Thank you, Sam. All right, looks like we're audio is skewed. Okay, we're live and ready to go. Thanks everybody for joining. Welcome back. We have got the financial breakout session here. I'm Kevin Kraus, CFO of 8x8. I'm here with Sam Wilson, our CEO, and Kate Patterson, who heads up our Investor Relations. I'll begin with a brief review of our financial performance and how it feeds our innovation engine. At the end of the session, I'll open it up to Q&A. For those of you listening online, you should have a box at the bottom of your screen, you can submit a question if you have one. I'm gonna read some safe harbor language here for you, just bear with me.
Before I begin, please note we may make forward-looking statements during the course of today's discussion. These statements are predictions only, and actual events or results may differ materially, depending on a number of factors. These factors include, but are not limited to, the risks and uncertainties listed on this slide. For a full discussion of risks and uncertainties that could cause our actual results to differ from our forward-looking statements, see the risk factor discussions in our 10-K and 10-Q filings. Also, the financial metrics we will be discussing are non-GAAP, with the exception of revenue and operating cash flow. We have provided a reconciliation of our non-GAAP to GAAP metrics, to the nearest GAAP equivalent in the appendix. Okay. Let's get started. Thanks everybody once again for joining.
I would like to run through some key messages from today's sessions that most of you have probably heard already, those of you who are here in person. We address a large market opportunity. You heard from Sam earlier today that we have an $80 billion cost saving opportunity. Gartner estimates that replacing human agents with AI chatbots can save the call center labor market $80 billion annually by 2026. You've heard about our platform and product strategy, which involves leveraging a well-funded partner ecosystem. You heard that earlier from Sam as well, a $100 billion investment, 1,000 companies. Our continued investment of in-house innovation, combined with that partner ecosystem, will drive customer demand through improved product features and functionality.
Our operating leverage will improve our non-GAAP operating income and cash flow, and that will enable us to delever our balance sheet. This is the flywheel of our strategy to deliver value to our customers, partners, employees, and shareholders. We've already improved our unit economics. We, you know that we had a couple of actions that we did recently. We expect that unit economic improvements to continue throughout time. We have improved the efficiency that enables us to continue investing in innovation, that part of the wheel, which, and that innovation actually drove some of the product announcements that you heard today. As we scale, the flywheel continues, and we generate more cash to delever and potentially buy back stock.
Under the right circumstances, we can do acquisitions that are accretive to operating profit and cash flow, just like we did with Fuze. All right. Let's review the three value creation priorities that we have at the company. First, increase profitability and cash flow. Our approach is that OpEx increases based on revenue growth, okay, not the other way around. We improve sales and marketing efficiency through go-to-market, channel leverage and ecosystem pull-through. Then, the incremental gross margins may occur as we increase with scale. Second, use increased cash flow to reduce debt and moderate the dilution associated with equity-based compensation. We'll talk about that later on. Third, invest approximately 15% of revenue in R&D to drive durable long-term growth.
We intend to expand the XCaaS platform to become a leading customer success platform for our small and mid-size enterprise customers. We look at increasing the value of the company over three time Horizons, and they're overlapping time Horizons. Horizon one, drive immediate profitability, which we already did. We wanna generate cash flow improvements while maintaining the target level of R&D that I just mentioned, the 15%. Horizon two, continue using excess cash flow to reduce the term loan and therefore reduce in-interest payments while continuing to cross-sell within our installed base, including Fuze. Then driving contact center-led new logo deals, that will include Teams environments as well.
We do expect some revenue growth in this time Horizon, but as we experience momentum in the XCaaS platform, it's somewhat offset with some headwinds from our small business customers, which we're not heavily investing in at this time. Horizon three, the flywheel's turning, reflecting high retention, cross-sell within our installed base, new customer logo acquisition, the headwinds from the small business decline in Horizon three. Let's dig a bit deeper into each of these value creation priorities. Increased non-GAAP profitability and cash flow. You can see we've had significant revenue growth in fiscal 2023, primarily driven by the Fuze acquisition. This anniversaried in January of this calendar year. We focus on prioritizing profitable growth, and we do see signs of stabilization in CPaaS right now.
We hired a new leader in CPaaS. Then the resumption of revenue growth is still several quarters away, as I mentioned on the earlier slide, when we talk about Horizons two and three. We do expect our revenue mix to transition to customer segments with higher long-term value, which you'll see later in this presentation. I want to highlight that we have a well-diversified revenue base. We have good geographic, go-to-market, and product segment characteristics. Let's talk about Fuze one year later. Recall, we acquired Fuze for the engineering and enterprise customer base. Okay. We've experienced better results from Fuze than we anticipated when we modeled the deal and consummated the transaction. We've improved COGS to be in line with the rest of the organic 8x8.
It's a higher, much better 8x8 COGS levels. Product maintenance costs are lower than anticipated when we looked at the company. Some of the product announcements you saw today were actually developed by Fuze engineers. For example, the Supervisor Workspace, which actually was highlighted in the earlier sessions. Again, as I just stated, we bought Fuze for the engineering team and the enterprise customers, and selling contact center into that installed base is still an opportunity for us. All right, let's talk about gross margin improvements. We've increased our gross margin by over 1,000 basis points over three years' time. We did this through cost reduction initiatives, favorable mix, and increased scale.
Some of the gross margin improvement initiatives included reduced direct COGS, like carrier costs, in public cloud. We improved efficiencies in customer support. We improved efficiencies in the professional services and deployment organizations as well. The service and application gross margin, excluding CPaaS, is actually at best-in-class levels right now. We have a cultural mindset of continuous improvement when it comes to gross margin. As you can see, over the course of the recent years, we've really ramped up the non-GAAP gross margin. Let's talk about operating leverage. Nearly all of our margin expansion or op margin expansion has come at the gross margin level. What are we doing about the operating margin right now through OpEx?
We stated in the last earnings call that we were giving color on 400-500 basis point improvement from our year ending 2023 operating margin. How do we get that? About half of that is gonna come from gross margin improvements, a more incremental gross margin improvements. About half is gonna come from OpEx. Okay? We are gonna continue our focus on sales and marketing efficiency. Recent cost reduction actions that we did in October and January were targeted. We're expected to generate These efficiencies will show up in our operating profits in 2024. We're also focused on target customer segments and channel efficiency, we're very precise about how we approach sales and marketing expense, which I'll show later on in this presentation.
The higher G&A that we're showing here is, you know, we completed the Fuze acquisition, we had some back-office integration, we had some, you know, one-time items associated with that. That has spiked up our G&A as a percentage of revenue. We expect that will come down as the business scales. We're certainly not, you know, we're targeting lower than what we're showing here. R&D, again, it's near our target we expect for 2023. It's near our target level of 15% of revenue. We expect to maintain this level of R&D spending in 2024 as we continue to invest for innovation. All right, let's take a look at sales and marketing efficiency over time.
At the end of fiscal 2021, we began really increasing sales and marketing spend to drive growth. We felt at the time it seemed like the right thing to do because the market was assigning a much higher multiple to growth and profitability at the time. As we began integrating Fuze, we decided to shift to a profitability and cash flow focus, so we changed our approach to sales and marketing spend. As a result, you can see that the sales and marketing spend has declined as a percentage of revenue fairly significantly, and it's also declined in absolute dollars.
The other interesting note here is that for the fourth quarter, our expectation is that our sales and marketing costs will be in the same general range as the quarter prior to the purchase of Fuze, and the revenue is approximately 20% higher. We're really generating a lot of sales and marketing efficiencies in the business right now. Okay, one of my favorite slides, this increasing non-GAAP profitability. Our total revenue growth on a year-over-year basis has outpaced our total spending growth on a year-over-year basis every quarter since fiscal Q1 2021. And that's showing up in higher non-GAAP operating profit and operating margin.
And our priotization of profitability over revenue growth has amplified the turnaround, and we expect to show improvement in fiscal 2024 per the guidance we gave in the last earnings call for 2024. This chart talks to the quality of our earnings. You can see here, operating cash flow in green, how that slipped since 2020, where we were in a negative position. The majority of our op income translates into cash from ops this fiscal year, adjusted for interest expense and other one-time items such as severance costs for our cost actions that we did. The new debt resulting from our debt refi that we did in August is generating the interest expense increase that you can see here.
Keep in mind, the increase in cash interest paid that's shown on this chart is primarily from our $250 million term loan. That will be outstanding for about 7.5 months of this fiscal year, since mid-August. Going forward, you should expect roughly $8 million per quarter interest expense, plus, minus $1 million or so, depending on what interest rates do. Okay? The, you know, without this term debt, our cash would've been more aligned with non-GAAP op income. We do have this term loan, but the great thing about this term loan is we've got a tremendous amount of prepayment flexibility. Our objective is to pay this down with the excess cash, which I'll go through later.
All right, let's take a closer look at debt reduction. You know, we also want to reduce the dilution from employee stock programs. This is an indicative view of a debt payback schedule, assuming a $1 billion constant market, $1 billion enterprise value from Q3 2023. A 100% chart. You can see as we reduce the debt load off our balance sheet over time, keeping the enterprise value constant, more value, more enterprise value accrues to the shareholders and debt holders. This, at the end of the period here, only the $202 million of 2028 converts remain.
As our plan here is to keep always at least $100 million of cash plus investment on the balance sheet at all times while we go through our debt paydown program. Okay? Here is an indication on employee stock programs. What we had done, in addition to creating value through debt paydown, we're increasing value to shareholders by reducing dilution. We are moving non-executives to a cash-based comp plan, a cash-based comp structure. That's already embedded in the 2024 commentary that we gave in our last earnings call, so it's a headwind to non-GAAP operating margin and operating profit. That's already built in there. We will continue to issue RSUs to executives in the company.
All employees will still be able to participate in equity appreciation through the employee stock purchase plan. With this program, you can see that as a result, in fiscal 2024, we expect the number of RSU grants to significantly decline. I think, actually, I think we're a thought leader in this area, you know, we're making this transition carefully. We are a thought leader in structuring competitive compensation programs that are less equity-dependent. All right. Much of what we talked about so far in this presentation has been what we've done in the near term to improve shareholder value and drive profitability and cash flow. We know that creating durable growth is the way to deliver long-term value.
We'll turn to value creation priority, drive durable long-term growth through innovation and investment to meet the needs of our targeted customer base, which is small to medium enterprise customers. As I stated earlier, we have been shifting to market segments with higher long-term values. Small business is still a good business, generates good cash for us. We want to expand our XCaaS platform to become the leading customer success platform for the small to mid-size enterprise customers. Actually, you can see our strategy is already resonating because we, the customer ARR is shifting more toward mid-market and enterprise customers. That, I, you know, that is already happening in our space. Enterprise customers have more than doubled in three years.
This is with significant organic contact center attach rates. It's greater than 50%, including Fuze. Remember, Fuze is mostly UC only. Organically, 8x8 without Fuze, the attach rate of contact center in the enterprise space is more than 70%. The ability to cross-sell the Fuze customer base with contact center is still the remaining opportunity represents a remaining opportunity, as I mentioned before. Good thing there. Here is XCaaS increasing. It was less than 30%, three years ago. It's about 40% now. It's growing over 30% CAGR. Again, this is XCaaS, so this is largely organic growth. When we start cross-selling Fuze to the mix, this can start moving up once we cross-sell into contact center.
Concluding this, you know, our we're already executing the strategy. We're delivering value to customers, partners, employees, and shareholders. Today's product announcements represent, you know, innovation that the innovation investment we're making to drive the growth. Let me open it up to Q&A here. Remember, those people who are on the web can submit a question on the web. I don't know, Kate, if you're monitoring it or if it'll show up here. Thank you very much. No problem.
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We have one out.
Okay. It doesn't matter. I'm gonna be passing around.
Okay.
A couple quick ones about 5, because five o'clock is the best for America. You mentioned expectations or maybe the potential.
I shouldn't have asked. Excuse him, he's at the end. I know. I know. I should have known better.
Two, if I could. You know, you mentioned expectation for churn attrition of the SMB customer as you focus less there. Can you frame that for us a bit better? I mean, what is the expectation for churn attrition and some of the projections that you gave? Second part here, you know, obviously, you're doing things internally, but there are external factors that could also affect rates of revenue growth. What is your expectation for the competitive environment, pricing pressure? What's baked into that forecast you laid out?
All right, I'll take the first part, and I'll let Kevin take the second part about the competition and pricing baked in the financial model. I don't know. I guess I don't see it as that. Okay. Let me tell you. I try to give you a soundbite answer. I'm gonna give you a little more nuanced answer. When we look at the SMB segment, we are not churning out the SMB customers. If you think about an SMB customer, the LTV to CAC ratios are not as good as on an enterprise customer. The NRR numbers aren't as good. Like, the overall life LTV of a small business customer just isn't as good as an enterprise customer. However, we've already the CAC is already sunk cost.
What we're doing is we're just not filling up the funnel the way we used to. The way we've done that is we've withdrawn demand generation spending and those kinds of things. We've reduced some sales capacity in those areas, right, et cetera, to try to make our CAC more efficient and just less. We'll naturally let the small business customers attrit. What can influence that tremendously is obviously economic stuff, right? If the economy, you know, comes under tremendous pressure, obviously small business mortality can increase slightly. Really what we expect is we expect to lose, you know, sort of customers to business mortality and those kinds of things. They're happy customers. Our base is relatively happy, they're healthy. As we said recently, our retention rates are the highest they've been in years.
I don't really see an issue. I think it's just about the fact that if you look at any kind of traditional small business number, you see, I don't know, it depends on who you look at, Bureau of Labor Statistics, you guys, whatever. It's, you know, 9%, 10%, 11%, 12% kind of business mortality. We're just not working on filling it in that quickly. We're, you know, really driving it more for cash flow to fund debt repurchases and those kinds of things and all the things that Kevin talked about. When I view the small business segment, I view it. The hard part and the thing that drives, you know, me nuts and Kevin nuts and all you guys nuts is, well, it's sometimes hard to model on a 90-day basis, right?
It can sometimes go a little all over the place. You know, obviously, during the pandemic when I was CFO, I could see when the government was putting subsidies in the system and when they weren't. You know, we could see credit card default rates change very rapidly and those kinds of things. So those types of things can cause a little bit of volatility. You see it, right? You see, for example, our small business segment in ARR had negative growth for a couple quarters, then it bounced positive. We actually got a fair number of questions after the call like, "Oh, my God, are you investing in that space? What's changed?" Whatever. You're like, "Whoa, whoa.
It's like -2 to +4. Like, this is kind of in the volatility band of nothing fundamentally really changing. On the small business side, I would say it's just a lack of investment in keeping that funnel really robust because we just have better ROIs investing higher up.
I will add to what Sam's saying about the investment. We've made consciously fairly significant investments over the last couple of years in our customer success organization. While we're not maybe investing in funnel demand generation as much in the small business area, we certainly have invested in our customer success organization. That has reflected. This is across all customer segments in the company, and that's reflected in these retention rates that have been the best in years.
That's great.
Well, and before he dives into the competitive thing, one last thing I'll say, though, is I'll tell you where it sucks. I mean, I was being really frank with the Wall Street community, right? It suppresses our revenue growth. Right. If I have, yeah, I have a segment of my business that's generating a lot of cash, but it's growing zero, and it's 24% segment, right? It's growing zero. It becomes a boat anchor to this overall headline growth number.
That's just the question, right?
Right. It becomes a boat anchor to the. It's a drag on the overall. It's interesting how frequently, you know, you guys are like, "Write it off. Discontinue operations." 'Cause like, no, like, it's really. Like, it's got a lot of cash, and it generates. I mean, these are one customers. We've already paid the channel spiffs. We've already paid all the odds and ends and all that other stuff, right? The number of support tickets we get from that base, especially with all the, you know, MLAI stuff we've done, is really small. Like, they're very profitable after they age, after the vintages age. It's just the cost to acquire, and that LTV is just, it's not where it needs to be compared to an enterprise customer.
Thank you for that.
You wanted to ask about pricing and the model and Pricing and competition and those types of things.
Yeah. I mean, there, I wouldn't say anything particularly specific. I mean, the pricing, I mean, like, that comes up, you know, at renewal time, right? If you have deals that are 2, 3 years, you know, we're not seeing a ton of that. Maybe on the... If, you know, if there's a new customer coming out in that segment that comes out, like, you know, then maybe you can see some of the pressures. We don't have anything particularly, you know, baked in there on that.
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No, I mean, we model status quo, right?
Yeah.
Zoom's already tried to be disruptive on the pricing front. I don't know, maybe they'll decide to get more disruptive, and, like, we'll have to deal with that accordingly.
Mm-hmm.
There's a switching cost, and what I'm certainly not gonna do is I'm not gonna race to the bottom. Like, I don't understand having 5 million seats and smaller ARR than we have and, like... I don't understand shrinking the TAM. That makes no sense to me in logical business terms.
Okay. Okay, we can take a question from... Wait a minute. Is this on?
Yeah.
From our website. We have a question, that is, "What is the relationship between 8x8 and OpenAI?
They're a ecosystem partner slash vendor to us, as we discussed today. We're using their Whisper technology. The week that they made it available, we were already on the phone with them. In under six months, we have customers in production live, and we're getting better transcription results with lower costs than our previous transcription vendors. Please. It's fine. I'll repeat it.
I just have a question with OpenAI and the contract that you guys have with them and things of that nature. Like, as you get more customers using, you know, the AI capabilities that you're looking to implement through OpenAI, is that a significant cost for you guys to add on to it? Like, is the contract itself with OpenAI significant?
Well, it's cheaper than what we were paying for transcription with better results.
Okay.
you know, right now it's a cost savings.
Okay.
Let me take a sec 'cause having spent some time with a technologist on this topic on OpenAI, right? Right now we're pulling the Whisper technology for transcription, right? Transcription's really core to our speech analytics, to agent assist, and these kinds of things. It's like a core foundational technology. Some of our ecosystem partners are using ChatGPT 3.5 and 4.0, and as are we, inside of their products. What's an example we're using it for? Call summary. It doesn't have to be super technical, but you can just feed a whole bunch of information to ChatGPT and get a, you know, four-line summary. Customer's happy. This was the core problem, et cetera, et cetera. These kinds of things. They're feature functionality capabilities, and they're not overly expensive.
Okay.
compared to other technologies that we were using already in that area.
Okay.
Is there anything else for online?
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You guys are too nice. You're always nice in person.
Okay, this is another question from our internet viewers. When you say less sales-focused, Kevin, do you mean fewer direct salespeople and more channel or something else?
In the small business context?
I think I said that, to be fair.
Okay, Sam said that. If you would like to answer it. There's no context in the question.
We've reduced some sales capacity. One of the actions we took, we said reduce sales capacity at that small business level. We've also moved some of the sales capacity to lower cost regions. Because look, if you're investing less demand generation dollars, i.e., producing less leads, then you need less raw salespeople to produce those leads, et cetera. That's really just what it comes down to. There's a question about direct versus channel, and I should address that, right? If you look at a vast majority of our channel, it's master sub-agent. The master sub-agent channel is a reference channel. That means it's the customer's still direct with us. The contract is between us and the end customer.
We pay a commission, commonly referred to as a residual, to that sub-agent, to the master sub-agent community, but it's our sales reps closing those deals. The concept, we don't really have the concept inside the company of a direct rep and a channel rep. They're just a rep. It's the same thing, and their job is to get deals closed.
We do have CAMs, channel account managers-
Right.
...inside salespeople, but they're not the AE on the deal.
Somebody must have a question.
I have one. I have one more. Really for either, you know, Sam or Kevin 'cause Sammy, you sat in the CFO seat before. I understand the slide showing the shift in value, assuming constant multiple of EV from debt to equity. I get that. There must be some longer term target leverage, right, for this company, assuming that you get to a more stable rate of revenue growth, profitability increases, that I would presume is above what you were showing in that screen earlier.
I don't Look, Michael, I'm not.
Is that right or is that not right?
I'm an old school CFO. Like when I got to Silicon Valley in the 1990s, tech companies didn't run with debt. Like my dream is to be a debt-free company. There's a very specific reason why tech companies didn't run with debt. It was because, like what we're going through shouldn't happen. It's a trip. You want incredible optionality when you run a technology company. Number one, you never wanna be pushed between R&D spending and debt payments. Like, you can never get yourself in a position where you have to sacrifice R&D spending, 'cause as soon as you sacrifice R&D spending, you're really risking the company and obsolescence risk. Number two is the greatest tech companies use periodic market downturns. You know, I'm telling all you guys this.
Market's kinda cyclical at times. Like it's happy, and it's sad, and it's happy, and it's sad, right? Use those sad times to buy back stock or acquire competitors or do any of those other things, right? That becomes really hard to do when you're sitting on a pile of debt and your investors suddenly become very concerned about debt levels. Maybe there is, but like in the, you know, in the intermediate term, I'd like to be debt-free. I'd really like to. We can pay off the term loans. As we, you know, that gets self-reinforcing very quickly, 'cause if we have the term loans, we get the cash interest back. That allows us to pay off term loans faster. The last $200 million of 2028 converts at $7.15.
It is not inconceivable to be completely debt-free in five years or less. That either gives us optionality to invest more in R&D, buy back stock, and we'd invest in R&D if we have good ROIC, right? If the ROIC is greater than our cost of capital, we're all good, like business school students. We can invest more in R&D, maybe we bump it to 20% at that time.
Mm-hmm.
We can invest in buying back stock, or we can invest in inorganic growth.
Yeah. Look, the R&D investment is well over $100 million a year.
Yeah.
We're expecting that to translate into growth opportunities-
Yep.
... Through feature, in, you know, through product features and functionality. We expect pull on that over time.
Okay.
I appreciate all the time spent today on contact center and, you know, partnership with best of breed AI, ML, and why that makes sense. You know, other contact center companies are either trying to build internally like a NiCE thing. Genesys is doing some as well. You have companies like Five9 that are also, I believe, doing more partnership or using more best of breed. Is there a way you can compare your offering with some of your peers, maybe, you know, what you can offer that they can't? Also if there are specific markets where you believe maybe you can punch above your weight, either verticals or enterprise size, where you believe that you just have a right to win that market share.
I'm gonna take these in reverse order. In terms of punching above our weight, look, I think we do great in the U.K. I think we do great in some international markets. I think we're, you know, I haven't seen the latest market share numbers, but I think we're still the largest cloud business communications company in the U.K. That's a market we can, you know, we can double or triple in and still, you know, not still scratch the surface 'cause especially since they have PSTN turnoff coming. I think that's an area we definitely punch above our weight. We have large presence in public sector and some of those kinds of things. The interesting to compare and contrast against my rivals.
What I would say is I think you nailed it by the way, Michael, which is, you know, several of them believe in everything natively in-house, and I really respect Five9's, has a bit of a hybrid strategy. There's things they can be good at, and there's things they can't. I wanna just use a case study in sort of how I think, how we think about this and how we develop this strategy. As some of you may or may not know, there's a company called Cresta. It's a Sequoia and Andreessen Horowitz backed startup company in Silicon Valley. Last raise was $300 million on $1.6 billion valuation just to do agent assist. That's all they're doing, just agent assist.
You have a company, a startup company, that's spending $300 million on a segment of MLAI that's this big. For those on the web, my fingers are very close together, right? Very close together, right? How, if you're a native NiCE or Genesys, are you really gonna compete with that? How are you really gonna do that? Because they're not spending. They don't have $300 million invested. By the way, Five9 was an investor in Cresta, so I could see how Five9 is doing it. A lot of these other, like Cisco, et cetera, are they really? They're not spending $300 million. Unless Cresta is terrible at R&D spending, which can happen, they're gonna have a better product than people are spending radically less.
What we generally see is first generation MLAI products were relatively crude. I wanna be clear, I don't blame these companies. I don't think they're incompetent or stupid or dumb, or I don't think they see any things that we don't see, et cetera. I think the difference is we actually happen to be a little late to the market, and a lot of them started a lot of their MLAI strategies. I remember when I first got to 8x8, we had an MLAI strategy, and we were doing some stuff in that space, and that was 2018, 2019, those types of periods, right? We actually are a little late to the market, and in 2020, everything changed.
I think the big difference between us and them right now is we're willing to embrace the change. We believe this is a fundamental inflection point in this market because of the venture capital community, because of the investments being made across the board and the applicability of that. I really think the compare and contrast is they still want to. I, you know, some of the third-party analysts that are not in this room right now are big proponents of telling customers, "You should buy everything one v-one vendor." I think they will turn out to be wrong. By definition, and if you look at large parts of SaaS offers, it's truly the case. If you go, I don't think anybody runs Salesforce by itself anymore.
Salesforce will have Groove or Apttus or whatever Apttus new name is, et cetera, all plugged into their Salesforce implementation to make it more of a complete solution for that company.
That was part of my question about if there are certain markets or verticals. I think that different sized enterprises, even different industries, have various purchasing patterns. I mean, some might want the, you know, buy the box and you get everything inside, but others might wanna buy best of breed, right?
I do think if you go to big enterprise, let's say mega big enterprise, I just use your Bank America, where you're from, you got huge credit card, or Capital One or United Airlines or one of these kinds of things. There, you probably have a vested interest in going fully custom, have your own developers in-house.
Yeah, we absolutely do.
Yeah. Be fully custom. That's not our market. We're looking at the person who says, "Look, I need to mix and match off-the-shelf technologies," that's why we generally say, and Kevin said this over and over again, right, you know, sort of small to medium sized enterprises, not the mega guys, not B of A. Like, I'll never call on your IT department, ever, right? Instead, you know, it's more about mixing and matching off-the-shelf technologies. Yeah.
Okay.
I have a couple, but anyone else here?
Right over here.
Right over here. All right. We'll take one more here, and then we'll switch to
I got it.
Thanks, R yan.
In 3Q, CPaaS was a little bit of a headwind in the quarter. You mentioned some stabilization you were seeing recently. Could that potentially drive upside to guidance or?
When we gave the 2024, I mean, you mean upside to guidance in this quarter?
For 2024.
For 2024. We deliberately did not forecast really a significant uptick in the CPaaS business in 2024, 'cause we wanted to be sure that stabilization actually was happening. We had said that before. I said it again today. We do see, you know, the signs, right? The 2024, it could be an upside in 2024, to answer your question directly. Right now, we're not including that in there because we just wanna be a bit conservative, really.
I give you a little bit of history, the way we model, right. We generally on our usage-based components, so CPaaS, toll-free minutes, those kinds of things, we generally take the exit run rate of the quarter and model that flat, right. Then, like, sometimes we'll layer in if we know particularly we're winning a large customer or something that's gonna start, we'll sort of stay on top of that. But generally, it's exit run rate flat on a go-forward basis. Now, for a while there, we were beating revenue numbers every quarter 'cause it turned out our usage revenues were increasing. So we had modeled flat, then our usage revenue just comes in above, and, you know, you guys would beat me up.
For the last several quarters, we had the usage revenue come in below what that exit rate is as the business trended down. We had those headwinds. Usage. Look, SaaS is getting more and more consumption-based. The ICA stuff we're talking about today is all consumption-based models, right? You'll see more of that, and you'll see a little bit more variability in our revenue performance on a quarter-to-quarter basis over the future as we adopt more of this stuff, consumption-based stuff, because it's just that philosophy of exit run rate flat. Kate.
Thank you. Okay, I'm gonna combine a few of these questions as soon as I get back to my computer, but we've got a number of questions about Teams and the Teams integration.
Yeah.
The first is how much actual innovation is built into that innovation? As a follow-on to that, maybe discuss how people are using Teams within the contact center infrastructure.
Okay, hold on a second. Just stop there 'cause you're gonna give me that one question in 12 parts, and I'll forget the whole thing.
Maybe do the three doors into-
Yeah, yeah.
Teams. Do that.
Okay.
Do that.
Just for everyone's benefit on the web, and I'm sure everybody in the room knows this, right? When Microsoft built Teams, they built an ecosystem strategy around it, and there's three doors to providing voice into Teams. There's Microsoft dialing plans, and I start from least popular to, you know, maybe most popular, in between popular, right? The least popular is Microsoft dialing plans. It's the old Skype for Business stuff. Not very popular, kind of a fallback option if you have nothing else. There's Operator Connect, and there's Direct Connect. Operator Connect is a SIP trunk. It's just simple dial tone. There's a pad that comes up. You can type a phone number in and make a phone call out. Then you have Direct Connect, which is a rich set of APIs.
When you work with a SIP trunk, you don't get a set of APIs. When you work in Direct Connect, you get a rich set of APIs. We've helped develop those APIs. I mean, people ask me often, "Does Microsoft resell our product?" No, they do not. However, our developers sit down with Microsoft's developers and say, "We need an API to do this, and this. Can you help us?" Microsoft is very complimentary and very helpful 'cause they wanna solve customer problems. The question is, do we add innovation on top? Yes, we add tremendous innovation on top because we have a set of APIs that allow us.
If it means changing queuing or SMS messages or MMS messages, as it stands today, Microsoft Teams cannot send a text message or receive a text message unless you're using 8x8 Direct Connect and then, or maybe, I don't know, some of the other competitors may have done it now. We were the first guys to ever come out with the ability to text in and out through the phone system to using texting in inside and out of Microsoft Teams. Presence is a big thing, and this gets into the contact center stuff. Presence is a big thing, right? If you're at a contact center. And let's say we have an inbound phone call from a customer on and o ur agents are on Microsoft Teams, and it's a billing question, and they need to transfer to a billing specialist.
Billing specialists will usually be on a UC solution. That agent can see immediately through presence, through Teams in the panel that they're used to working with, the UI they're used to working with, whether the billing person is on the phone or not and available or not. If they are, then they can send them to a message or do whatever. If they're not, they can immediately warm transfer the call over to that Teams person through Teams and get the customer over there. This is why we were the first Microsoft Teams certified contact center. Brian's in the corner, 'cause if you ask me a bunch more technical questions, I'm gonna throw it to him. Cloud contact center.
Yes, and the thing that Hunter didn't talk about today, but there is a very robust roadmap for further into innovation on top of Microsoft Teams. I'm not sure what the right verb there is. You know, we've got a lot of further things that we wanna do to have that Direct Connect route. Operator Connect is really the cheap solution, right? Direct Connect is the rich solution for a few dollars more. One of the questions is probably coming up from Kate in a second is, like, how does that work? It really comes down to in our sales cycle, our sales reps need to explain to the customer that for a few dollars extra per seat, per month, you get all this additional feature functionality, and is that worthwhile?
If we can get into the sales cycle, usually it is. That's why that Teams business is growing triple digit year-over-year.
With a good, contact center, attached.
Yeah. Oh, yeah. To be fair, we are purposely not trying to sell Teams seats. We are purposely trying to sell Teams plus contact center seats. If it's a pure Teams-only integration telephony type of thing, those typically go more towards the Operator Connect route, and it becomes a bit of a price war, and I generally try not to participate in those.
That was the combination. I think you answered the combination of those questions. Any other questions around the room? Here's another one. We have a question about, you talked about a 400-500 basis point improvement in operating margin in fiscal year 2024. Where does that come from out of the income statement?
As I mentioned in the remarks earlier, we're gonna get some incremental gross margin. We're expecting incremental gross margin improvements. Roughly half of it will come from gross margin, and the other half will come from operating expense. We've done a great job, as you guys saw, on improving the gross margin over the last three years, over 1,000 basis points. You know, we're not gonna see another big step function in gross margin anymore.
Kevin, R&D's at 15%, right? So we're gonna take that.
R&D is at 15, yeah. Absolutely. We get.
between sales and marketing and G&A.
Yeah.
Half, half?
Yeah, yeah. Roughly 50/50. Look, as we gain scale in the future, you know, we'll see, you know, nominal incremental improvement, hopefully in GM over time.
Look, for everyone that's listening, there's always a little variability. I mean, everybody likes to think. It's one of the first things I learned, switching sides from being on Wall Street to the other side of the house. When you're inside of a company, there's a little more variability. Like, it's not every quarter you may have an expense or a change in accounting policies. I think that those kinds of things that come naturally. Please don't make that, like, an absolute every quarter, but that's kind of the trend we're going in.
Also, don't forget, we have a little bit of seasonality.
That's true.
in our OpEx too. We do our annual pay increase, in, you know, July 1st, so our Q2, July, August, September. In Q4, each year in the U.S., that's January, February, March, we reset FICA tax withholding of the employer taxes, as well as, you know, 401 match restarts. Those are the kinds of things that affect us in Q4.
Okay. More questions from the room? We started a little late, so we'll go a few minutes over.
Oh, man. I was like, it was, like, one minute last question.
You think you're in, we stand in between this group and, like, a cocktail hour or something.
I think it's a little early for a cocktail hour.
For the $1,000.
Well, maybe. Okay.
What's in that cup?
Here is. You mentioned, Sam, that you might opportunistically buy revenue growth. The question is: what's your M&A strategy, and do you foresee industry consolidation?
All right. I think our strategy is, look, in my mind, there's two types of acquisitions. There's technology acquisitions, and there's customer revenue acquisitions. In a technology acquisition, it's a simple make versus buy decision. You can sit down with your engineering department and you say, "We're buying a set of capabilities, you know, how long would it take us? How many engineering man-hours would it take us to build that same capability?" and those kinds of things. Generally, I'm not a big fan of technology acquisitions, mainly because we're focused on the enterprise, and most technology acquisitions aren't enterprise-ready, so you end up buying it, and then you end up sort of rewriting it or whatever the case may be as you go on.
On the customer side, the customer side to me is all about acquiring recurring revenue below what you can acquire it for organically in your own sales and marketing engine. The question is, how far below is based on kind of intangibles around a couple things. Integration costs, how good is their engineering-Plan on keeping it or not keeping it, those kinds of things, right? In Fuze's case, we bought it at about 2x ARR, so below what we could acquire at in the open market, you know, through our own sales and marketing engine, and then when you adjust for integration costs or whatever, it's like 2.25 was the acquisition price, and it's turned out to be even way better than that.
You know, that's an example of where we would look opportunistically, if the stars align. I'm a very price-sensitive acquirer. In terms of industry, consolidation, I mean, honestly, I'd welcome it. You know, I'd welcome a, you know, a few less competitors on both the UC and CC side.
Look, what we did with Fuze is helpful in terms of cash flow generation, right? This really enables us to pay down our debt. If we could do that again-
Yeah.
We would.
I mean, Fuze is probably what? 25%, 30%, 35% operating margin right now.
The, uh, uh, you know, op... The contribution-
Yeah.
When you factor in everybody.
Yeah.
Yeah, it's high.
Yes.
Definitely accretive to our total.
Yeah.
For sure.
Okay, last question, unless there's anything from the room. Do you have any exposure to Silicon Valley Bank?
Uh.
In the Fuze transaction, we inherited a small banking relationship with Silicon Valley Bank. Fuze received some payments from some customers to SVB, and there's some payments that go out from SVB. We keep no cash. We keep de minimis cash there. We sweep it out regularly to our primary banking relationship we have through Wells Fargo.
Okay. All right.
All right.
Well, thanks for joining us. For those of you listening online, we'll be posting the slides later today when the archive of the webcast is available. Please feel free to reach out if you have any questions.
I think it's, there's like a one-hour check emails, network, chat with the industry analysts, do whatever you want, and then we're sort of gearing up for the closing bell ceremonies if you care to stay. After that, it's drinks on us.
Thanks, everybody.
Thank you.
Appreciate it.
Thanks, thanks for making the trip.