty good — we’ve operationalized fairly well an understanding of the customer renewals and when they’re coming up and well in advance of their renewal, just make sure that the customer is using the product, it’s working as promised, making sure that they’re delighted in the performance of the product and so forth. And that’s where the investment came in — the investment comment comes in that I mentioned about making sure that the customers are happy. So by doing so, we don’t necessarily have to go discount on renewal. It could happen, but basically, we just want to make sure that we get ahead of it.

Samuel Wilson: Yes. And I would sort of piggyback on what Kevin said, right? Switching costs are not low in this industry with line nonreporting and everything else. We are training agents or doing it as other things, right? So really, like once we land to customers, there are ours to lose. And the GCC organization here has just done an exceptional job of removing the bottlenecks to renewal, number one. And then the engineering organization has done an exceptional job with just very high reliability. I mean we have Five9 platform SLA, and most of our competitors don’t because they can’t meet those kinds of numbers.

Operator: The next question is from the line of Josh Nichols with B. Riley. Your line is now open.

Josh Nichols: Good to see the improving operating margin guidance as the company continues to make progress on the deleveraging front here. Just — most of my questions have been answered, but I guess I’d say, if you could kind of compare and contrast what you’re seeing in the U.S. versus other markets such as the U.K. that’d be interesting given the economic weakness that we’re seeing and that foreign markets have been a lot faster growing from you of late. Just curious what that looks like today.

Samuel Wilson: Kevin, you should chime in. I think the biggest difference I see is our XCaaS messaging resonates in our Microsoft Teams messaging resonates really strongly in the U.K. market and the foreign market is a little bit better. In the U.S., there’s still a little bit of the Microsoft channel and the telecom channel being 2 separate channels. And so the — our channel team has done a tremendous yeoman’s work, building our Microsoft Teams channel, and that’s paying dividends. And so I think it’s just — I see economics less. It’s just 2 different structured markets, in particular. And it’s easier for us to gain that sweet traction in our foreign markets.

Josh Nichols: And then last question for me. I guess it sounds like the CPaaS business has been a little bit of a headwind. I know that’s a lower-margin offering, but likely stabilizing over the next couple of quarters here. One, I guess, like will the companies focus on deleveraging, like one, would you consider that like a core business or potentially not as you look at opportunities to kind of accelerate this deleveraging process? And are there any also like repayment restrictions that you have on your debt aside from the remaining notes that are due in ’24?

Samuel Wilson: I’ll let Kevin take the second one. Look, the CPaaS business is a great business. It’s got beautiful unit economics when it’s running right. Step 1 is to get it running right, and then we can talk about strategic options for it. But Josh, as you know me, I’m a seller from strength, not from weakness.

Kevin Kraus: Yes. On the debt question, we have February 1, 2024 is when the remaining 2024 converts are due.

Samuel Wilson: I think he’s asking, though, on the — on the term notes, we can pay back 10%.

Kevin Kraus: Starting in August. Yes, that’s what we have. And then there is a prepayment penalty for the succeeding year, small prepayment penalty. And then after that, there’s none.

Operator: There are no additional questions waiting at this time, so I will pass the conference back to Samuel Wilson, CEO, for any closing remarks.

Samuel Wilson: All right. Thank you, Matt. Thank you for your continued support. I hope we have conveyed some of the excitement about our opportunity and our future path tempered by the recognition that success will require commitment and hard work. I am confident we can do this. We are a vibrant and financially strong organization, and we are accelerating the pace of innovation. With a steady stream of new products coming this calendar year, including ML-AI based features and tailored experiences, we are well positioned for the future. Thank you so much, and I look forward to reporting our progress next quarter.

Operator: That concludes the conference call. Thank you for your participation.