EGHT - NASDAQ

Hello, and welcome to today's 8x8, Inc. Fiscal Second Quarter 2023 Earnings Call. My name is Bailey, and I'll be your moderator for today's call. . I would now like to pass the conference over to Kate Patterson. Please go ahead when you're ready.

Thank you, operator. Good afternoon, everyone. Today's agenda will include a review of our second quarter results with Dave Sipes, Chief Executive Officer; and Sam Wilson, 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 our increased focus on profitability and cash flow as well as our business, products 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 report 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 those non-GAAP measures to the closest comparable GAAP measures is provided in the 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 our CEO, Dave Sipes.

Thank you, Kate. Good afternoon, everyone, and thank you for joining us today. On the call today, I will review our second quarter results and provide an update on our plan for fiscal year 2023 as we place greater emphasis on profitability and cash flow generation. We believe that this is the right strategy to deliver value to our stakeholders, customers, employees and shareholders, and it is reflected in our increased operating margin guidance range for the year. We delivered another solid quarter, delivering revenue in line with our guidance and non-GAAP profits and operating cash flow above expectations. Our continued emphasis on operational efficiency as well as a favorable mix of higher margin ex cap revenue resulted in higher gross profit. Second quarter non-GAAP gross margin was above 70% and service gross margin was above 74%. Both were up nearly 5 points in the last year. We have demonstrated sequential improvements in our gross margin performance for both service and total revenue in every quarter since Q3 2021. And non-GAAP gross profit on a dollar basis increased 35% year-over-year. The Fuze acquisition continues to outperform our expectations and was accretive to operating margin this quarter. We also strengthened our already solid financial foundation by refinancing over 80% of our convertible notes due in 2024 in a transaction that increases our flexibility to delever the company as our cash flows increase. We remain committed to our strategy of empowering every employee through integrated contact center and unified communications in the cloud delivering outstanding customer experiences at a lower overall total cost of ownership. We reinforced this commitment by increasing our investments in innovation and repurchasing 10.7 million shares of our common stock. The quality of our ARR remains high, with enterprise ARR growing more than 40% year-over-year and accounting for 58% of total ARR. XCaaS ARR continues to grow at approximately 40% year-over-year and increased as a percentage of total ARR as customers add contact center functionality to their 8x8 deployments. XCaaS accounts for more than 35% of our ARR, and we see an opportunity to grow this percentage materially as we continue to innovate on the XCaaS platform with features designed for our targeted enterprise customer base. Progress in our strategic enterprise XCaaS business was partially offset by continued challenges in our CPaaS business. We believe this business has been impacted by a combination of currency fluctuations and macroeconomic headwinds. We are focused on stabilizing this business and continue to add new customers with innovative use cases like SES Home Services, SES provides professional and reliable home emergency support using 8x8's video interaction solution to enable agents to provide remote support, reducing operational time and costs. On the plus side, small business ARR grew modestly on a sequential basis. The stabilization in small business ARR this quarter reflected good retention and upsell in our commercial sectors in both the U.S. and U.K., driven by our efforts to improve efficiency and focus on customer satisfaction. On our last call, we increased our operating margin guidance for the current fiscal year to 2% to 3%, and said we had line of sight to doubling operating margin in fiscal year '24. We are once again increasing our operating margin guidance for the current year. We now expect to deliver non-GAAP operating margins above 5% this year. We believe we can achieve these targets through increased efficiency in our cost structure, particularly sales and marketing and have taken steps to rationalize some of our spend across the company. As Sam will discuss in greater detail, we expect these steps, combined with an increased mix of higher margin XCaaS business will allow us to exit this year at or above 6.5% operating margin. Further, we have demonstrated our ability to expand margins and now believe we have line of sight to achieve double-digit operating margin in fiscal year '24. Our unified XCaaS platform remains a competitive advantage for us, and this advantage is only amplified in a more cautious spending environment. Recent research from Metrigy showed that organizations deploying a unified solution to achieve a 56% lower total cost of ownership versus a multi-vendor strategy. Casey's, the third largest convenience store chain in the United States with more than 2,400 locations in 16 states is an example of a customer migrating to the cloud to reduce total cost of ownership. The company is moving all stores to the cloud with 5,000 8x8 UCaaS seats to replace costly traditional phone lines. We continue to deliver advanced features that allow our customers to improve their employees and customers' experiences. We recently released an update to the 8x8 XCaaS platform that extended our global coverage to 56 countries and enhanced our omnichannel customer experience analytics, featuring new visual interaction flow diagrams, enhanced reporting into digital interactions and new advanced search and filter capabilities. Our XCaaS platform continues to be broadly deployed across a range of industry verticals and geographic regions. Recent customer wins included Medline, a leading health care manufacturer, distributor and solutions provider with over 30,000 employees worldwide with businesses in more than 125 countries and territories. Medline is moving to the cloud with 8x8 initially to support over 2,500 employees on an easy-to-administer global unified platform. Factom Vision Partners is a leading management services organization, serving ophthalmology practices and ambulatory surgery centers throughout the Mid-Atlantic and New England regions. Spectrum selected 8x8 XCaaS to support employee and customer engagement for its contact center and clinics. Prepay power, Ireland's first dedicated prepaid energy supplier of pay-as-you-go energy with over 250,000 customers working with partner Work Air, they chose 8x8 XCaaS to support employees and a 300 agent contact center that will enable them to scale, gain business insights and serve their fast-growing customer base. The availability of contact center like functionality such as conversation IQ is driving expanded deployments with UCaaS customers. An example is LSH Auto U.K. They have 8 Mercedes-Benz, AMG, EQ and smart dealerships across the Midlands and Northwest, LSH U.K. turned to 8x8 XCaaS for a single UCaaS and CCaaS solution to support the employee and customer experience across their dealerships. This past quarter, LSH added 8x8 conversational IQ to 20% of their UC users to drive improvements in the sales team's interactions with customers. Our global reach and rich feature set continue to be important competitive differentiators with customers adopting teams as their collaboration platform. In Q2, we added a new 8x8 phone app for Microsoft Teams, providing customers with additional options for enabling cost-effective PSTN calling within teams. We continue to build momentum in our 8x8 voice routine solution. Customers choosing a voice for teams in Q2 included a worldwide holiday tour operator recently acquired an existing 8x8 customer in the U.S. The company evaluated 8x8 XCaaS and decided to transition its entire global organization to XCaaS with voice for Microsoft Teams to manage communications and customer engagement from a single platform. Delek, a downstream energy company with assets and petroleum, refining, logistics, asphalt, renewable fuels and convenience store retailing. They turned to 8x8 UCaaS with voice for Microsoft Teams to strengthen security, compliance and support global communications for more than 2,500 users. Miller's Ale House is a sports-themed casual dining restaurant with almost 100 locations in 10 states. Following a proof-of-concept trial, a fast-growing change shows 8x8 UCaaS with voice for Microsoft Teams to deploy at their Florida headquarters and all restaurants to enhance the overall customer and employee experience. We continue to expand our relationship with Microsoft Modern Work Solutions partners through our 8x8 Elevate Partner program. This quarter, we added 3 new partners, including Cloud Revolution, a Microsoft 2022 Partner of the Year finalist. Cyclotron, a 2020 U.S. top Microsoft 365 team's partner award winner and Apex digital solutions, also an advanced Microsoft partner specialized and Microsoft teams calling to our program. We continue to invest in channel with our co-marketing training and lead sharing initiatives. Cross-sell of CCaaS to existing UCaaS customers is an important aspect of our growth strategy as we expand our enterprise customer base, including Teams users. As one of the first partners to achieve Microsoft certification for integrated contact center, we are in the early days of land and expand cross-sell into our enterprise customer base. In a recent example, University of Bristol in the U.K. expanded its 8x8 XCaaS with voice for Microsoft Teams deployment by adding 25% more CCaaS seats following the successful delivery of Phase 1 of the project. We believe the next wave of cloud migration is contact center. This was reinforced at last week's Gartner symposium, where our booth was crowded with prospects asking about our contact center solution. We are investing more than 2/3 of our R&D and contact center. XCaaS innovations like Front Desk, Agent Workspace and Conversation IQ differentiate our solution and increase our ability to win with enterprise customers. It is clear that product innovation is a core value for us, and we are maintaining our investments to deliver a greater customer experience even as we focus on higher margins. I remain confident in the path 8x8 is on, and I look forward to giving you an update on our next call. Before handing the call over to Sam, I want to thank our teammates at 8x8 for their hard work and commitment. I also want to welcome Janet Winters, our new Chief Human Resource Officer. Sam?

Thanks, Dave, and good afternoon. We remained a financially agile and disciplined organization that delivered solid results for the second fiscal quarter. We did experience continued challenges in our CPaaS business and foreign currency headwinds were strong both of which impacted service revenue performance. We are going to make some adjustments and guidance based mainly on foreign exchange. In spite of these challenges, revenue was in our guidance range, and we continue to post broad improvements in gross margin, delivered solid operating income and another quarter of positive cash from operations. Total revenue for the quarter was $187.4 million, an increase of 24% year-over-year and inside of our $185 million to $188 million guidance. We generated $178.6 million in service revenue, an increase of 25% year-over-year, and again in line with our $177 million to $180 million guidance range. The CPaaS business did not bounce back as hoped with a sequential decline for the third quarter in a row, but we are seeing signs of stabilization. The endpoint supply chain improved and this helped other revenue. The strengthening dollar, especially versus the pound sterling negatively impacted total revenue by about $1 million for the quarter. Fuze accounted for $27.9 million of service revenue and $28.4 million of total revenue. Service revenue from Fuze was in line with expectations and retention remains solid. Fuze continues to do better than we had modeled when we closed the deal 10 months ago. Fuze was accretive to non-GAAP operating income again this quarter and contributed to overperformance relative to operating margin expectations. We committed to remaining non-GAAP profitable post acquisition and so far so good. As an example, we have raised Fuze's non-GAAP gross margin percentage from the high 50s to the mid-70s. Total ARR was $692 million at quarter's end, up 25% year-over-year. As we stated in our prior earnings calls, we will not be breaking out Fuze from 8x8 separately for ARR reporting but will continue to give you visibility into Fuze contribution to reported revenue. Enterprise customers accounted for 58% of total ARR, and enterprise ARR was up 42% year-over-year. Mid-market was 18% of ARR and grew 23% year-over-year, and small business was flattish sequentially at 24% of ARR and declined 2% year-over-year. Growing our enterprise business is one of the core tenets of our long-term strategy due to the customers' longer commitments, higher retention and better efficiency ratios. Turning to expenses. Remember that all expense items discussed are non-GAAP unless otherwise noted. Service revenue gross margin came in at 74.1%, an increase of 470 basis points from Q2 '22 and 70 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 minus 11.2% for the quarter compared with negative 35.2% in the first quarter of '23 and negative 16.6% in the year ago quarter. Overall, second quarter gross margin was 70.1%, up nearly 600 basis points year-over-year and up 150 basis points sequentially. Turning to first quarter operating expenses. This is our third combined quarter with Fuze. R&D stepped up to 15% of revenue where we want it. We showed some leverage on sales and marketing and took a step back in G&A. The increased cost in G&A were mainly driven by several nonrecurring items that should improve over the next several quarters. Total non-GAAP spending, as measured by COGS plus R&D, plus sales and marketing plus G&A, was up approximately 19% year-over-year, below our 24% total revenue growth. In early October, we made the very tough decision to reduce our total headcount. While it impacted less than 10% of our total employees we have factored the applicable employee-related cost savings into our non-GAAP guidance, and we expect some onetime severance and restructuring costs in our third quarter cash flow and GAAP results. Non-GAAP operating profit was $9.1 million, up from a year ago, but down approximately $1 million on a sequential basis. As a reminder, the first quarter operating income of $10.1 million included approximately $3 million in onetime benefits. Turning to the balance sheet. Total cash, cash equivalents and restricted cash ended the second quarter at approximately $132 million, compared with approximately $143 million last quarter and $146 million for a year ago ended March 31, 2022. Restricted cash was down to $1.3 million so we will just report a single number in future quarters. With this cash balance and future expected cash flow, we see no current issues with repaying the 2024 debt. During the quarter, we made significant progress adjusting our balance sheet and at the same time, took steps to reduce our share count. As a quick summary, we did the following in August. We entered into a term loan credit agreement with Francisco Partners as lenders for $250 million in aggregate principal amount maturing in August 2027. This is a floating rate loan based on secured overnight financing rate or SOFR. In conjunction with the term loan, we issued warrants to Francisco Partners to purchase an aggregate 3.1 million shares with a 5-year term at an exercise price of $7.15. We exchanged approximately $404 million in aggregate principal amount of old 2024 notes for $202 million aggregate principal amount of new 4% convertible senior notes due in 2028, along with $182 million in cash. After giving effect to the exchange, the total amount of old notes outstanding on August 11, 2022, was $96 million. On September 28, we repurchased another $6 million of par value 2024 notes at 88.5% for $5.3 million in cash, bringing the balance down to $90 million at quarter's end. In conjunction with the exchange, we purchased 10.7 million shares for approximately $60 million of our common stock at a price per share of $5.61. RPO was approximately $715 million for the quarter, up from $700 million in the first quarter. Cash from operations came in at approximately $13 million for the quarter, ahead of our expectations. We continue to actively manage cash flow and watch it closely and collections remain solid. Free cash flow was over $10 million for the quarter, our CapEx costs have steadily declined as we focused on capital efficiency. Last quarter, we were clear that we were prioritizing profits and cash flow over growth. We adjusted the financial model accordingly with a decrease in revenue, but an increase in operating margin. This quarter, we're going to raise our exit operating margin target for the fiscal year based on cost savings, but it slightly lower our revenue. The change in revenue for next quarter and the remainder of the fiscal year is primarily due to changes in foreign exchange. We generate about 1/3 of our revenue internationally. So the strong dollar hurts our headline revenue numbers. From a bottling standpoint, we take the closing months weighted value and run it through the financial model and in September, the dollar rallied a lot. We have a number of natural hedges in place, so that on the operating line, FX has little impact. I cannot stress this enough. While our revenue may change because of FX. Our operating income and cash flow is a little impacted. We built it that way. For operating expenses, we plan to control sales and marketing spend and would like to exit fiscal '23 between 36% and 38% of revenue, down from 41% 4 quarters ago. We plan to focus our R&D efforts on our core product offerings and expect R&D as a percentage of revenue to remain about 15%. Innovation is key for any software company. And for us, with a multibillion-dollar market opportunity, even more so. We believe continued investment in our customer-focused product strategy with emphasis on contact center functionality, these investments will be good ROI. We are focused post Fuze on getting leverage on the G&A line over the next few quarters as we further integrate the 2 organizations. This set of initiatives will drive operating wages higher in the second half of '23. As Dave mentioned, we think we can add more operating margin in fiscal '24 through continued improvements in unit economics, incremental savings in G&A, cost containment and improved sales efficiency. We are establishing the following guidance for third quarter fiscal '23 ended December 31, 2022. We anticipate service revenue to be in a range of $178 million to $180 million, essentially flat with the second quarter. This is representing approximately 19% to 21% year-over-year growth. We expect Fuze service revenue contribution will be between $27 million and $28 million. We anticipate total revenue to be in a range of $185 million to $188 million, representing approximately 18% to 20% year-over-year growth. We expect other revenue to be flat to down slightly compared to Q2 due to less billable days associated with the holidays. We are targeting an operating margin in a range of 5% to 5.8% for the quarter. We should get a sequential increase on a non-GAAP basis from second quarter's 4.8%. We are updating our guidance for fiscal 2023 ending March 31, 2023, as follows: We anticipate service revenue to be in a range of $712 million to $720 million, representing approximately 18% to 20% year-over-year growth; we have reduced second half '23 revenue performance by approximately $7 million due to foreign exchange based on the method stated above. The remainder of the decrease is some incremental caution in the CPaaS business. If FX stays at these rates, we would expect to exit fiscal 2023 with service revenue growth in the mid-single digits on a year-over-year basis. We anticipate total revenue to be in the range of $745 million to $755 million, representing approximately 17% to 18% year-over-year growth. We are focused on improving operating margin over time and have a goal of exiting fiscal '23 over 6.5% for the fourth quarter and roughly or so 5.5% for the fiscal year. In closing, we believe the increased focus on the operating margin and cash flow is the correct strategy for us right now. At the same time, we believe we need to continue to fund our investment in R&D and our contact center product continues to evolve. We address a broad market opportunity and the focused product strategy that leverages our unique advantages of a unified platform, global connectivity and leading teams integration. As we extend these advantages and deliver superior ROI to our customers, we reinforce our strong financial foundation and remain an agile organization. And with that, operator, we are ready for questions.

. The first question today comes from the line of Mike Latimore from Northland Capital Markets.

Great. Yes, I guess just 2 things here. It sounds like the slight change in revenue guidance is tied to FX mainly and then CPaaS secondly. I guess, can you talk a little bit about just what you're seeing in the international kind of geography? Are bookings tracking as expected there? And then second, just in terms of the sales cycle overall in the business, have you seen any -- I mean are sales cycles basically the same as you were expecting 3 months ago?

All right. I'll take the first part, and I'll let Dave take the second part. So in terms of international business performance, I would say, yes, it's generally where we expect in constant currency. It's actually -- so for example, if you look at our business, it would have been up on a constant currency, ARR would have been better on a constant currency basis. As I tried to highlight in the script, basically, we particularly the strong dollar in the month of September really had an influence on our revenue performance, but now really influence our op income performance. So international is performing well. We love it. We love our international businesses. just the revenue number doesn't quite look so good because of the FX effects. And to be clear, I mean, if you look at our change in guidance, almost all of it is due to FX on a go-forward basis. The CPaaS business is stabilizing. We kind of have that in the model. It's really -- we just run the last month on a forward basis. And since September was such a strong dollar month, it just has a tendency to suppress revenues in the back half of the year. And then, Dave, you want to cover sales cycles?

Yes. On sale cycles, we are seeing a little more justification requirement from our buyers getting through additional approvals, but we're countering that with our cost of doing nothing analysis, which really demonstrates how our prospects can save money by switching off of on-prem into cloud, and every day they fail to do that costs money. And so that's our -- we really lay into our TCO advantages and getting through those self-cycle additional approvals.

The next question today comes from the line of Matt VanVliet from BTIG.

I guess, first, as you look towards the channel and how that's been a driving force in your growth here. Curious on sort of two-pronged here. How is that business shaping up, selling XCaaS, selling kind of the full platform of solutions here? And how much is that driving a lot of the contact center growth you've seen? And then secondarily, on the Microsoft team side, how do you feel like you're kind of growing there, what the offering is and how the ELEVATE program is really driving attention from your channel partners there?

Yes. So channel is obviously an important element of our go-to-market strategy. It's over half our new business. And our partners have really moved strongly behind our XCaaS motion and do well in selling the combination contact center UC. On the Teams side, Teams is an important aspect of what we're doing. When I look across our largest new logo wins, about half of Teams attached. And we're getting good traction there on the channel with our team-specific ELEVATE program. We talked about the 3, we added this quarter in Cloud Revolution, Cyclotron and Apex. We're also arming those -- that channel and our sellers with more quivers or more arrows in the quiver, so to speak, with our XT SKU, which really gives operator connect type pricing with direct routing type capabilities. So superior capabilities at a great price and the Microsoft phone app, which give slightly more cost-effective solution for different types of users with a different user experience, so we have that. We have our direct routing solutions. We have our XT SKUs and it's allowing us to stay competitive in that market. It's obviously driving a lot of business for us and allows are ultimate of connecting contact center users to Teams users in an organization. So it really enables the XCaaS, so.

All right. Great. And then, Sam, obviously, never fund reduced headcount. But curious kind of in the wake of that, how you're assessing sort of making sure that those cuts were sort of onetime and deep enough. And then as you're looking forward, projecting out into next year and beyond. What are areas that you expect you'll continue to add headcount versus sort of holding the line to improve that margin as much as you have already?

All right. I'll take those in reverse order. So look, I mean, the place where we bought Fuze to get more R&D capacity. We're very focused on R&D capacity. And we want to continue and as we mentioned in the closing remarks, over 2/3 of our R&D is spent on the contact center. So we're really putting -- I don't know what analogy you want to use, but a lot of effort, arrows, if we're going to use the Arrow 1 around investing in contact center and really focused on that. And so that's an area. Things like sales capacity, those can fluctuate a little bit more. And I mentioned earlier that we're an agile finance organization. So in terms of headcount, I think we're sort of rightsized for what we think is going to happen in the near term and then we'll have to continue to adjust over time. Hopefully, it's add more employees, but we can adjust either way based on what the market conditions are.

The next question today comes from the line of Ryan MacWilliams from Barclays.

So as we think about what a more difficult macro environment could mean for 8x8, are you seeing reductions in headcount within your existing customer base at this point? And I know you're less focused on SMB, but would you expect to see continued small business momentum as those deals may be easier to close in a period where the lower total cost of ownership of 8x8 can resonate?

So I think the first part is in the macroeconomic environment. Are we seeing fewer employees with our customer base? You see that occasionally on renewal. Now remember, we have very well contracted customers being enterprise software 1 to 3 years. So a lot of that will come post this economic cycle anyway. And we do things when we do renewal, allowing people to extend contracts and adjust appropriately if they're impacted economically. Additionally, we try to shoot funnel some of those users into our cross-sell products with contact center, conversation IQ and other ways to enhance their current productivity. And then the second part of your question, Ryan?

Small business.

Small business. Small business stabilized this quarter. We had an uptick in ARR. We continue to -- strategically, we focus on mid-market and enterprise customers as they are -- have stronger contact center needs. But we continue to service both inbound interest in small business and continue to service our installed base with great reliability and great customer support. So I think you're seeing that, and it's a good sign that, that stabilized even in the current macroeconomic environment.

Yes, absolutely. I also like seeing the new 8x8 phone app for Microsoft Teams. Maybe one for Sam. As we see more business keep going through this Microsoft Teams channel, are there any differences to call out on profitability of the 8x8 team sale versus attritional 8x8 voice?

All right. I want to be careful and I answer this because it's obviously a lot of market discussion around this topic. So with -- in terms of the way you phrased the question with profitability, we see the margins as being pretty comparable. But historically, what we've seen is a lower type of SKU, a lower functionality SKU being purchased. So in a Microsoft Teams environment, we sell a lot more X1s and X2s than we do in a traditional 8x8 only type of customer, we would sell X1, X2s, 3s and 4s. And that's kind of the big difference we see.

Any difference in deal sizes? Sorry, I just don't follow up. Like could there be a larger deal size attached to those teams deployments?

I mean some of them are really big, so they can be just because we sell a lot of seats. And remember, we're selling a lot of contact center when we sell Microsoft Teams. So that's kind of the blend thing that blends in and makes us enthusiastic about the Microsoft Teams market. So I would say it's not radically different. It could be higher.

The next question today comes from the line of Siti Panigrahi from Mizuho.

Just wanted to ask about this enterprise segment. What sort of trends are you seeing? I see a downtick on ARR? And what sort of visibility you have into the second half of your fiscal year, given this macro environment?

Well, I mean, look, I'll take part of this, and I'll let Dave if he wants to add anything. So first off, I mean, one of the influences to ARR, the downtick was FX. So if it wasn't for FX, our ARR would have been even stronger quarter-on-quarter, our enterprise would have been up quarter-on-quarter. So -- and remember, I mean, that's just because FX was a big headwind on those numbers in the month of September. In terms of visibility in the back half of the year, I mean, I wouldn't say it's substantially different than what we've had in the past. We have a deal pipeline, we have deals sitting in various sales stages, and we use that to drive what we think our business performance is going to be. So in terms of visibility, I think there may be some question if close rates will change substantially, which so far, we're not seeing any indication of that. But in terms of visibility, I'd say it's kind of the way it's always been.

Okay. And then you talked about contact center opportunity. Any trends that you're seeing? And how do you differentiate in that contact center market?

Yes. So the contact center is -- continues just to be a core piece of what we do in our XCaaS ARR. You see that growing almost 40% and over 35% of our business. It continues to accrete. And when I look across our large deal wins, it's a significant contributor across all of those. I think we've had some great progression in the product over the last couple of years and reliability, our agent experience and the analytics. We just announced on just an example on the analytics. It's always been one of our hallmarks, best-in-class voice analytics. And now we've thrown a UX refresh and additional digital journey analytics. We brought that digital analytics up to that same world-class level. And we continue to work -- we're doing 2/3 of our R&D in contact centers. So there's going to be some great announcements in supervisor and admin experiences coming up in the coming quarters, as well as some of our digital offerings. So I'm -- we're winning a lot already today and the road map is looking -- I'm happy with what we've done to date, but I'm super excited about what I see coming in the works on contact center.

That's great color. And one quick follow-up, if I may. You talked about the weakness in the CPaaS. Is it mostly slowdown in overall volume or any loss of customer? What are you seeing on the CPaaS side?

It's a little bit of both. We have seen a slowdown. So carriers have been raising prices. And that's made some of the maybe marginal traffic, less interesting to send. And so we've seen some reduction in the amount of traffic. And a customer too is switched to doing other methods for things like OTP and that sort of stuff. Right now, we're seeing the business stabilize, and our focus is getting the growth to rebound back to where it was.

The next question today comes from the line of Michael Turrin from Wells Fargo Securities.

Maybe just on Fuze integration there. I think there's been some commentary just around converting that base over to the XCaaS platform over time. Is that something that you're still working towards and is progressing? I'm curious if that all drives some of the gross margin improvements as well. Or just any further update you can provide on just the combination of those 2 bases.

Yes. I'll take the first half and Sam will take the second half. But we continue to build the coding to make that upgrade onto the XCaaS platform seamless and easy for those customers, and I'm happy to say we anticipate launching that in the first -- very first part of the new year, and that's on track. And so we'll have our first set of customers experiencing that seamless upgrade around that talent our fiscal year Q4 time frame.

All right. I'll take gross margins. So I think I said this on the last call, and if I didn't, I'll say it here, we've been able to get Fuze gross margins up towards our UCaaS business faster than expected. And so a couple of things are going on here. Number one is we got Fuze up into the mid-70s now. And so we're blending our total UCaaS business as a percentage of the overall business, UCaaS, CCaaS business. But our communications business relative to the CPaaS business is higher, and that's driving overall corporate margins up we have more plans in place to grow gross margins. So I think they were over -- they were 70.1% this quarter. Over 70%. We'd like to keep them above 70% on a go-forward basis, very focused on that. And then in general, the addition of Fuze gave us more buying power at core 8x8, so we have translated some of that into lower costs from our carrier partners. I think sometimes the Street forgets that we buy probably, I don't know, close to $100 million of carrier interconnect. So the more volume I can get, the better per unit pricing I get and that shows up in gross margins.

Okay. That's interesting. I guess just on the margin in general, there's clearly a lot of focus there. What are some of the things you're finding that allow you to keep moving the targets up into next fiscal year? And are you feeling good about the continuation of those trends as needed just based on what you're finding there so far sound?

Well, I'll take those reverse. I think Dave in his script said that we have line of sight to double our op margins next year. So he's already put a stake in the ground for me to go achieve. And yes, we have line of sight into how to do that. And then I think it's -- I'd love to tell you, Michael, it's a single thing, but it's just a lot of blocking and tackling around efficiency. We are very focused right now on being more efficient. I think the offset that you see is a little bit on the revenue growth side, right? So we've reduced our spending a little bit in sales and marketing. Some of the more inefficient places we were spending in that area, which may have led to revenue growth, but not necessarily highly efficient revenue growth and be more focused on generating operating margin, EBITDA, cash flow, those types of metrics. Particularly now that we made our first interest payment on our debt in the September quarter, and we have future interest payments on a go-forward basis. So we want to make sure we cover those with tons of room to clear and tons of room to delever the balance sheet over time. And so I think the offset that you're looking for in terms of we have line of sight to improved operating margins. It just may show up in the less revenue growth than we might have gotten in the past.

The next question today comes from the line of Josh Nichols from B. Riley.

Clearly, the company has been making a very big pivot here. I think it's probably the right decision and good to see the cash flow numbers moving in the right direction, especially when you think about the debt payments and also the stock at these current levels. I guess if you're going to do double-digit operating margins next year, could you talk a little bit about what that would translate to for free cash flow? And how you might use that between some debt payments and potential stock buybacks?

Okay. So I mean, our CapEx needs have been declining. And you see we're getting a lot more capital efficient. It's one of the projects we've been working on for a number of years now. And so op margin. I mean, basically, the attritional cash flow being cash from operations minus CapEx is looking more like cash from operations. And so as we drive non-GAAP operating income up, we should correspondingly see that. So the offset being, we're looking at single-digit revenue growth with double-digit margins attached to it, which I think is a positive and gives us -- if done, it goes as we expect, more than enough room to start to delever. So let's break that second part of the question into a couple of pieces. We've got $132 million in cash. We have $90 million of the 2024s, we are generating cash. So no problem clearing the 2024s. And then starting in the second year of our term loan, we can repay an extra 10%, I'm sorry, we can pay back 10% of that with no prepayment penalty and then starting in years 3 on, we can prepay or pay back our term loans with no payment penalties. And so right now, the company is very focused on generating enough cash to try to hit some of those milestones. We'll clear 2024, no problem, and we'd like to start prepaying the term loans as quickly as possible so that we can save on interest at these rates.

I guess if I'm just looking at it, I mean, roughly $800 million of revenue next year, right, based on kind of what you talked about for the growth rate. So if you're doing that type of margin that you just mentioned that probably translates to somewhere in the ballpark of like $80-ish million of free cash flow, which should afford you plenty of capital, I would think, to start paying off some of the debt, and that's with -- I guess, I think you mentioned if we assume kind of like mid-single-digit service revenue growth since that's what you talked about exiting the year is kind of a long-term target. Is that kind of reasonable guidance that we're thinking about how to build out the model?

So I mean, I think everything you said makes complete sense to me. I would put maybe -- for those that are -- Josh, I know you well, you're very accounting focused. So $80 million in, let's say, operating income, roughly a cash from operations number, minus a tiny bit of CapEx, let's say, $10 million, that's $70 million, minus $30 million in interest payments gives us maybe $40 million a year per year times 5 years, we could take $200 million of the $250 million out. We would save a lot of interest along the way. So maybe I can squeak out the last $50 million. And I think if we did that, we might see the stock appreciate enough to convert the 2028 notes. And so I think there is a path and it is not a difficult path to almost have this company debt free in 5 years.

The next question today comes from the line of Meta Marshall from Morgan Stanley.

This is Erik on for Meta. I want to go back to the XCaaS side. I know a couple of quarters ago, you noted that nearly half of your incremental ARR was coming from contact center. Can you maybe just give us an update on if that percentage has changed meaningfully at all over the past few quarters in either direction?

Can you repeat it?

Incremental ARR.

Half the incremental ARR is coming from XCaaS?

From I think a few quarters ago, you had said from contact center in new XCaaS deals? Just curious if that's...

Well, I mean, yes, if you think about the growth that was mentioned in the script in XCaaS, half of which is contact center, typically. And you look at the standalone, yes, we're generating a -- I do the math, and I didn't do it, to be fair, last night. But the thought process you're going through is not radically wrong. A significant portion of our incremental ARR is coming from contact center.

Okay. That's helpful. And then if we just think about the focus kind of shifting more towards operating margins and that in the context of Fuze product strategy, is this plan largely to leave the Fuze product as is and gradually upsell contact center? Or do you see kind of initiatives within Fuze to maybe shift from that in any way?

Yes. So we see a big focus on our installed base overall as we do more laser focused on sales and marketing efficiency. And we've done a lot of improvements, both in the product basis and the customer support levels. On the Fuze side, we talked about the coding we're doing for seamless upgrades onto the X-Series product for those customers that will kick off next calendar year, and that gives us even more opportunity on cross-sell of those customers into the 8x8 contact center.

The next question today comes from the line of Catharine Trebnick from MKM Partners.

With this macro backdrop, you guys did a really good job. Can you talk about the competitive landscape and especially hit on contact center with

Yes. So we've been focused on XCaaS for almost a couple of years now and doing 70% of our R&D investment into contact centers. So we keep strengthening our contact center product, it becomes more effective and more client pleasing in the market. And I think that's why we're winning. When we go up, we're -- we don't see new entrants as much as existing players in the contact center space, and I don't think that's really changed with entrance you mentioned. And with our XCaaS capability, we bring a lot of advantages over just a standard contact center with everything from unified analytics and administration, the reliability SLAs we bring, the front desk visibility and things like bringing sentiment analysis across all employees and teams. So the things we're doing are differentiated and allow our buyers to have lower total cost of ownership than supporting 2 separate platforms.

And then are you seeing any pickup with Avaya troubles and your opportunities for just your core UCaaS business?

There is a lot of buyers that are looking to -- that have moved maybe over to like a teams for collaboration, but are still on historical UC on-prem PBX that are looking to get off and whether that's Cisco or Avaya or other, we see a lot of that transition going on and a lot of interest from the IT CIO organizations.

The next question today comes from the line of George Sutton from Craig-Hallum.

I appreciate the details on the Microsoft partner ads in your app. I'm wondering if we could talk about Microsoft relative to that friend versus Ultimate so argument. And I'm curious how you look at it. We look at about 260 million seats out there and 12 million or so, we believe, using third-party voice. I'm just curious if you can address your objectives relative to some of those numbers and relative to Microsoft's own voice objectives.

Yes. I think a huge universe of collab users. Not many currently lit up with voice, but a substantial number when you think of the 12 million. But we really look at that relative to maybe the 250 million, 270 million active users on Collab and lining those up. And we see the bulk of that or almost all of it going to either direct routing or operator connect to ecosystems. So we have a leading direct routing solution and by doing things like our XT SKU, we've become very price competitive with the increased functionality you get from direct routing and the phone app helps also. I think that universe the 12 million voice users can go up very significantly over the next couple of years. I think Gartner's thinking that you get to 20% penetration of those teams users over a couple of years, which gives you like tremendous growth on that 12 million. And we want to capture a good share of that.

Perfect. And second for me, relative to Fuze, I don't think anybody on this call would have expected you to have done as well with that acquisition as you've done. Begging the question of -- there are other businesses out there that could use a better home in a consolidating market. What is your ultimate objective relative to other M&A?

George, maybe last. Look, I think with the .

Earlier, when you were fighting for analogies.

So it's not the right time to be in the market. Look, if I had -- when we did Fuze, we took out a little debt, which hindsight maybe and then we took on -- we used some stock. It's not -- like with the stock at our valuation where it's at. And I think it's more important to delever the balance sheet and drive cash. I don't think it's the right time. I think actually, a number of those businesses will really struggle with more fundraising, et cetera. So there may be easier ways to get their customer base. I think it's something we always kind of think about and look at, but there's a right time and place for it.

The next question comes from the line of Pete from Evercore.

Maybe just, Dave, one for you is segmenting contact centers as a stand-alone, how are you priced on a seat on seat basis versus competitors? Are you above or below the mean? And then one for you, Sam, gross margins contact center historically have been, call it, high 50s, 60s, if you just look at some of the companies trading today. How should we model margins from contact center going forward?

Yes. Well, contact center pricing is very advantageous for our customers. I mean we're a fair pricer. We're not a premium pricer, but we give great functionality and capability, and we do it with super high reliability. We do it now over 56 countries, which is the largest footprint of any UCCC player, and we do that with both UC and CC in every one of those countries. So our pricing, while it's significantly higher than UC seats, 4 or 5x higher it's very competitive in the market and then by combining it with UC, so it's competitive stand-alone, just straight up. But when you combine it also with UC, you get all the lower cost of ownership by having like single integration to manage with things like teams or sales force or other integration CRMs and the easier to deploy, manage, so much lower total cost of ownership than anything else in the market.

And then on gross margins, I get your point. I would tell you, I think it's not just because of who we are. It's not the right way to think about it. So if you think about my service revenue margins are 74.1% and that includes relatively lower-margin CPaaS. So I'm basically getting very similar margins between my UC and my CC business. And I think that's because XCaaS works, right? It's one platform. We get to spread our carrier interconnect costs and our costs across that one platform. And I think it just -- it's sort of a scale thing and it works. And so I don't really see substantial difference in gross margins between the 2 products, but it's also, to be fair, hard because they're integrated. But I think because they're integrated, I just -- we're just not going to see a big difference.

And just to follow up on a prior question. Sam, help me think through steady-state organic growth, right? I mean are there levers you can kind of pull to reaccelerate to call it double digits? Or is it just should we think about it going forward is just a highly efficient single-digit story.

No, we're not giving up our goal of being double-digit grower. I think right now, we have a currency headwind that's causing suppression, and we're focused on pivoting to more cash, and that has some consequences associated with it also. I think if we were really focused on being a central digit grower, we would probably reduce our R&D spending and we're not. We continue to invest very aggressively in R&D. We hit our 15% goal that we've been trying to achieve for a while this quarter. And so I think the next leg will be based on innovation and those kinds of things to read at a higher growth rate. And maybe just maybe the dollar weakening a little bit would help me also.

Next question today comes from the line of James Breen from William Blair.

Just a couple. One on growth and just sort of think about across your segments in small, mid and large enterprise. Any color on how much of the growth is coming from existing customers versus new customers? And is it to differ amongst those groups? And then a little bit in relation to the question on sort of M&A and consolidation. Any change in the competitive environment? Are you seeing some of the smaller players just not show up as much because they don't have the funding available to be affected competitors?

I'll take the first part and either one of us can go on the second part. Actually, let's cover the first -- sector part first, right? So on a competitive environment, I would say not radical changes, but in the end, it was still -- look, it's us versus those guys up in Belmont are the 2 big players that we see most of the time. And yes, I think the smaller players are running into trouble. It's less so on that this quarter, next quarter, but I think they're going to fall behind on innovation. We're using this downturn to continue to invest in our innovative funnel and flow. And people are going to have to step up and continue to invest to keep up with people like us. And so I think that's where you'll see that thing diverge over time. And then -- I'm sorry...

Yes, installed base versus new. We do about half of our bookings from the split is about 50-50. And we have even greater emphasis on installed base as we have great cross-sell products with contact center, things like Conversation IQ. So that's been a focus of the organization as we improve sales and marketing efficiencies. We'll continue to do that. And I think our customers have been more receptive as we've improved product reliability and customer support elements and with the innovation we're getting on contact center, it all goes hand in hand.

The next question today comes from the line of Ryan Koontz from Needham Company.

Dave, I wanted to circle back to your comment about direct routing versus Operator Connect there and how you frame up that competitive threat. It looks like Operator Connect is a little more integrated into the selection process, admin panels and onboarding and how you think about that competitive environment there for the new Operator Connect competitors? .

Yes. The Operator Connect gives you like carrier connectivity, the direct routing really allows you to apply core routing PBX functionality to that and enhance the overall capabilities for adding voice to Microsoft Teams. So it's truly a superior functionality solution. And so our goal is to stay price competitive, and we sell the value of that solution. And we're doing things to continue to lower our costs. We talked about the XT SKU. We talked about the phone app. All those continue to have the superior capabilities that you get with the 8x8 platform, and it's all that series. So it allows you to seamlessly integrate contact center users on top of that. And really connecting your contact center to Teams users is like a big pain point with CIOs today. And something like Operator Connect doesn't solve that for you. So we think we have a tremendous number of advantages there, and it just creates a much richer experience for the customers and what they get.

Next question today comes from the line of Michael Funk from Bank of America.

A couple if I could. As you think about sequential revenue growth heading into fiscal '24, what are the variables that you're most focused on to present the most upside and downside risk to sequential revenue growth. Is that net revenue retention? Is the CPaaS business? Is it SMB? What are those variables we should be thinking about?

You sort of highlighted some of them, right? So in terms of sequential revenue growth, FX right now is #1, I mean, I admit I was utterly surprised by how the dollar reacted. And it doesn't -- I want to reiterate what I said in my script, right? It doesn't affect our operating numbers, but it definitely affects our headline revenue performance because we have so many natural hedges in place. The CPaaS business was a big worry 90 days ago. It's starting to stabilize here. So I think we knock on wood, that's less of it. As I mentioned, it was mentioned in previous calls, SMB for us is a focus on efficiency and cash generation. So I think we've got our arms around that now. So you mentioned things that are all potential sort of downsized. I just want to highlight the upside is we've got a number of new products coming out of the R&D we bought Fuze 9 months ago. So we've had those design teams working for a number of sprints now. So we've got new things coming out of the design funnel over the next 6 and 12 months. Those are all positives. We've been doing a lot of work on Microsoft with additional SKUs and pricing and packaging around those. The Microsoft channel partners that Dave mentioned in the script, are always a big positive. So there's, I think, some go-to-market stuff around Microsoft teams that could be a positive and some new product innovation that could be a positive on a go-forward basis.

Understood. And then on CPaaS, is that core to the 8x8 business, maybe not the best monetized CPaaS, but is that something that might be noncore, you could look to get rid of at some point? Or is that core of the strategy going forward?

I think it's something we're evaluating. I think the previous management team bought the company in 2019. It's a great business. It's got good unit economics when it's coming along. But it's not deeply integrated into the company. I think the vision back then and the vision today have kind of diverged a little bit. And so I think it's something we're assessing over time. But I don't think we have no immediate plans in this environment to do anything along those lines. Right now, I think it's -- get it back on its right footing and get it going in the right direction.

Our final question today comes from the line of Will Power from Baird.

This is Charlie Erlikh on for Will. Just one quick one for me. What are you seeing on the pricing front, maybe on a seat per seat basis relative to 3 months ago? Are you seeing any pressure on pricing, especially you mentioned there are some customers that are looking at elongated sales cycles? Are they maybe pushing back on price at all when it comes time for renewal or just your customer conversations? Any change in pricing appetite?

Well, I mean, Will, I'm not going to, I mean, in this environment, everybody -- I mean, we do it. So everybody is digging about pricing at least 1 or 2 extra spin cycles. And for anybody that's a supplier to me, yes, I held all your contracts to the last day of the quarter at 11:59 before I would sign them. So yes, I mean I think we're seeing a little bit of aggressive. I don't think it's related as much the competition as it's related to sort of the economic environment. And on renewals, if there's one statement I've heard a lot of is it can't hurt to ask. So you've heard some of those kinds of things. And so I don't think it's anything that we haven't factored into the guidance, and it's anything that we're not thinking about and working on. And for us, I think it's important in this type of environment to be able to lower our costs. And so we're very focused on making sure that we protect and grow our margins. And part of that is when we get pressure from our customers, we're certainly the first guys to put pressure on our suppliers.